India’s new GDP calculations have puzzled and surprised most people, including senior officials in the finance ministry and in the RBI. India has carried out two major changes in calculation, altering both the base year and the calculation methodology.
The results are, frankly, hard to believe. The net size of the economy is reckoned to be much the same under both methods. But the new method claims that the GDP has grown much faster over the past two fiscals. This year, the GDP growth rate is set to overtake that of China, which has slowed down.
A pure “bottom-up” investor would advocate ignoring changes in GDP calculation and concentrate only on the macroeconomic data which impact stock markets, i.e., look at interest rates, inflation, housing mortgages, vehicle sales, corporate earnings, etc. But none of those data support claims of faster GDP growth.
The changes were necessary. Base years need to be updated every so often and there was a need to change to a value-added system, since that is how taxation is computed. The change of base to 2011-12 from the earlier 2004-05 makes sense. The respective contributions of various sectors to the GDP changes over time. Adjusting inflation data is also hard when inflation has been high for long periods, as in India.
Most countries update GDP base years regularly. China updates the base year once every five years. Nigeria offered another recent example of changing base. Nigeria changed its base year to 2010 in 2014, from an earlier base of 1990. The new Nigerian estimate claimed that its economy was about $509 billion in size and thus about 90 per cent larger than the $267 billion size claimed in the old estimate.
India did not declare a higher GDP in 2014-15. The new calculation claims that the economy was smaller in 2011-12 and thus higher rates of growth were registered in 2012-13, especially in 2013-14. In the first three quarters of 2014-15 as well, growth rates were considerably higher in the new calculations.
In the old method, the GDP growth was 4.7 per cent in 2013-14. The new method says that the GDP grew at 6.9 per cent in 2013-14. The previous fiscal year, 2012-13, saw growth at 4.5 per cent (old method) versus 5.1 per cent (new).
Consider 2013-14 over 2012-13. The old calculation claimed that the GDP growth in 2013-14 (4.7 per cent) was barely 0.2 per cent better than that in 2012-13 (4.5 per cent). The new figures say that growth rebounded to 6.9 per cent in 2013-14. That’s a huge difference of 2.2 per cent of GDP. It is also a massive 1.8 per cent change over the growth in 2012-13 (5.1 per cent in the new series).
The current fiscal is estimated to be registering even higher growth. In the old series, various GDP growth estimates ranged from about 5.5-6 per cent. The new series pegs growth at 7.4 per cent. The first two quarters estimates show the amazing variation.
Many sectors supposedly registered a growth rate of over 7 per cent in 2014-15. These include financial, real estate and professional services; trade, hotels, transport, communication and services related to broadcasting; public administration, defence and other services; and electricity, gas, water supply and other utilities. Growth in agriculture, forestry and fishing; mining and quarrying; construction and manufacturing is estimated to be 1.1 per cent, 2.3 per cent, 4.5 per cent and 6.8 per cent, respectively.
The problem is, these numbers don’t gel with other supporting data across the last three fiscals. We have seen prior periods such as 2003-04 to 2007-08 when the Indian economy grew at a high pace. It is not normal for an economy growing at 7 per cent or higher to exhibit a combination of slack credit demand, flat vehicle sales, low cargo and railway goods traffic, falling corporate profits, low tax collections, rising non-performing assets in the banking system, lower real estate values, flat demand for housing mortgages, lower steel prices, flat cement prices, etc.
But India has seen exactly these variations since 2012-13. The numbers cited above come from multiple sources and must be considered credible, particularly since these data gel with each other. Taken together, all these data indicate a sluggish economy, which went through a growth recession for two fiscals. The supporting evidence suggests that there has been a slow recovery through April-December 2014.
Earlier, India used an expenditure-based system of GDP accounting, where it summed up government expenditure, private consumption, private investment and net exports. Prices were taken after subtracting indirect taxes (excise taxes, sales tax) and net of subsidies.
Now, India has moved to a value-added (VA) system where indirect taxes are included. The final value of goods and transactions is taken into the GDP calculation. It is possible that there has been some spreadsheet error in calculation in the changeover. The VA system always has a high risk of double accounting. The opacity and quantity of government data makes it difficult to check for such errors from first principles.
Just for example, consider the value chain of the automobile industry. There are factories making specific components. Those components are sold to auto manufacturers and transported to their plants. Cars are then assembled, with many components put together. The vehicles are transported to dealers, who sell them, with buyers financing purchases via EMIs. At each stage, there is ‘value-addition’. This means some margin of profit for component manufacturers, for car manufacturers, for transporters, for dealers, financiers, etc.
In value-added GDP calculations, only the final value of cars should be counted at market prices. In practice, this means adding up and offsetting many costs and the re-calculation of VA at every step. It is possible that there is some inadvertent double-counting, across the vast array of goods and services, with data collected from various ministries.
In practical terms, India had to switch to a value-added (VA) GDP calculation method for several reasons. One key point is that VA gels directly with modern taxation. If you are levying taxes on the basis of value addition, you must calculate VA anyhow. So, you may as well use VA as the GDP calculation method.
Incidentally, the new VA system uses a lot of corporate data (from over 5 lakh firms) to do the calculations. So, it should eventually offer more accurate estimates. This makes the divergences even more puzzling - corporate earnings and taxes collected show a much weaker growth trend.
Another reason for a switch to VA is that this method is better at picking up value of services. Services are notoriously hard to price because these are intangible and there is enormous variation in demand and prices for different services.
One classic example is haircut. A rural barber will charge a lot less than an urban salon and an average urban salon will charge much less for the service than a fancy designer salon (even after adjusting for the different value of materials used and the quality of tools). Yet the services provided and the time taken are much the same.
Unfortunately, the government has decided to discontinue the earlier method of calculation, which could have provided some basis for comparison or helped us understand why there is such a difference in rates.
GDP data are usually revised at least twice. There is a good chance that there will be big changes in the revisions. A telltale signal is that the RBI and other institutions have not yet updated their models and started using the new data series for the GDP. Another telltale is that the stock market has entirely ignored these optimistic new numbers.
The fiscal deficit target remains the same, around 4.1 per cent of GDP, since the economy remains the same size. The demand indicators - vehicle sales, housing mortgages - are spotty, with some improvements and some disappointments. The slackness in credit demand suggests that the private sector is not in the investment mode yet.
The interest rate policy decisions will be interesting. The RBI cut policy rates in January by a token 25 basis points before the new GDP calculations were announced. At that stage, inflation was trending down and growth was also down. It looked as though the central bank would continue to cut rates. The inflation trend still appears to be down.
However, if the GDP growth rate is actually 7.4 per cent, the RBI doesn’t have an imperative to cut rates at all. In its February policy review (prior to the new series quarterly estimates being released), the RBI did reduce the statutory liquidity ratio (SLR; it is the mandatory cash and cash-equivalent government debt that every bank must hold). But RBI did not cut rates. SLR reduction encourages banks to move from buying government debt to more of commercial lending.
The RBI will probably hold off on policy changes until it can incorporate the new numbers and understand the Budget. Most investors will continue to run with the old series until there is more detail on how the new calculations are done.
The writer is an independent financial analyst.