Why India’s GDP Numbers Are Not Inconsistent With the Macroeconomic Reality

There is a lot of hubbub about India’s latest gross domestic product (GDP) data. Analysts are unable to reconcile their expectations of GDP with the data that has been put out by the Central Statistics Office (CSO). To the analysts, the CSO data appears to be presenting a rosy picture of the Indian economy when, in fact, a majority of them, including the likes of the International Monetary Fund (IMF) and many well known economists, expected a marked slowdown in the growth rate of almost 1% year-on-year (Y-o-Y) to between 6-7% from between 7-8% because of the shock of demonetization which began on November 8, 2016. Some have even questioned the integrity of the data. The main expectation was that consumption would fall drastically because of the sudden withdrawal of 86% of cash from circulation. Still some expect the informal sector of the economy – the many small and medium enterprises (SMEs) which mostly deal in cash – to be better factored into future releases of the GDP data by the CSO to prove that their estimates of India’s economic slowdown are, after all, accurate.

The CSO GDP data does indeed show some effect of the demonetization. The economy did indeed slowdown by about 0.5% which, however, is not as much as has been expected. Construction and real estate sectors which largely deal in cash have slowed. It is inaccurate, however, to expect that in reality people would dramatically reduce their consumption because a large chunk of bank notes have been removed from circulation. People have, in fact, borne the inconvenience of exchanging their obsolete bank notes for valid currency to pay for their consumption and the impact of demonetization has only waned with time as the government put more and more of the new notes into circulation after November 8 to replace the banned bills. Also, the suggestion and introduction by the government of electronic payments including for the poor and previously unbanked and payments in the form of cheques have kept the economy humming. Strong private consumption has buoyed the GDP. Along with private consumption, a timely and good monsoon season has siginificantly raised the contribution of agriculture to the GDP.

Many have pointed to the slowed credit growth to not believe in the GDP investment component which has risen when compared to previous quarters and also pointed to the Index of Industrial Production (IIP) numbers to doubt the strong contribution of manufacturing to the GDP which diverges from IIP significantly. The economy could have been at a point of upturn at the time of demonetization explaining the rise in Gross Fixed Capital Formation (GFCF) due to the upward momentum. Capital investment is not dependent as much on cash transactions. The IIP is a narrower measure when compared to the broader economy-wide manufacturing sector component of the GDP and it has to be better aligned with the GDP by changing, among other things, the IIP’s base-year from 2005-06 to 2011-12. IIP is useful but it is not fully representative of India’s dynamic manufacturing sector.

Whatever method used to compute the GDP should produce a number that is nearly the same and it is. Therefore, it is not analytically accurate to say that the CSO changed its method of calculating GDP after the Modi administration came into power and that this is why the GDP is not as expected after its slowdown in the 2 waning years of the prior government before the 2014 election. All that the CSO had done was change its base year from 2005-06 to 2011-12 and align its computation of the GDP to international standards by using expenditures rather than factor costs. It can be argued that the change in government may have given a boost to the economy after the 2014 election due to expectations of a government that is friendlier to business. More importantly, the low inflation due to a worldwide decline in commodity prices helped the Indian economy regain its growth momentum when the Reserve Bank of India (RBI) lowered its policy rate significantly.

GDP as a measure of economic well-being can be critiqued, but not the data or the computation that has gone into calculating India’s growth rate. India’s GDP – as a macroeconomic measure – is reasonably representative of the underlying macroeconomic reality. It now falls to the analysts to revise their expectations. For once, and reassuringly so, the RBI and the Indian government may be correct on macroeconomic policy. The micro-reality on the ground of jobless growth and ensuing issues such as uncertainty about the future and consumer confidence still need to be addressed.

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