New economics: GDP growth uncouples from investment rates

Difficult to reconcile today’s higher GDP growth with lower investment levels as compared to those in the UPA years

GDP growth,  investment rates, Narendra Modi, FY15 growth, MCA, RBI
FY15 growth, based on 2004-05 prices, was reckoned at 5-5.5% till the advance estimates, with 2011-12 as a base, put it at 7.4%.

Even when the GDP series was first rebased, and 2011-12 used as the base as opposed to 2004-05 earlier, most dismissed it as a political gimmick, aimed at ensuring Narendra Modi could show a higher growth rate. FY15 growth, based on 2004-05 prices, was reckoned at 5-5.5% till the advance estimates, with 2011-12 as a base, put it at 7.4%. This criticism ignored the fact that the rebasing was planned under the UPA, and the methodology finalised before Modi came to power. Similarly, those seeing a political hand in the CSO coming out with back-series data—based on 2011-12 data—showing GDP grew slower in the UPA period as compared to the Modi one, are probably being unfair by believing CSO and its experts tailored their view to suit the NDA. While GDP grew by 7.7% per year in the UPA period under the old series, this rose to 8% when the back-series was originally calculated by the Sudipto Mundle-led panel, and this has now been lowered to 6.7% as compared to Modi’s average of 7.4%.

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While alleging political fixing may be unfair, there are obvious problems or inconsistencies with the latest back-series; indeed, the original rebasing also suffered from similar inconsistencies. The major inconsistency is that the GDP doesn’t jell with other facts. The FY06-08 period, for instance, was one of scorching growth in investment, when gross fixed capital formation (GFCF) averaged around 31.5% of GDP, so it jelled with the fact that GDP growth averaged 9.5%. Though it is true that investment and GDP aren’t as closely correlated in the very short run, for the UPA period as a whole, GFCF-to-GDP averaged 31.8% and GDP grew at 7.8%. It is a bit difficult to believe, then, that a 28% or so, GFCF can produce an 8% GDP today; so has productivity shot up so dramatically?

Nor are the inconsistencies related to just the investment data. During UPA-1, when GDP averaged 8%, credit grew at 29.3%; this fell to 16.3% as GDP growth fell to 6.7% in UPA-2. In which case, how is an 8.6% credit growth—average since Modi came to power—giving an average GDP growth of 7.4%? Does it mean the economy has become so efficient that it is using less credit to grow? The fact that exports boomed in UPA-1—they grew 23.4% per annum in UPA-1 and 12.2% in UPA-2—also gels with the overall GDP growth story. By contrast, exports contracted by 0.8% per year in the Modi period, something that is consistent with overall GDP growth slowing. Corporate profits, a determinant of GDP, also grew much faster in the UPA years, as can be seen from the corporate tax collections during the period.

There are various reasons advanced by the CSO for how it arrived at the numbers, but one obvious problem is the fact that the ministry of corporate affairs (MCA) data that played a big role in GDP growing faster when the original rebasing was done is not available for the back-series; to that extent, it would appear this lowered GDP growth in the back-series. Using sales tax data to estimate the growth of the trade sector—as has been done—is a good idea, but in periods of high inflation, it may bias the numbers. Similarly, the CSO press release says that, in the past, while telecom growth was measured by the explosive growth in subscriber numbers, this has now been changed to the number of minutes of calls—it is not clear if this is the right thing to do. In the case of financial services, similarly, the GDP created by RBI actions has been removed since this is considered “non-market”—once again, this lowers GDP growth of the back-series. While few serious financial/economic analyses are solely focused on GDP numbers across different series—since they are based on different assumptions and data—an unintended consequence of this could be on RBI policy. Since the new back-series suggests India’s potential rate of growth is around 7-7.5%, which is the rate at which the economy is growing right now, RBI may not be able to cut repo rates by much.

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