Month: December 2015

What the media did not tell you about the economic growth number

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In yesterday’s column I had explained why the gross domestic product (GDP) growth number of 7.4% is more of a statistical quirk. The GDP is essentially the measure of the size of an economy.

The coverage of the GDP news in the media talked about the 7.4% economic growth, without really getting into the details of how that number was arrived at. The GDP growth of 7.4% that everyone from the politicians to the media seem to be talking about is essentially the real GDP growth.

Neither the media nor the economists and the politicians talked about the nominal GDP, which came in at 6%. The nominal GDP is calculated at the current price levels. Once this is adjusted for the prevailing inflation, we arrive at the real GDP.

Hence, nominal GDP growth minus inflation equals the real GDP growth. In this case, the nominal GDP growth came in at 6% and was lower than the real GDP growth of 7.4%. This meant that the inflation was negative. The inflation in this case is referred to as GDP deflator and came in at – 1.4%.

This as I had explained yesterday is because the GDP deflator is a sort of a combination of inflation as measured by the consumer price index and inflation as measured by the wholesale price index. The wholesale price index has been in negative territory for some time now. And this has led the GDP deflator into negative territory as well. Hence, the deflator instead of deflating the nominal GDP number is inflating it.

This is a point that the experts and the media missed out on. There was another important point that the media missed out on and was brought to my notice by Anindya Banerjee, Analyst, Kotak Securities, FX and interest rate desk.

Nominal GDP Growth

Earlier this year, the ministry of statistics and programme implementation moved to a new way of measuring the gross domestic product. They also produced some backdated data for the last few years. The red curve shows the nominal GDP growth rate as per the new method of calculating the GDP. The blue curve, on the other hand, shows the GDP growth as per the old method of calculating the GDP.

What the table clearly tells us is that the nominal GDP growth has collapsed. In fact, as the table clearly shows the nominal GDP growth has never been as low as it is now, in the last ten years. I know I am committing a sin here by mixing data from two different GDP series but the trend has been clearly downward. And this is a reason to worry.

As I had mentioned in yesterday’s column, negative wholesale price inflation has had a huge role to play in inflating the economic growth number. India is seeing a negative wholesale price inflation because of several reasons. Commodity prices have crashed and that is the good bit, because we import a huge amount of important commodities like oil.

On the flip side, negative wholesale price inflation is also a reflection of weak industrial and consumer demand, low capacity utilisation by factories as well as low private investment and falling exports.

These factors are a negative for the economy. But they have ended up adding to the calculation of the GDP in a positive way. The negative wholesale price inflation has led to a negative GDP deflator which has in turn inflated the real GDP growth number. And this has meant that even though the real GDP growth number is strong, the economic growth doesn’t really seem strong.

What all this tells us is that for economic growth to really recover, the nominal GDP number needs to start to move up. Also, it is worth highlighting here that nominal growth really matters.

Corporate earnings are not adjusted for inflation through the GDP deflator. Neither are wages given by companies both private and government, as well as entrepreneurs. And this has an impact on the psychology of private consumption. The corporate earnings for the period of three months between July and September 2015 grew by less than 1%. In this scenario wage increments will be low.

Let’s say the companies are generous and give around 3% wage increments to their employees in the coming year. The employee will look at it as a 3% increment in wages, which is not huge. He will not look at it as a 7.5% ‘real’ increase in wages (3% nominal wages minus the wholesale price inflation of around – 4.5%). This tendency to look at money in nominal rather than real terms is referred to as the money illusion. Given this, higher wages will not lead to a higher consumption.

The government revenue and the fiscal deficit are not adjusted for inflation either. Also, the fiscal deficit of the government is expressed as a percentage of nominal GDP and not real GDP. Fiscal deficit is the difference between what a government earns and what it spends. Let’s take a closer look at the fiscal deficit number projected by the government for the current financial year, 2015-2016. The fiscal deficit has been projected at Rs 5,55,649 crore or 3.9% of the GDP.

The GDP has been assumed to be at Rs 14,108,945 crore for 2015-2016. The GDP under consideration is nominal GDP. The nominal GDP number for 2015-2016 was arrived at by assuming a growth of 11.5% over the nominal GDP number for 2014-2015.

The nominal GDP growth number between April and June 2015 had stood at 8.8%. Between July and September 2015 it came in at 6%. Hence, for the six months of this financial year, the nominal GDP growth has been nowhere near the assumed 11.5%.

Let’s assume that the nominal GDP growth improves during the second half of the year, and the final nominal GDP growth number comes in at 9%. What happens to the fiscal deficit? Assuming the absolute fiscal deficit stays the same, the fiscal deficit as a proportion of the GDP will cross 4%, against the targeted 3.9%. In order to ensure that this does not happen, the government will have to cut down on its expenditure. In an economy where private expenditure and investment is slow that is not the best thing that can happen.

Further, the government wants to reduce the fiscal deficit to 3% of the GDP by 2017-2018. For that to happen, the nominal GDP has to start to go up at a higher rate. It also needs to be pointed out here that the Raghuram Rajan, the governor of the Reserve Bank of India, in the latest monetary policy statement said that he expects the government to continue maintaining the fiscal deficit in the years to come, despite the increased expenditure due to the implantation of the recommendations of the Seventh Pay Commission.

The column was originally published on December 3, 2015 on The Daily Reckoning

The economic growth of 7.4% needs to be taken with a pinch of salt

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The ministry of statistics and programme implementation published the gross domestic product (GDP) data for India for the period July and September 2015, a couple of days back. The GDP, a measure of the size of the economy, grew by 7.4% during the period in comparison to the same period in 2014.

If we just look at this number then we have to conclude that the Indian economy is doing fabulously well. But other economic data clearly suggests otherwise.

The exports have been going down for the last 11 months.

The corporate earnings for the three months ending September 2015 saw a growth of less than 1%.

The real estate sector is down in the dumps.

The loan growth of banks has been in single digits for some time now.

The bad loans of banks continue to grow.

Two wheeler and tractor sales, a reflection of rural demand, fell during the first six months of the year.

The vehicle sales, a good reflection of urban demand, grew at a very low rate during the first six months of the year.

The number of stalled industrial projects continue to grow.

The factories are running 30% below capacity.

And India has seen two deficient monsoons in a row.

So how is the economy still growing at 7.4%? The answer might very well lie in the way the GDP growth is calculated. The 7.4% economic growth that we are talking about here and which the economists, politicians and regulators also talk about, is essentially the real GDP growth. The real GDP growth is obtained by subtracting inflation from nominal GDP growth.

For example, if the nominal GDP growth is 11% and the inflation is 4%, then the real GDP growth is 7%, to put it in a very simple way. This is essentially done to ensure that the GDP numbers across different periods of time are comparable, by removing the inflation component from the growth numbers.

The inflation number used in this case is referred to as the GDP deflator and it deflates the nominal GDP growth to the real GDP growth. As the Chief Economic Adviser Arvind Subramanian said in a recent interview to a television channel: “They actually only measure the wholesale and consumer prices, the GDP deflator is just constructed.” The GDP deflator typically falls between the inflation measured by the wholesale price index and inflation as measured by the consumer price index. Also, given that it is a combination of both the consumer price index and the wholesale price index, it is the most broad based measure of inflation.

During the period July to September 2015, the nominal growth came in at 6%. The GDP deflator on the other hand was at − 1.4%. This was primarily because inflation as measured by the wholesale price index number has been in negative territory for a while now. For the months of July, August and September, it stood at −4.05%, −4.95% and −4.54%, respectively.

The consumer price inflation on the other hand stood at 3.78%, 3.66% and 4.41%, respectively. Given that, the GDP deflator falls somewhere in between the inflation as measured by the consumer price index and the inflation as measured by the wholesale price index, it was at −1.4%.

Real GDP as explained earlier is obtained by subtraction the GDP deflator from the nominal GDP. And this led to a real GDP growth of 7.4% (6% − (−1.4%). Given that the GDP deflator was in negative territory, instead of deflating the nominal GDP number, it has ended up inflating it. And this explains how an economic growth rate of 7.4% has been arrived at.

The question that crops up here is why has inflation as measured by the wholesale price index been in the negative territory? One reason for this has been a fall in commodity prices, which has benefited the Indian economy. India is a huge importer of commodities like oil. On the flip side, a fall in exports, stagnant consumer and industrial demand, low private investment, etc., are also reasons of falling inflation as measured by the wholesale price index.

Over and above this, the Reserve Bank of India governor, Raghuram Rajan recently talked about the capacity utilisation of the factories being at 70%. This has been falling from levels of over 75% in January to March 2013. This suggests a significant slack in the economy. And it means that businesses really do not have pricing power. This is reflected in the more or less flat corporate earnings.

All these reasons have led to a negative inflation number as measured by the wholesale price index. This negative number has led to a negative GDP deflator and that in turn has led to an inflated real GDP number.

In simple English many economic factors which are negative for the economy have ultimately ended up becoming positive for the real GDP number. That’s the long and short of it and perhaps explains why the economy is “supposedly” growing by 7.4%, even though all real economic indicators suggests otherwise.

Further, economists Pranjul Bhandari and Prithviraj Srinivas economists at HSBC Securities and Capital Markets India, have raised some doubt regarding the reliability of the GDP deflator. As they write in a research note: “Nominal GDP…grew at a much slower clip than real GDP…implying that deflators have fallen sharply into the negative territory. Parsing through details throws up more questions than answers. We find that growth in services deflator, which is infamous for high and sticky prices, was actually running below the industry deflator. This is odd because manufacturing and industry at large should be the prime beneficiaries of falling commodity prices and as such should run below services (which is largely non-tradable) inflation.”

What they mean here is that the inflation in services was higher than inflation in manufacturing. This seems odd given that manufacturing should have benefited more because of falling commodity prices.

Due to this anomaly the HSBC economists suggest that the “real growth is lower than the headline reading suggests.”

The column originally appeared on The Daily Reckoning on Dec 2, 2015

 

In the media, if it bleeds, it leads

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I am a big fan of the British-American writer Bill Bryson. And I think it’s unfair that he tends to get categorised as a travel writer. He is much more than that, though it is very difficult to categorise him. His latest book is called The Road to Little Dribbling—More Notes From a Small Island. In this book, one of the things that Bryson talks about is the uniquely British phenomenon of attacks by cows on human beings, making national news.

As he writes: “In America, cow trampling would never make the national news other than in highly exceptional circumstances. If, let’s say, Dick Cheney was trampled to death by cows (and we can always dream), that would be national news.” But the same is clearly not true about Great Britan.

“In Britain if a single cow tramples a walker anywhere in the country, it will almost certainly make national headlines,” writes Bryson.
Cow attacks on human beings are pretty rare. But the surfeit of news in the British media about cow attacks, leads the British to believe that cow attacks are very common in Britain. This belief comes from reading about the attacks in the media at regular points of time.

Economists and psychologists refer to this tendency as an availability bias. As Leonard Mlodinow writes in The Drunkard’s Walk—How Randomness Rules Our Lives: “In reconstructing the past, we give unwarranted importance to memories that are most vivid and hence most available for retrieval. The nasty thing about the availability bias is that it insidiously distorts our views of the word by distorting our perception of past events and our environment.”

Air-crashes are an excellent example of this. As Jason Zweig writes in The Devil’s Financial Dictionary: “Flying is among the safest ways to travel, but on the rare occasions when an airplane does crash, the fireball on the runway is broadcast worldwide and burned into the brain of everyone who sees it.”

This leads people to believe that airplane travel is unsafe. But what they don’t realise is that the media does not report about the thousands of planes that land safely every day all over the world. It also does not report the many car crashes that happen all over the world every day, unless a celebrity is involved.

The same logic works in case of a stock market. Every big fall is reported on the front pages of newspapers and by the other media. As Zweig writes: “Market crashes are rare, too, but the spectacular damage they cause is also seared into the collective unconscious. That leads many investors to miss out on the gains stocks can generate during the surprisingly long periods between crashes.” Like safe airplane landings, the media does not report the small gains (or losses) that add up, over a period of time.

Further, the advent of cable TV has brought war into our drawing rooms. But is the world more unsafe that it was let’s say 70 years back or 100 years back or may be even 500 years back? The feeling that the world has become more unsafe than it was in the past, is another excellent example of the availability bias.

As Steven Pinker writes in an essay titled A History of Violence: “Several historians have suggested that there has been an increase in the number of recorded wars across the centuries to the present, but, as political scientist James Payne has noted, this may show only that “the Associated Press is a more comprehensive source of information about battles around the world than were sixteenth century monks.” Associated Press is a wire news agency, which reports from all over the world.

This is not to suggest that the world is a totally safe place and that wars have come to an end. Nevertheless, things are not as bad as they seem to be.
To conclude, dear reader, when you are reading a newspaper or a digital publication, it is always worth remembering that old saying in journalism: “If it bleeds, it leads.”

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared in the Bangalore Mirror dated December 2, 2015

11 reasons why India growing at 7.4% is simply not believable

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Data released by the ministry of statistics and programme implementation shows that India’s gross domestic product (GDP), a measure of the size of the economy, grew by 7.4% during the period between July to September 2015. These are fantastic numbers in a world where real economic growth is slowing down. Even China is finding it tough to grow at rates that it did in the past.

So what is driving India’s economy? Manufacturing grew by a 9.3%. Trade, hotel, transport, communication & services related to broadcasting grew by 10.6%.

And financial, insurance, real estate and professional services grew by 9.7%. These three segments which formed 62.6% of the total economy between July to September 2014, helped the economy grow by 7.4%. Agricultural, forestry and fishing grew by just 2.2%.

The question is how believable is this growth of 7.4%? The short answer is—not very. It is worth mentioning here that GDP is ultimately a theoretical construct.

Most real economic numbers suggest otherwise.

Let’s take a look at them one by one.

1) Exports have been falling eleven months in a row. In fact, between April and October 2015, exports have fallen by 17.6% to $154.29 billion, in comparison to the same period last year. Between April and October 2014, the exports had stood at $187.29 billion. A greater than 7% economic growth rate with falling exports is a little difficult to believe.

2) Corporate profitability continues to remain subdued. As a recent news-report in the Business Standard points out regarding the profitability for the period July to September 2015: “It was another muted quarter for India Inc, with aggregate profit growth at both the operating and net level growing at only under one per cent over a year-ago period. The sample is of 2,300 companies…The numbers are worse for the benchmark indices such as the Nifty, where operating and net profit are down between three-five per cent over the year-ago quarter, with aggregate numbers below expectations.”

3) Passenger vehicles sales, another good measure of economic recovery, have been subdued through most of this financial year, though there has been some recovery in October 2015, which doesn’t come under the July to September 2015 period, for which the economic growth number has been reported. Between September 2015 and September 2014, passenger vehicles sales went up by only 3.85%.

4) Motorcycle sales, a very good economic indicator in the Indian context, have fallen for most of the financial year, only to have recovered a little in October due to festival season sales. It remains to be seen whether the sales can be sustained for November 2015. Data from the Society of Indian Automobile Manufacturers (Siam) points out that motorcycle sales during the first six months of the year (April to September 2015) were down by 4.06% to 5.36 million units, in comparison to the same period last year.

5) Tractor sales have been falling for thirteen months in a row. Data from the Tractor Manufacturers Association shows that sales have fallen by 20% during the first six months of this financial year (i.e. April to September 2015). This is a clear example of weak agricultural growth.

6) The loan growth of banks continues to remain subdued. The sectoral deployment of credit data released by the Reserve Bank of India (RBI) shows that bank loans grew by 8.4% between September 2014 and September 2015. In fact, they grew by an even slower 8.1% between October 2014 and October 2015.

7) Along with this, the bad loans of banks continue to pile up. As a recent report in The Indian Express points out: “Already burdened by bad loans, 37 banks, led by public sector ones, have reported a 26.8 per cent rise in non-performing assets (NPAs) over the 12-month period ending September this year.”
The overall non-performing assets of banks as of September 2015 stood at Rs 3,36,685 crore. This was an increase of Rs 71,000 crore, according to numbers put together by credit rating firm CARE.

8) The number of stalled industrial projects went up during the period July to September 2015. As a recent research note by Morgan Stanley points out: “The stock of stalled projects climbed in the September quarter, while existing capacity is being underutilized. This has, not surprisingly, lowered interest in greenfield investments, with industrial credit loan growth stagnating in single-digits.” The bulk of the stalled projects belong to the manufacturing and infrastructure sectors. Further, there is a good anecdotal evidence to suggest that small and medium enterprises, a major source of job growth, continue to struggle.

9) The Reserve Bank of India governor Raghuram Rajan recently pointed out that factories were running 30% below capacity as of now. A research report by DBS points out that the capacity utilisation rate was at 80% in 2011-2012. This suggests a significant slack in the economy. How is manufacturing then growing by 9%, as suggested by the data released by the ministry of statistics and programme implementation?

10) The real estate sector, a major employer of people, continues to be in the doldrums, with new launches coming down and the number of unsold homes going up.

11) Further, for two years in a row India has had a deficient monsoon. In its end of season report, the India Meteorological Department (IMD), the nation’s weather forecaster, stated that “rainfall over the country as a whole was 86% of its long period average (LPA). Thus years 2014 & 2015 was the fourth case of two consecutive all India deficient monsoon years during the last 115 years.”

IMD uses rainfall data for the last 50 years to come up with the long period average. If the rainfall is between 96% and 104% of the 50 year average, then it is categorised as normal. If it is between 90% and 96% of the 50 year average is categorised as below-normal. And anything below 90% is categorised as deficient.

If something has happened only four times in 115 years, there is clearly reason to worry, given that nearly half of India’s population is dependent on agriculture. Also, this has clearly slowed down consumer demand in much of rural India.

On the positive side a lot has been written on the 36% jump in indirect tax collections. This has been offered as an example of a revival in economic activity.

Nevertheless, much of this huge jump has come from the government increasing the excise duty on petrol and diesel and capturing much of the fall in oil prices. Excise duty collections have jumped by 68.6% during the course of this financial year.

In fact as a recent ministry of finance press release points out: “These collections reflect in part increase due to additional measures taken by the Government from time to time, including the excise increases on diesel and petrol, the increase in clean energy cess, the withdrawal of exemptions for motor vehicles, capital goods and consumer durables, and from June 2015, the increase in Service Tax rates from 12.36% to 14%. However, stripped of all these additional measures, indirect tax collections increased by 11.6% during April-October 2015 as compared to April-October 2014.”

As the Chief Economic Adviser Arvind Subramanian recently said in an interview: “Even if you take away all the new things, new taxes have been added, that number[indirect taxes number] is growing at a robust about 11.5 -12% and if that number is right, that means that the underlined economy is recovering.”

There are few other data points on the positive side. The commercial vehicle sales have been robust during the first six months of the financial year. At the same time consumption of petroleum products has also gone up by 8.5% between April and Septmber 2015.

While the underlying economy might be recovering, it is very difficult to believe that it is growing at 7.4%. In fact, Subramanian and Rajan suggested the same in a very roundabout sort of way in a recent joint interview to a television channel.

To conclude, once you take all the factors I have listed above into account, the economic growth (or GDP growth) number of 7.4%, doesn’t look believable at all.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

(The column was originally published on Firstpost on December 1, 2015)

Why high dal prices are not enough to increase production

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In response to yesterday’s column a reader on the social media concluded that it is obvious that farmers should grow tur dal which is priced at Rs 200 per kg, in comparison to sugar which is selling at a much lower price. He further said that businesses which tend to enjoy pricing power tend to do well.

Only if it were as simple as that. This is the classic, interest rate cut will lead to increased consumption, kind of economic theory—it doesn’t always work. In fact, in order to encourage farmers to plant more dal (pulses) the government in early November announced a significant increase in the minimum support price of gram and masur dal.

The minimum support price of gram was increased by Rs 250 to Rs 3425 per quintal (i.e. 100 kgs). The minimum support price of masur was increased by Rs 250 to Rs 3325 per quintal. Over and above this, a bonus of Rs 75 per quintal has also been announced.

Does this increase in minimum support price and a bonus to top it, mean that farmers will now automatically plant more dal in the rabi season, which is currently on. The government clearly thinks so. As the press release announcing the increase in minimum support prices (MSPs) pointed out: “The higher MSPs would increase investment and production through assured remunerative prices to farmers.”

In a world of lower interest rates leading to increased consumption kind of economics, this would have made perfect sense. The trouble is do farmers know about the government offering a minimum support price on dal? The Commission for Agricultural Costs and Prices (CACP), a part of the ministry of agriculture, suggests otherwise.

As the report titled Price Policy for Kharif Crops—The Marketing Season of 2015-2016 points out: “Two most important procurement agencies of the Government of India namely Food Corporation of India (FCI) and National Agricultural Cooperative Marketing Federation of India Limited (Nafed) were set up with the main objectives of procuring notified commodities at MSP, if and when the market prices go below MSP. These agencies have been in the existence for over 50 years and 30 years respectively. Yet, the benefits of MSP bypass a large section of farmers, rendering the pricing policy and procurement operations ineffective. As per Situation Assessment Survey (NSS 70th Round), only 2.57 million households were benefitted directly from procurement of paddy during 2012. The procurement of oilseeds and pulses is far worse.”

So the question is do the farmers know about these price signals being sent out by the government? And the answer is no. In fact, as can be seen from the accompanying table in 2014-2015, the Nafed barely picked up any tur, moong or urad dal.

Table: Procurement of Pulses by Nafed.

Nafed picked up 1543 tonnes of tur dal in 2014-2015. The total production of tur dal in 2014-2015 was around 2.78 million tonnes. The total production in 2013-2014 had stood at 3.34 million tonnes. What this tells us is that unlike rice and wheat, the government agencies are picking up very little of dal directly from the farmers at the minimum support price.

The fact that the government picks up rice and wheat and does not pick up dal has distorted the entire production process of dal. What does not help is that the average farmer has faced losses.

As a recent news-report in The Economic Times points out: “According to an analysis done by the scientists of the Mahatma Phule Krishi Vidyapeeth (Agricultural University), Rahuri, farmers who grew tur in 2014, suffered losses of 12.7 per cent.”

The news-report then goes on to suggest that most farmers had to sell the tur dal they had produced at below MSP in 2013 and 2012. And this explains why the production of tur dal fell from 3.34 million tonnes in 2013-2014 to 2.78 million tonnes in 2014-2015. What this also tells us is that high prices are not leading to increased gains for farmers, and it is the middle men who are gaining the most.

 

Imports are not a solution because the global market for dal is very thin. As the report titled Price Policy for Rabi Crops—The Marketing Season of 2016-2017 points out: “As per Food and Agricultural Organization (FAO), the total global production of pulses was 72.3 million tonnes in 2013, out of which about 19% is traded. India is the largest producer of pulses in the world with a share of 24.3 percent…India is the largest importer with a share of 27.3%.”

In fact, India’s import of pulses has gone up dramatically from 13.4 lakh tonnes in 2004-2005 to around 45.7 lakh tonnes in 2014-2015. Further any more jumps in imports will only lead to an increase in prices of dal. So what is the way out?

The farmers first and foremost need to be aware that there is something known as a minimum support price. As the report titled Price Policy for Kharif Crops—The Marketing Season of 2015-2016 points out: “This calls for giving wide publicity about MSP and procurement agencies on radios, television and vernacular languages in popular local dailies, at least 15 days before the start of procurement operations so as to reach farmers far and wide.”

Second, given that state agencies are procuring rice and wheat, they need to procure dal as well, in order to balance things out.  As the report titled Price Policy for Kharif Crops—The Marketing Season of 2015-2016 points out: “A pertinent question arises as to why farmers are not wholeheartedly diversifying towards oilseeds and pulses. Based on CACP’s interaction with a wide spectrum of farmers and also based on field visits, it emerged that farmers need a backup plan in the form of reasonably strong procurement machinery to be put in place to fall back upon when the prices fall below minimum support price.”

As the press release announcing an increase in the minimum support price of Rabi crops pointed out: “The Cabinet also directed that in order to strengthen the procurement mechanism for pulses and oilseeds, Food Corporation of India (FCI) will be the Central Nodal Agency for procurement of pulses and oilseeds.”

Let’s see how much impact this move has. In an ideal world, the market should do its own thing, but in this case government intervention seems to be the best way out, at least in the short-term.

(The column originally appeared on The Daily Reckoning on Dec 1, 2015)