Going beyond the GDP puzzle

There is a well-known conversation between an optimist and a pessimist.  The optimist says, “Isn’t it wonderful that GDP is growing at 7 per cent? We have such a strong and resilient economy!” To which the pessimist answers, “I am afraid that’s true, my friend.”  The point being that those pessimists are not satisfied with 7 per cent, and want more. They are implicitly saying is that the best we can do?

Real GDP (adjusted for inflation) during October to December of 2016 grew at 7 percent, says the CSO. Most analysts and experts had expected a growth rate of around 6.2 per cent. That difference of 0.8 is equivalent to Rupees 1.2 lakh crore of GDP (on an annualised basis). So this is not exactly a minor difference.

The latest data released by the Central Statistical Organisation (CSO) on the GDP growth for the quarter in which we had demonetisation, has reminded us of that conversation.  Of course data has also raised eyebrows, since it turned out to be surprisingly rosy. Real GDP (adjusted for inflation) during October to December of 2016 grew at 7 percent, says the CSO. Most analysts and experts had expected a growth rate of around 6.2 per cent. That difference of 0.8 is equivalent to Rupees 1.2 lakh crore of GDP (on an annualised basis). So this is not exactly a minor difference. While it is heartening to note that the impact of demonetisation on the economy was less negative than imagined, the data nevertheless does throw up questions. There seems to be a disconnect between the macro data and micro reality.

Two examples suffice to illustrate this. The CSO data says that manufacturing growth during this quarter accelerated from 6.9 per cent during the previous quarter to 8.3 per cent. Overall, industrial growth, which includes manufacturing and mining, clocked at 9.5 per cent. How is this possible, particularly since bank credit to industry during the quarter under review actually declined by 4.3 per cent. In normal times, it grows in double digits. The Purchasing Managers’ Index for manufacturing, which captures the growth outlook was below 50 during the quarter.  It has subsequently moved up. Anything below 50 indicates contraction; above 50 is expansion. 

The CSO also says that private consumption spending growth doubled from 5.1 per cent in the previous quarters to 10.1 per cent. This is certainly head-scratching! When 86 per cent of the country’s currency was withdrawn suddenly in November, how is it possible for consumer spending to actually accelerate? Almost half of the economy is in the informal sector, which operates on cash. If cash was in shortage, were consumers using credit?  One bit of micro data shows the anomaly. Automobile sales were growing at 19 per cent during the previous quarter, and declined by 3.9 per cent during the demonetisation quarter.

There can be many such tidbits from the micro data that are in apparent conflict with macro data. We will know the full picture only when the fourth quarter data is released, and the third quarter data is revised.  It is true that government consumption spending went up substantially (possibly as an antidote to demonetisation), by 19.9 per cent. Agriculture growth also grew at 6 per cent, much higher than 3.8 per cent in the previous quarter. These two did provide some impetus to the GDP. 

It is also worth remembering that CSO changed the methodology of measuring GDP a few years ago. That new method uses data from the Ministry of Corporate Affairs (MCA) to get an estimate of industrial growth.  This data consists of profit and loss accounts filed with MCA. We can speculate whether some firms artificially inflated their invoices so as to be able to stuff their bank accounts with old (illegitimate) notes.  Only time will tell whether this happened and if it tainted the current estimates. Of course, the CSO has robust ways of cross checking but that takes time.

There is a difference between GDP and Gross Value Added (GVA). The former is equal to GVA plus indirect taxes less subsidies. Since indirect taxes during 2016-17 have grown at more than 12 per cent, and subsidies have been cut back, this could inflate GDP growth estimates. This is possible, and is also prone to overestimation if the indirect taxes are not properly deflated (to get real GDP). Excise duties, part of indirect taxes, have risen by more than 45% last year. This could be one more key to unravelling the puzzle of quarterly GDP.

India’s statistical machinery of data collection has a very long history and tradition. The CSO is a world-renowned body consisting of very able statisticians and data analysts. So the doubt is not about CSO, or even its methodology.  It’s about the inadequacy of data from India’s rather large informal sector. That picture becomes clearer only with a time lag. Maybe the next data release from CSO will lead to a downward revision, thus bridging the macro and micro disconnect.

However, going beyond the current debate, we must face the larger challenge. Last year’s GDP growth was 7.9 per cent and this year it will be 7 per cent or lower. We have lost a full percentage of growth during a year when we had a normal monsoon, declining interest rates, healthy FDI and relatively modest commodity and oil prices.

With such favourable winds, we have not been able to convert this advantage to a more robust economic growth. Beyond GDP, the numbers on job creation are dismal. Investment growth, especially from the private sector, is stagnant. The mega projects stuck because of clearances or loan delinquency are a huge backlog. The twin balance sheet problem of banks non-performing loans and heavily indebted corporations is still not resolved. We still have the challenge of skilling millions of young workers to make them ready for a rapidly changing industrial landscape. Global headwinds of more protectionism will make it harder for us to export. But exports are essential for industrial revival and robustness.

So let’s get beyond the current GDP debate and puzzle, and focus on the larger task at hand. Both the optimist and pessimist need to come together on this one!

(The writer is a senior economist based in Mumbai)