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Tuesday, April 20, 2021

ExplainSpeaking: Is India misrepresenting/misreading its GDP growth rate?

GDP Growth Rate of India: The jury is still out whether countries like India should replace the existing year-on-year method for calculating GDP growth rate with the quarter-on-quarter formula

Written by Udit Misra , Edited by Explained Desk | New Delhi |
Updated: March 24, 2021 8:58:11 am
Vendors sell fruit and vegetables next to trucks in the Burrabazar area of Kolkata

Dear Readers,

Over the past several years, India’s GDP (or the gross domestic product) and its growth rate have become very controversial subjects.

Partly this has to do with the growing resentment against the very concept of GDP.

As many of you know, an economy’s annual GDP is the total money value of all final (not intermediate) goods and services produced within the geographical boundaries in a year.

It can be argued — and quite justifiably — that the GDP does not really map the wellbeing of a population. It is quite possible — and is often quite likely — that even as the overall GDP goes up, economic inequalities also rise, fuelling discontent.

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But even among those who don’t exactly dismiss the use of GDP to map the performance of an economy, there are disagreements galore.

Most of them have had to do with the way GDP is calculated. For instance, in 2015, when India’s Central Statistics Office (CSO) introduced a new GDP series, it kickstarted a series of disagreements that we explained here.

But even within the group of economists who adopted the new series, there were disagreements. Thanks to the repeated and significant revisions in GDP data, several economists have questioned the official GDP data.

Now there is a new addition to the existing list of complaints. This one pertains to how we calculate the “growth rate” of GDP — it doesn’t concern the calculation of the absolute level of GDP per se.

In his opinion piece in The Indian Express, dated March 8, Jahangir Aziz, who is Chief Emerging Markets Economist at J P Morgan, has argued that the way India calculates its GDP growth rate paints an incorrect or misleading picture of the current state of economic growth.

What is the issue?

As things stand in India, when we say that the Indian economy grew by 10 per cent in a particular quarter (that is, a period of three months) what it essentially means is that the total GDP of the country in that quarter was 10 per cent more than the total GDP produced in the same quarter a year ago.

Similarly, when we say the economy contracted by 8 per cent this year what we mean to say is that the total output of the economy (as calculated by GDP) is 8 per cent less than the total output of the economy in the preceding year.

This is called the year-on-year (YoY) method of arriving at the growth rate.

But this is not the only way to arrive at a growth rate. One could have compared GDP quarter-on-quarter (QoQ) — that is, compare the GDP in the current quarter with the GDP in the preceding quarter. For that matter, theoretically speaking, if the data were available, one could calculate the growth rate month-on-month (MoM) or even week-on-week.

On the face of it, the Y-o-Y method is intuitive and takes care of the seasonal variations. For example, if agricultural production is typically low during the April-May-June quarter (because it doesn’t rain as much during this period) and typically high during the July-August-September quarter, then there is little value in comparing farm productivity growth rate between these two quarters. Doing so will just throw up massive fluctuations without adding any real insight.

But comparing farm output YoY — that is, July to September current year with July to September last year — provides a more robust and reasonable growth rate. It is a like-to-like comparison, thanks to the similarities in weather and farming conditions. The same argument of “seasonality” applies to other sectors of the economy as well and, as such, it makes sense to use the YoY method to arrive at the growth rate.

But Aziz has argued that there are very well-established statistical methods to take away the effect of seasonality from quarterly data. He has argued that once the data is deseasonalised, the growth rate arrived at by using the QoQ method presents a far more accurate picture of the economic growth rate. It is for this reason, he argues, that other large economies report QoQ growth rate.

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How much is the difference between YoY and QoQ GDP growth rate in India’s case?

The graph alongside provides a glimpse. The time corresponds to the last four quarters for which we have the latest data. This covers the four quarters of Calendar Year 2020.

India’s GDP growth rate: Headed up or down?

While it is clear that no matter how one calculates, the GDP growth rate plummeted during the April-May-June quarter in 2020.

But, as the graph shows, the story goes haywire immediately after that.

The YoY method that we use in India shows the GDP growth rate steadily improving through the next two quarters. The QoQ method, which Aziz favours, suggests that GDP growth recovered sharply in Q2FY21 but has lost steam since then.

This is not just about quibbling over the past growth rate. Depending on what growth rate one uses, the policy response could be completely different.

Aziz worries that “the year-on-year quarterly numbers will keep rising giving the false assurance of a strengthening recovery when in reality the level of income would rise only at a grinding pace”.

That is why he argues India must shift from YoY to QoQ method of calculating GDP growth rate.

So why is India allowing this apparent misrepresentation to carry on?

N R Bhanumurthy, Vice-Chancellor of Bengaluru Dr B.R. Ambedkar School of Economics (BASE), counters the claims that the QoQ method is better than the YoY method for India.

“This not a new debate,” he says. “I remember there was a similar debate a decade ago as well.”

Bhanumurthy says stable economies such as the US use the QoQ method and provide what is called the seasonally-adjusted annualised rate. [To get the annualised rate from quarterly growth data one has to multiply by four; to get it from monthly growth data, one has to multiply by 12].

“But the YoY method is better for India — especially when there is a lot of ‘noise’ between the quarters,” said Bhanumurthy.

What he refers to as “noise” or “stability” is essentially a settled seasonality. For example, in the US the holiday season — say Christmas — is predefined but in India, the festivals do not fall on the same date or even the same month each year. As such, growth rates of different economic variables tend to fluctuate far more in India.

“In the past, we have looked at the month-on-month growth rate (instead of YoY) of the Index of Industrial Production and found that one month it would grow by over 90 per cent and the very next month it would contract,” he says.

The point being that such massive fluctuations as witnessed in India tend to undermine any cogent analysis. More often than not, macro policymaking is based on medium- to long-term growth cycles rather than short-term fluctuations. The YoY method is better suited to spot such cyclical patterns, argues Bhanumurthy.

What’s the upshot?

As seen above, the calculation of growth rates is a tricky matter and can substantially alter the policy advice. This is more so for economies like India which tend to grow in fits and starts and especially during a crisis.

But it is for these reasons that, as early as June 2020, ExplainSpeaking had alerted readers that in times of severe economic shocks it is important to look at the absolute level of GDP instead of just the GDP growth rates.

We had also explained how India’s economic growth and other parameters were already rather anaemic going into the Covid pandemic and how this meant that the pace of economic recovery out of this crisis is unlikely to be quick.

Take care,

Udit

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