Calculating GDP – Changes
Suddenly the Indian economy is looking much better than it did two weeks ago, thanks to a little sleight of hand. The Government’s statistics wing made two changes to the GDP calculation last week which have had the happy effect of lifting growth to 6.9 per cent for 2013-14 instead of 4.7 per cent as estimated earlier.
What is it?
There have been two changes to the GDP calculations. One was a change in the base year for the calculation which is done routinely every five years or so. The other was to adopt a new method to measure output. But why make any changes?
Starting now, Indian GDP will be measured by using gross value added (GVA) at market price, rather than factor cost. If you are not an economist, the previous sentence may have sounded like it’s in Swahili. Simply put, GDP is the total value of goods and services produced within the country during a year. You take all final finished goods and services produced domestically in volume terms and multiply this by their market prices to arrive at the value of output. Intermediate goods need to be excluded to avoid double-counting.
In India GDP did not include what that the Government received . Now, what it earns by way of indirect taxes such as sales tax and excise duty after deducting subsidy is also added into the GDP.
Why is it important?
You can question the timing, but the change in method of calculation has brought Indian GDP calculations more in line with global practice. For example, IMF’s world economic outlook projections, which all of us used even recently to make India-China comparisons, are not based on factor costs. This used to create confusion in the past, with IMF’s projections turning out to be very different from the Government’s.
As for the base year change, it is the only way to ensure that the products and services included in the GDP calculation do remain contemporary and reflect the present state of the economy.
For instance, the latest change in base year from 2004-05 to 2011-12 has included the recycling industry which didn’t figure in the earlier GDP computations.
Similarly trading activities by manufacturing firms are now included in that sector’s share. This change along with better data compilation (online data filed with the Ministry of Corporate Affairs) has led to manufacturing increasing its share in GDP.
Why should I care?
Global investors use growth prospect numbers to allocate their investment allocations between countries – GDP is a key metric here. So news that India’s GDP growth has averaged 6 per cent for the last three years and not 4.6 per cent as thought earlier, may help investors view India in a more favourable light.
Let’s not forget that important indicators such as the fiscal deficit are measured as a ratio of GDP too. Economists say that the latest revisions will help the Government meet this year’s fiscal deficit target. A more comfortable deficit number could help the Government stop tightening its belt and consider budget sops.
With indirect taxes added and subsidies deducted under the new GDP calculations, there is more incentive for the Government to raise indirect taxes and reduce subsidies. This may have an impact on sectors such as agriculture which receive a lot of subsidy.
The bottom line
It’s not always the economy. It’s sometimes the calculation.
10 Things to Know About the GDP Revision
The government on 30th Jan,2015(Friday) changed the way it calculates the gross domestic product. New GDP estimates, calculated using the new formula, show that India’s growth was much higher in the last two years of the UPA government. Former Finance Minister P Chidambaram was quoted as saying, “The new data conclusively establishes the fact that UPA succeeded to revive the economy. The revised GDP data will end misconceived charge that UPA mismanaged economy.” The new methodology is also likely to boost GDP growth in the current fiscal, providing a shot in the arm for the Narendra Modi-led government.
Here are 10 things to know about the GDP revision:
1) So far, domestic GDP was calculated at factor or basic cost, which took into account prices of products received by producers.
2) The new formula takes into account market prices paid by consumers. It is calculated by adding GDP at factor price and indirect taxes (minus subsidies). It is in line with international practice and is expected to better capture the changing structure of the Indian economy.
3) The government has also changed the base year for estimating GDP from 2004-05 to 2011-12. This has been done to incorporate the changing structure of the economy, especially rural India.
4) Data for the new GDP series will now be collected from 5 lakh companies (against 2,500 companies earlier), HSBC says. Under-represented and informal sectors as well as items such as smartphones and LED television sets will now be taken into account to calculate the gross domestic product.
5) India’s GDP grew at a healthy 6.9 per cent in fiscal year 2013-14 and not 4.7 per cent as reported earlier, according to the revised methodology. This means the previous UPA government was doing much better when it came to managing the economy than what was thought earlier, analysts say.
6) According to Nomura’s Sonal Varma, India’s manufacturing sector contributed to 17.3 per cent in FY14 GDP (against 12.9 per cent estimated earlier). Private consumer demand was growing at a much faster pace than estimated earlier, perhaps explaining the sustained inflation surge, she added.
7) The revision in GDP does not alter the size of India’s economy ($1.8 trillion) nor will it alter key ratios such as fiscal deficit, CAD etc. (as percentage of GDP) for 2013-14. “Our ranking in GDP terms will not change as the size of economy has almost remained the same,” chief statistician T.C.A. Anant said.
8) According to Pranjul Bhandari of HSBC, the RBI will assess the new GDP data to set its monetary policy stance. This means the quantum of rate cuts in the coming few months may not be as large as earlier expected because the economy is growing faster-than-estimated. HSBC expects the central bank to cut rates by 75 basis points in 2015. Bank of America Merrill Lynch expects the central bank to cut 100 basis points by April 2016.
9) According to Indranil Sengupta of BofAML, India will grow at 6.6 per cent (against 5.5 per cent forecast) and cross Brazil and Russia in GDP this year to emerge as the second largest BRIC after China.
10) The revised methodology, however, poses several challenges as well. “It is a problem for the government and economists who are trying to understand the exact situation,” said D. H. Pai Panandiker of RPG Foundation. “It is even a problem for the RBI, that doesn’t have a full view about how the economy is performing.”