Breaking news: The GDP debate has now shifted to whether the GDP deflator is accurate or not. For more than a year now, there has been deep questioning about the reliability of the Indian GDP data after the “new” estimates were presented in January 2015. Of late, perhaps after noting that this was a losing cause (also see my article, ‘GDP Debate: RIP’, The Indian Express, April 23), the GDP sceptics have turned their criticism towards the possibility that the GDP price index (also called the deflator) is understating inflation. Since the real GDP growth is the difference between the nominal growth and the deflator (inflation), the intended outcome of the investigation is the same, that is, the GDP growth in India is overstated — back to square one.
The main contention is that the GDP deflator is flawed because of its heavy reliance on the wholesale price index (WPI). This questioning of the GDP deflator was started by the RBI in their September 2015 monetary policy report: “This (WPI) tends to overstate the extent of price decline in the GDP deflator when WPI is in deflation”. In its very recent report on India, the IMF regurgitates the RBI conclusion.
The following two quotes from prominent Western experts — The Economist (‘India’s GDP Data: The Elephant in the Stats’, April 9) and the Wall Street Journal (‘On close inspection, India’s sharp growth picture gets fuzzy’, May 1) — confirms the authoritative Western seal that Indian GDP growth is overstated, and maybe by as much as 250 basis points for 2015-16. That is, instead of being 7.6 per cent, it “likely” to be close to 5 per cent. In other words, there has been no improvement in the economy since Narendra Modi, and the BJP, won the election in May 2014.
So you get the picture: Indian GDP is low, because deflator is underestimated, while the real indicator of inflation in the economy, the consumer price index (CPI), is rising at around 5 per cent.
What if, and I know it is heretic to say so, the authorities (and journalist experts) have got the CPI inflation estimate wrong? There is considerable evidence that this is the case, and not by a small amount either. The CPI inflation in India, correctly measured, is running at a 3.8 per cent rate rather than the official 4.9 per cent rate.
The CPI is based on price surveys conducted every month. There is no problem with the CPI data on prices but it has got the expenditure weights wrong. These weights are obtained from the National Sample Survey of Consumer Expenditures, 2011-12. Unfortunately, the NSS surveys have strangely and mysteriously been under-estimating the average per capita consumption for three decades now.
To make the point of flawed weights clearer, according to the NSS, a typical Indian consumer spends 46 per cent of her monthly expenditure on food and beverages; 3.7 per cent on household goods and services, 8.6 per cent on transport and communication and zero per cent on financial services. The comparative shares in the National Accounts (NA) data (that is, private final consumption expenditure) are 31.4, 6.3, 16.8 and 7.2 per cent respectively. Clearly, there is a large difference in the shares. More importantly, the CPI data also completely misses out on an increasingly significant part of each consumer’s life — the financial and insurance services (zero in CPI and 7.2 percent in NA).
There is no question that the 2011-12 NSS-based consumption weights are flawed. Our purpose here is to assess whether the CPI is measuring actual inflation correctly. But this solves only one half of the GDP deflator puzzle. The GDP in India is (approximately) composed of 65 per cent consumption and 35 per cent investment. If one gets appropriate deflators for the two components, one can obtain an independent assessment of what deflator inflation looks like in India, and an estimate that does not erroneously use WPI prices for consumption expenditures (as pointed out by the RBI). Whether the GDP deflator is measuring inflation correctly will be addressed in a subsequent article.
For now, we restrict ourselves to correctly assessing the consumption component of the GDP deflator. By definition, one should use the consumption weights as in the NA, which is what we do. We use the CPI prices for 25 broad items of expenditure and equivalent consumption shares as per private final consumption expenditure in the national accounts for 2011-12.
Inflation data are reported for three different consumer price series — the official CPI as calculated by CSO, the first CPI adjusted measure or CPI1 (NA weights and CPI prices and zero weight for financial services), and the second CPI adjusted measure CPIf (CPI1 along with 7.2 per cent weight for financial services). Price data for financial services are proxied via the banking service index, available on the Office of Economic Advisor website. Comparing with the first adjusted measure CPI1, CPI overstates inflation by a large 0.9 percentage points in 2015-16. In three of the last four years, and both in high and low inflation times, the CPI has exceeded inflation (CPI1) to the order of 0.8 percentage points.
If consumer purchases are assumed to include financial services (which they are supposed to), then NA CPI was even lower by 20 basis points, that is correctly adjusted, inflation (CPIf) in India in 2015-16 was a full 110 basis points below the official estimate, and an average of 130 basis points below the official estimate over the last four years.
The difference in inflation estimates are not small. If the adjusted CPI estimates do reflect the underlying reality of consumer inflation, then the results have strong implications for the RBI policy (are Indian repo rates too high?) and the GDP growth (are we underestimating the GDP deflator inflation?) For these, and other conclusions, tune in again, next week.