On 29 May 2015, the Ministry of Statistics and Programme Implementation (Mospi) released figures for gross domestic product (GDP) growth last year. The GDP is a measure of the size of an economy. According to this data, the Indian GDP grew by 7.3 percent during 2014-15.
This perky number is the result of a new method of calculating GDP. In January 2015, Mospi, using this new method of projecting growth, had projected a growth of 7.4 percent for 2014-15. Before this number came out, the growth projected by the RBI was at 5.5 percent. The GDP growth finally came in at 7.3 percent.
Not many people believe this higher number given that real economic data like car sales, bank lending, exports, and corporate profits have all been pretty dull. And GDP ultimately is a theoretical construct unlike the real data.
In fact, RBI Governor Raghuram Rajan, in the interaction he had with the media after presenting the monetary policy on 2 June, said: “In the eyes of the rest of the world, it is a discrepancy why we feel the need for rate cuts when the economy is growing at 7.5 percent. Most economies growing at 7-7.5 percent are just going gang-busters and the issue there would be to restrain rather than accelerate growth.”
The answer lies in the fact that there is something not quite right about the GDP growth number. As Rajan put it: “We still have very weak investment. Corporate results, even after adjusting for slow inflation, have been quite weak, suggesting that demand is yet to pick up strongly…Even with the 7.5 percent growth number, there is some discussion of how much that includes special factors in the last quarter, including excise taxes and subsidies. When you subtract that, the growth in the last quarter does not look as strong.”
In fact, Rajan’s argument can be taken further by looking at the accompanying chart 1.
This chart essentially maps the nominal GDP growth as per the old method as well as the new method. Nominal GDP is essentially GDP growth which has not been adjusted for inflation. The blue curve shows GDP growth using the old method whereas the red curve shows GDP growth as per the new method. The data for the GDP growth as per the new method is available only for the last few years.
While, there may be a lot of debate around the validity of the new method of calculating GDP, what it clearly shows is that nominal GDP growth has been falling for a while. In fact, the red and the blue curves almost go hand in hand over the last few years.
As Anindya Banerjee of Kotak Securities puts it: “Though the real GDP growth has created quite a bit of controversy, it’s the nominal growth picture which has immense information value. There is continuity between the old series and the new series and they together are pointing towards the weak state of the economy.”
Now take a look at chart 2 which shows corporate profits expressed as a proportion of GDP. In the last financial year they stood at 4.3 percent of the GDP, which was a 10-year low.
As Banerjee, who brought these charts to my notice, puts it: “Nominal GDP, which portrays both real growth as well as inflation in the economy, has a strong correlation with the taxes that government earns, the earnings of corporates and hence the price multiples that the equity markets enjoy. A decadal low in the nominal GDP is in line with the decadal low witnessed in corporate profit growth or share of corporate profits in GDP. Corporate profits as a share of GDP is at lowest level seen at least since FY04, at 4.3 percent.”
These two charts clearly tell us that the Indian economy is not in a good shape, despite wherever the real GDP growth number might be. It will be difficult for the government to spend its way out of trouble simply because it won’t earn enough taxes to do that. If it wants to spend more and pump prime the economy then it will have to borrow more and in the process compromise on fiscal discipline. The government borrowing more will also push up interest rates and that will have its own share of repercussions.
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)
The column originally appeared on The Daily Reckoning on June 9, 2015