Is India’s growth rate overestimated?
Relevance: GS Paper III
Why in News?
The Indian economy has grown at 7-8% recently, but the actual improvement is uncertain due to measurement issues, particularly with the GDP deflator. Experts raised concerns about this issue after releasing the 2011-12 base year series of national accounts, indicating a need for revisiting it.
GDP measurement methodology:
- The third quarter of 2023-24 (October-December) saw a 10.1% nominal GDP increase, resulting in real growth of 8.4%, with a deflator of 1.7%.
- This raises questions about India's low inflation, which is not plausible.
- In the old GDP measurement methodology, estimates of real GDP relied heavily on volume-based indices such as the index of industrial production.
- Real growth (for the most part) was calculated directly, and a deflator was then applied to produce a nominal growth figure.
- Hence, problems in the deflator did not really matter for the real growth rate.
- Under a new methodology adopted in 2015, GDP is measured in nominal terms, which are then deflated by price indices to derive the real numbers.
- The deflator has, therefore, become crucial. If the deflator underestimates actual inflation, then real growth will be overstated, as has been the case for the last year.
Issues with India’s GDP deflator:
- First, the National Statistics Office (NSO) does not use the international standard measure of output prices, i.e., the Producer Price Index (PPI), to deflate GDP.
- This is because India does not have a PPI.
- The NSO proxies the PPI with the Wholesale Price Index (WPI).
- The WPI does not track producer prices very well. It is heavily skewed towards commodities such as oil and steel, which are essential inputs in commodity-importing countries like India. Also, the WPI does not measure the price of services, and services constitute two-thirds of the economy.
- This skew in the composition of WPI means that whenever commodity prices fall steeply, the WPI will decline, even if producer prices are still rising. Since September 2022, consumer price index (CPI) inflation has been above 5%, as producers kept increasing prices, but WPI inflation has steadily declined because global commodity prices have fallen. During April-December 2023, WPI inflation averaged -1.0%. This persistent fall in WPI inflation artificially inflated real GDP during 2023-24.
- Second, most G20 countries calculate real gross value added (GVA) in the manufacturing sector using a methodology known as double deflation.
- In this method, nominal outputs are deflated using an output deflator, while inputs are deflated using a separate input deflator. Then, the real inputs are subtracted from real outputs to derive real GVA.
- India, by contrast, deflates nominal numbers using a single deflator.
- Single deflation can misstate growth by a big margin if input prices diverge from output prices.
Single deflation vis-a-vis Double deflation:
- When the price of inputs falls and the price of output increases, profits increase, and nominal value added goes up (it helps to think of GVA as profits, which go up when input prices fall).
- Since real GDP is supposed to be measured at “constant prices”, this increase needs to be deflated away. Double deflation will do this easily. But single deflation using an input price index like WPI will amplify the nominal increase.
- So, if the nominal increase in GVA is 10% due to rising profits, while WPI falls by 1%, the real increase will be calculated as 11%, even if the real output has not changed at all.
Way forward:
- CPI is used as a deflator (short-term measure):
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- The NSO can start using the CPI series to deflate nominal value added. The CPI is closer to producer prices than the WPI. If CPI is used as a deflator for manufacturing GDP computation for 2023-24. Official numbers show that for the first three quarters, nominal growth rates in this sector were 2.2, 12.0, and 10.6%, respectively, while real growth rates were 5.0, 14.4 and 11.6%.
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- CPI inflation (excluding food, fuel and house rent) for these three quarters was 5.9, 5.1 and 4.4%. If the correct deflator had been in line with this CPI inflation, then real manufacturing growth rates would instead have been -3.7, 6.9 and 6.2% for the three quarters.
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- The change to CPI makes even more sense in the services sector. CPI has extensive information on price movements in various service sub-sectors.
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- It would make a big difference to the estimated 2023-24 growth figures in trade/transport/communication and financial services, bringing down their growth rates by around 6 and 4 percentage points, respectively.
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- Whenever there is a collapse of global commodity prices that pushes the WPI-based deflator far below the CPI, the real GDP growth rate of India is likely to be overestimated. Similarly, as the gap between input and output inflation starts to close, the problem will diminish. But that could also send a misleading signal because it might seem that growth is slowing when only the measurement bias is disappearing.
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- Producer Price Index and double deflation methodology (long-term measure):
- The CPI-WPI differential gives a rough indication of the degree to which the real GDP numbers might be distorted. Given how important the GDP data is, it is imperative that the NSO develops producer price indices and applies the double deflation methodology to avoid these distortions.
Conclusion:
The issue of GDP measurement, regarding the deflator and deflation methodology, is crucial for India's economic growth evaluation. The solution proposed could reduce distortions and provide more reliable data to policymakers and stakeholders.
Mains PYQ:
Q. Explain the difference between computing methodology of India’s Gross Domestic Product (GDP) before the year 2015 and after the year 2015. (UPSC 2021)
Q. Define potential GDP and explain its determinants. What are the factorsthat have been inhibiting India from realizing its potential GDP? (UPSC 2020)
Q. Despite the consistent experience of high growth, India still goes with the lowest indicators of human development. Examine the issues that make balanced and inclusive development elusive. (UPSC 2019)
