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

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


Two charts that clearly tell you why the Indian economy is not in good shape

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 

Numb and number: new GDP data can be knotty, nutty and naughty

discount-10The ministry of statistics and programme implementation released a new set of gross domestic product(GDP) numbers for this financial year on February 9, 2015. A new method has been used to calculate the GDP and as per this method, the GDP growth in the current financial year (2014-2015) will come in at 7.4%. This is significantly higher than the 5.5% growth that had been forecast by RBI earlier.
It needs to be stated upfront that revising the method of calculating GDP is par for the course as government gets access to better information and at the same time needs to take into account the changing structure of the economy.
This revision of the GDP number and in the process GDP growth has got everybody excited. Nevertheless, the new GDP number needs to be looked at very carefully. Take a look at the following table which has the nominal GDP as per the new method compared with the nominal GDP as per the old method.

YearNominal GDP
Old MethodNew Method
2011-12Rs 90.52 lakh croreRs 88.30 lakh crore
2012-13Rs 100.03 lakh croreRs 99.90 lakh crore
2013-14Rs 114.03 lakh croreRs 113.50 lakh crore
2014-15Rs 129.55 lakh croreRs 126.54 lakh crore

Source: Press information bureau and budget documents

The nominal GDP is calculated using current prices in a given year and hence, is not adjusted for inflation. As per the old method, the nominal GDP has jumped by 43.1% between 2011-2012 and 2014-2015. As per the new method, the nominal GDP has jumped by 43.3% between 2011-2012 and 2014-2015. Hence, as far as growth in nominal GDP is concerned, it is more or less the same over the last four years, using both the methods.
Let’s get a little more specific now and look at the jump in nominal GDP between 2013-2014 and 2014-2015. As per the old method the nominal GDP was expected to go up by 13.6%. As per the new method, the nominal GDP is expected to go up by 11.5%. This is slower than the growth expected through the old method. In absolute terms the difference in nominal GDP between the old method and the new method is more than Rs 3 lakh crore.
Nevertheless, the growth in real GDP in the current financial year is expected to come in at 7.4% as per the new method. As mentioned earlier RBI had forecast that the real GDP growth in the current financial year would be at 5.5%. Real GDP growth essentially takes inflation into account.
So, what explains this disconnect? The nominal GDP growth is faster as per the old method but the real GDP growth is faster as per the new method. The explanation may very well lie in what sort of GDP deflator was used to convert nominal GDP numbers into real GDP. defines the GDP deflator as: “An economic metric that accounts for inflation by converting output measured at current prices into constant-dollar GDP.” Deutsche Bank economists Taimur Baig and Kaushik Das write in a research note that: “The…nominal [GDP] growth of (11.5% year on year) and real GDP growth (7.4% year on year) estimates for FY14/15[financial year 2014-2015] imply that the GDP deflator is likely to be 4.1% for the current fiscal year.”
This is where things get interesting. Inflation as measured by the consumer price index has been falling this year, but it still hasn’t fallen to a level of 4.1%. For the month of December 2014 (the latest number available) it stood at 5%. The average inflation for the period April to December 2014 was at 6.8% (a simple average of monthly inflation numbers). As
Crisil Research points out in a research note: “The new GDP series accounts for much lower inflation than recorded by CPI-2010 base[the method currently used to calculated inflation based on the consumer price index].”
So, the question is if the inflation has been at 6.8% for the first nine months of the financial year, how can the GDP deflator be at 4.1%? (It needs to be mentioned here that inflation as measured by the GDP deflator can be different from the inflation as measured by the consumer price index given that the coverage and weights of different items differ.) But the difference between that the two numbers is fairly significant.
If we consider the deflator to be at 6.8% then the real GDP growth for this year falls to 4.7% (11.5% minus 6.8%). This number is much more closer to the 5.5% real economic growth that has been forecast by RBI. It is also in line with a lot of high frequency data that has been coming out.
In fact, for the period October to December 2014, things get even more interesting. The nominal GDP growth during this period as per the new method was at 9%. The real GDP growth was at 7.5%. This implies a deflator of 1.5%. The inflation measured by the consumer price index, during this period was around 5%. Hence, how did the deflator turn out to be 1.5%?
Given this, there are too many points in the new way of calcuating GDP that do not make sense. As Baig and Das point out: “Overall, we are unsure about how to reconcile this new data with indicators that show companies struggling with earnings and investment, banks seeing rising bad loans, credit growth slowing, and exporters reporting negative growth.” Other than this car sales have been muted, tax collections have been slow and the total number of stalled projects continues to be huge. Businesses also remained cautious about making fresh investments. As
Crisil Research points out: “India Inc remained cautious on fresh investments. While there was some pick-up in investments from -0.3% in fiscal 2013 to 3% in fiscal 2014, a large part of the rise in consumer demand was also met by utilising existing inventory.”
Numbers highlighted in the last paragraph(from slow growth in bank lending to companies struggling with earnings) are real numbers unlike the GDP which is a theoretical construct. And these numbers do not reflect in any way a GDP growth of 7.4%, given the inflation level of 6.8% during the course of this financial year.
So what possibly explains this jump in growth? A possible explanation, as highlighted earlier, is that the inflation that has been considered to arrive at real GDP numbers is much lower than the prevailing inflation as measured by the consumer price index.
Further, on February 12, the ministry of statistics and programme implementation is going to release a new method of calculating inflation based on the consumer price index. If the new inflation number turns out to be considerably lower than the numbers that have been released during the course of this year, then we will have a possible explanation for this jump in GDP growth. If it does not we will have to look somewhere else.
To conclude it is worth remembering what the American professor Aaron Levenstein once said: “Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital.” (And no Navjot Singh Sidhu did not say this).

(The column originally appeared on as a part of The Daily Reckoning as on Feb 11, 2015)