With the latest GDP estimates surprising the market, analysts have suddenly noticed that there is such a thing as “discrepancy”. Based on this, a wide range of completely disparate conclusions are being drawn about the GDP growth. Estimates of 5 to 8 per cent are being bandied about. The hoary issue of new versus old system of the GDP measurement has again been disinterred. This article tries to clarify the new issues raised.
The GDP is estimated from the supply side by aggregating the value added in different sectors such as agriculture (agri), manufacturing (manf), electricity (elec) and construction (const). It is also estimated from the demand side by aggregating private consumption (C), government consumption (G), total investment (I) and exports (X) and subtracting imports (M). The difference between the two estimates is shown as a discrepancy (disc). Mathematically these can be represented as, Supply side estimate of GDP = Gross Value Added (agri, manf, etc) + Producer Taxes – Producer Subsidies.
Demand Side estimate of GDP= C+G + I +(X-M).
Discrepancy = GDP (demand side) – GDP (supply side).
Historically, in India, the data basis for supply side estimation has been better than the demand side estimation. As such, the discrepancy is shown in the demand side estimates. Over the past four financial years, from 2012-13 to 2015-16, the average growth of the GDP (in constant 2011-12 prices) as measured by the supply side has been 6.8 per cent per annum — that is 0.5 percentage point faster than the GDP growth measured by the demand side.
In contrast, the average growth in nominal terms is an identical 11.7 per cent from both supply and demand sides. Thus, the difference in real growth rates is entirely due to the 0.5 percentage point difference in the price deflators (or inflation): The supply side price deflator averaged 4.6 per cent during this period while the demand side deflator averaged 5.1 per cent. As the difference in the two deflators was the largest in 2015-16 — 2.6 per cent, to be precise — so was the real growth differential also the highest in 2015-16 (minus 2.4 per cent).
In 2015-16, the real GDP as measured from the demand side grew by 2.4 percentage points slower than the real GDP as measured from supply side because the deflator (or inflation) as estimated from the demand side was 2.6 percentage points higher than the deflator as measured from the supply side. Thus, a majority of the producer sectors of the Indian economy were characterised by deflation ranging from minus 1.1 per cent to minus 2.6 per cent. In contrast, the consumption demand (private and public) was characterised by inflation ranging from 3.1 to 4.5 per cent, with only investment and external trade (imports and exports) showing deflation.
For those inclined to blame everything on the change from old method to new method, the following comparison is useful: The discrepancies in current prices in the new accounts for 2011-12 were only 0.72 of the errors and omissions in the old accounts. The numbers for 2012-13 and 2013-14 were 0.08 and 0.04 respectively.
The UN-IMF system of GDP accounting was devised during a period of positive inflation when few thought 90 per cent of the world could face deflation in several parts of the economy and for periods ranging up to a year or more. In normal times, various indicators of inflation diverge and converge either on an annual basis or even on a moving average basis. This was the case in India for the wholesale price index and the different indicators of consumer price index.
Since the global financial crises, the new CPI inflation has diverged progressively from the WPI (even adjusted for different weights) inflation and shows no signs of converging. These divergences have translated into divergences in the deflators for different sectors and demand components. This methodological problem is probably most acute when an economy transitions from inflation to deflation and reverse. I would hypothesise that the inflation-deflation dynamics is likely one reason for the increasing gaps.
When we move from an annual GDP to quarterly GDP the data basis is even weaker since most of the data is available (minimum acceptable quality) only on an annual basis. Quarterly data is useful for judging the trends in different sub-components on the supply and demand side. The quarterly trends for the GDP and its components are most useful when the data for the second and third quarters of a financial year becomes available; it is least useful in the fourth quarter as the full financial year data is available. This is partly because the UN-IMF GDP methodology that we follow has technical rules for certain estimates, which are confusing even to the users.
Analysts have made too much of a deal of the GDP growth in the fourth quarter: Both the 7.9 per cent growth shown by the supply side and the 5.4 per cent growth shown by the demand side. More significantly, the quarterly data shows that during the second year of drought, private consumption maintains its slow but steady recovery while gross fixed investment remains on a downtrend with large quarterly fluctuations.
The annual data for 2015-16 confirms the estimate of 7.6 per cent GDP growth that the CSO had estimated in February. This strengthens the confidence I have in the forecast I made in March-end: One, the GDP growth in 2016-17 will accelerate to 7.8- 8.1 per cent and two, the growth will be much more evenly distributed than in the past two years with both the agricultural and the corporate sector accelerating more than the rest of the economy.