Finally, an Economist Explains Why the Indian GDP Growth Number Is Wrong



I was just joking to a friend the other day that if economists started writing their stuff in simple English, which everybody can understand, guys like me who make a living out of translating what economists think and write, into simple English, would be driven out of the business very quickly.

The question is why do economists write the way they do? As John Lanchester writes in How to Speak Money: “As your vocabulary becomes more specific, more useful, more effective, it also becomes more exclusive. You are talking to a smaller audience…There are a lot of things like that in the world of money, where the explanation is hard to hold on to because it compresses a whole sequence of explanations into a phrase, or even just into a single word.” This is precisely what happens when economists write, or talk for that matter.

Nevertheless, given the chances of economists writing in simple English are low, I guess I am likely to continue to be in business.

Moving forward, in this piece I wanted to look at a column which was recently published in the Mint newspaper. The column is titled Real GDP is growing at 5%, not 7.1% and has been written by economist Rajeswari Sengupta.

I think the column makes a very important point. Nevertheless, my only quibble with it is that it has not been written in simple English. An idea as important as this column communicates needs to reach a wider audience and not just other economists.

So what is the core idea of the Mint column? As Sengupta writes: “Are our gross domestic product (GDP) numbers credible? Many commentators have expressed their doubts. But no one has yet identified problems with the Central Statistical Organisation’s (CSO) methodology. This is because they have been looking in the wrong place.”

Sengupta essentially goes on to explain what is wrong with the Indian GDP growth numbers.

In January 2015, the CSO moved to a new way of calculating the GDP. The GDP is a measure of all goods and services produced within a country. It is a measure of the economic size of any country. And GDP growth is essentially a measure of economic growth.

After the CSO last January unveiled the new way of calculating the GDP, the Indian GDP numbers suddenly started to look better. The GDP growth as per the old method had stood at around 5%. With the new method, the GDP growth suddenly crossed 7%.

The CSO estimates that in 2015-2016 (the current financial year) the Indian economy is likely to grow at the rate of 7.6%. It is important to understand that the GDP is a theoretical construct. There are many high frequency economic data indicators which tell us very clearly that there is no way that the country is growing at the rate at which the CSO wants us to believe it is.

Exports are down. Two wheeler sales growth has been fairly insipid. Railway freight growth has been very slow. Bad loans of banks are rising at a fairly rapid rate and their lending growth has been very slow. Corporate earnings growth has been terrible.

Given these reasons, how can the GDP possibly grow at 7.6% during this financial year, is a question worth asking.

Sengupta in her column explains what is wrong with the GDP growth number of 7.6%. As she writes: “The problem is not, as many have suspected, in the nominal numbers. It lies in the system for constructing the deflators. This methodology is flawed, yielding exaggerated estimates of the speed at which the economy is growing.

Let me explain this mumbo jumbo in simple English. The GDP growth number of 7.6% is essentially what economists call the real GDP growth. The real GDP growth is essentially GDP growth which has been adjusted for inflation. The nominal GDP is the GDP growth which hasn’t been adjusted for inflation.

Hence, real GDP growth is essentially nominal GDP growth minus the prevailing rate of inflation. So far so good.

Now Sengupta talks about something known as a deflator in her column. What is a deflator? Lanchester defines a deflator in his book as “the number you use when working out the value of money minus the effect of inflation.”

In Sengupta’s case, she is talking about what economists refer to as the GDP deflator, which is nothing but the rate of inflation used to come up with the real GDP growth number from the nominal GDP growth number.

The real GDP growth number is essentially the nominal GDP growth number minus the GDP deflator. Let’s understand this through an example. Let’s say the nominal GDP growth is 10%. The GDP deflator is at 3%. Then the real GDP growth is 7% (10% minus 3%). If the GDP deflator is 1%, then the real GDP growth is 9% (10% minus 1%). That is how it works

What is the problem with the GDP growth number? As Sengupta puts it: “The real numbers are derived by taking nominal data on the economy and deflating them by price indices. So, if inflation is understated, then real growth is going to be overstated. And this is what has been happening.”

Hence, the CSO seems to be using a lower GDP deflator to arrive at the real GDP growth number. This has led to a higher real GDP growth number, which seems unreal.

And this is precisely where the problem lies. If we look at the nominal growth number for the period October to December 2015, it stands at 7.9%. A deflator of 0.7% meant that the real growth came in at 7.1%. (The number should be 7.2% if we follow what I explained earlier, but there must be some rounding off errors here).

Sengupta’s contention is that the CSO is understating the GDP deflator at 0.7% and the number should be higher than this. As she writes: “Could India’s inflation be so low? In effect, the CSO is saying that despite India’s booming economy, producer inflation is lower than that of the recession-wracked economies of the West, or even that of Japan, which has been wrestling with deflation since the 1990s.

This underestimation is happening primarily because the calculation of the GDP deflator closely tracks the inflation as measured by the wholesale price index, which has been in negative territory for some time now (16 months to be precise).

This explains why CSO feels that the Indian economic growth in 2015-2016 will be at 7.6%, even though the high speed economic indicators indicate otherwise. Sengupta shows that by using the right GDP deflator, the real GDP growth cannot be possibly more than 5%. And that is precisely the point I have been making over the last few months.

The column originally appeared on The 5 Minute Wrapup on Equitymaster on March 18, 2016

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

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

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


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)