Few weeks back, Central Statistics Office (CSO) released provisional estimates of GDP/GVA for Q4 FY17. This was one of the most awaited data releases in the recent times. After all, it was seen as a report card on the economic impact—or rather, the economic fallout—of demonetisation. As per the release, in Q4 FY17, the Gross Value Added (GVA) grew by 5.6% in constant prices (2011-12 prices). The same was 6.7% in Q3 FY17. Half of Q3 and almost all of Q4 was the period when economists anticipated the maximum effect of demonetisation. Given this, many intuitively attributed the decrease in GVA quarterly trend to demonetisation. People argued that demonetisation halted production/economic activities and that explained the GVA trends. While this is quite understandable, in reality, it is not such a simple, straight-forward correlation.
Starting with basic aspects of GVA computation first. GVA is defined as “the value of output less the value of input used up in the process of production”. Simply put, GVA is the quantitative measure of value added in the national economy within a given reference time period. CSO is able to collect reliable information on price (P), quantity (Q) of various inputs and outputs and therefore compute the gross value added in the national economy. This information, however, is estimated at prices prevailing during the reference period i.e “current prices”. The inherent shortcoming with this is that it becomes difficult to delineate inflation (i.e., price increase) from increase in production/economic activity (quantity produced). For example, an increase in GVA may not necessarily be due to an increase in production activity alone. It can be due to price increase (inflation) or increase in production activity or both. And therefore, to take the effect of inflation out, CSO fixes a base year and adjusts the data of the reference year with respect to the base year. This is done by deflating the current prices data through a “deflator”—that reflects inflation between the reference year and the base year. The recomputed data is now referred to as data in “constant prices”. Thus, in constant prices, an increase in GVA should ideally be contributed by increase in production alone. But there’s a catch. A part of the increase in GVA is also on account of changes to “deflator”—a parameter which is mostly ignored by experts and analysts. And this fact needs to be noted.
Turning now to the assessment of GVA trends. Here, the basic argument is that demonetisation negatively impacted economic activities and this led to the decrease in Q4 GVA. Let’s now look at the CSO release (see accompanying table) to probe this further. It is safe to assume that demonetisation would have had maximum impact on sectors which are majorly driven by cash. Construction (item no. 5) and trade, hotels, etc, (item no. 6) are two such sectors that exhibit dominant cash usage. A review of data on these sectors suggests the following:
a) For construction sector, the GVA in constant prices shows a growth of 3.4% for Q3 FY17 and a -3.7% growth (contraction) for Q4 FY17. In current prices, however, Q3 FY17 GVA grew by 5.2% and Q4 by 1.2%. Continuing the arguments made earlier, the change in Q4 GVA in constant prices needs to be explained by changes in production activity as well as changes in deflator. Deflator is unlikely to be a negative number as inflation levels may have increased in FY17 compared to the base year FY12 and hence the real cause of concern in this case looks to be production activity. It is therefore likely that taking out cash from the system may have reduced production activity for construction sector during the referred quarter.
b) For trades, hotels, etc, the GVA in constant prices shows a growth of 8.3% for Q3 FY17 and 6.5% growth for Q4 FY17. In current prices, Q3 FY17 GVA grew by 10.3% and Q4 by 11.7%. In this case, the GVA in current prices exhibits a broadly similar increase between Q3 (10.3%) and Q4 (11.7%). However, GVA in constant prices shows that the growth trend has come down in Q4 compared to Q3. What this means is that though the numerator (measure of value add or production activity) has increased at similar rates each quarter, most likely the deflator has gone up in this period. And therefore the cause of concern in this sector looks to be the deflator and not so much the production activity. Possibly, demonetisation did not negatively impact the production levels or demand levels in this sector. But, could it have impacted the sector deflator?
Demonetisation clearly impacted cash in circulation. Therefore, by its very nature, it is likely to impact price levels/inflation and, hence, in turn, the deflator. But cash is just one of the parameters. Deflator trends are also impacted by various structural and supply-side factors. We are now entering a speculative territory here; demonetisation is likely to have initiated major structural changes in the way our economy worked. These changes include increased replacement of cash with cheque/digital payment modes, increased transparency particularly in construction/real estate sector, higher formalisation of transactions in trade, hotels, other services sectors etc. And hence all these may well have played a role in deflator computations thereby directly affecting the way GVA trends in constant prices came out in Q3 and
Q4 FY17. In any case, it is clear that changes in production activity alone can’t sufficiently explain trends in GVA. Analysing deflator also merits equal focus purely from a factual perspective. Many a times it is important to take a step back and go back to basics before drawing larger conclusions.
By Kishore Desai OSD, NITI aayog
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