GDP Growth And Interest Rates: India’s Unreliable GDP Numbers And The Policy Implications

India’s gross domestic product growth rate edged up largely as a result of a significant improvement in manufacturing output that moved up sharply. This is contrary to developments in some other indicators including low industrial production (manufacturing) and slightly negative bank credit growth to the industrial sector. India’s GDP at market prices recorded a slight uptick to 6.3 percent in July-September 2017 (Q2FY18) after a declining trend in the previous 5 quarters and 5.7 percent in Q1FY18. Gross value added (GVA), a better measure of economic activity (since it does not include the impact of discretionary indirect tax increases) increased from 5.6 percent in Q1FY18 to 6.1 percent in Q2FY18.

We believe that relying on financial statements of non-financial companies — that are not made publicly available — may be overstating the growth in manufacturing and overall GDP growth.

We compare the change in gross value added in manufacturing (GVA: Manufacturing) and the manufacturing component of the index of industrial production (IIP: Manufacturing) over the past several quarters and find an unexplained significant gap between the two measures of manufacturing growth.

There are at least three major problems with using quarterly corporate financial statements to calculate value added in manufacturing.

  • Firstly, these tend to depend on accounts for large diversified corporates and do not typically include smaller firms that do not need to file their financial statements every quarter.
  • Secondly, data for larger companies that skew these calculations are conglomerates that operate not only in the manufacturing space but in the services space as well. For example, Reliance Industries operates not only in manufacturing petroleum products but also in services such as telecommunications, retail, etc. that may witness faster — or slower — growth than manufactured products. Given that financial numbers are consolidated for manufacturing and services, it would be virtually impossible to un-entangle Reliance’s contribution to value added from manufacturing alone and indeed for most conglomerates and other companies.
  • Finally, as services and goods production gets more integrated, it would be very difficult to discern growth in manufacturing separately from services. For example, how would you distinguish service provided for maintenance by a household goods supplier such as Samsung from sales of goods?

India must be one of the very few countries in the world, currently and historically, to record a manufacturing growth of 9.5 percent in nominal terms in a quarter (Q2FY18) while credit growth was negative at close to 0.3 percent year-on-year. Indeed, whether the industrial sector is now capable of growing at such high rates with no credit growth needs to be examined by the Reserve Bank of India in great detail.

Either it indicates that productivity has gone up sharply in the industrial sector, or the numbers are not correct.

What is worrying about the Q2FY18 GDP number is that a large part of the uptick is attributed to the 7 percent growth in GVA: Manufacturing, while IIP: Manufacturing has grown by a mere 2.2 percent in the same period. While the IIP number reflects production numbers, the GVA number is calculated using financial accounts of firms on a quarterly basis.

A gap of 4.8 percent between IIP: Manufacturing growth (2.2 percent) and GVA: Manufacturing (7 percent) should not be accepted without more analysis, especially by the Central Statistical Organisation itself and various economic departments of the authorities including the RBI.

Even if half of the gap of 4.8 percent is regarded as an overestimate of the growth in manufacturing, with a weight of close to 20 percent in GDP, this would reduce GDP growth by 0.4 percent, i.e. GDP growth would be 5.9 percent and GVA growth would be 5.7 percent, instead of 6.1 percent.

To compound matters, the Central Statistical Organisation does not release the firm level data it uses to calculate value added in manufacturing. This remains a black box for no review or authentication by independent sources. Its reliability, therefore, cannot be and must not be trusted blindly in good faith by policymakers. Other indicators must also be considered and more seriously.

On the expenditure side, there is a noticeable and worrying deceleration in real consumption expenditure in Q2FY18, both in the private sector as well as the government sector. Both are worrying trends, especially the slowdown in government spending that would partially account for a deceleration in operations and maintenance including in soft sectors (social – education, public health, etc.).

While statistical discrepancy has contributed a full 1.3 percent to GDP growth in Q2FY18, growth in valuables has contributed 0.8 percent.

Together, the two total 2.1 percent of the 6.3 percent.

Surely, this cannot give a lot of solace to policymakers and should be a matter of concern.

Meanwhile, while CPI inflation has edged up, it remains quite low at 3.6 percent, driven in recent months by higher vegetable prices. Given a policy rate of 6 percent, the real policy rate remains very high, and the real lending rate even higher. 10-year government bond yields have edged up over 7 percent as global liquidity conditions tighten, oil prices rise and with increasing fears of low tax collections and higher fiscal deficit – it reached 96 percent of full financial year budget estimates in October 2017.

The low inflation rate — given the uncertainty about the real GDP growth and no trigger for higher sustainable GDP growth going forward — should prompt a policy rate reduction from the RBI. The RBI has hitherto been rather obstinate in focusing on its higher inflation forecasts while inflation has come in much lower.

We expect the RBI to stay this course and not reduce policy rates in the forthcoming December meeting.

Policymakers should be analysing economic developments and indicators more thoroughly and in detail rather than glossing over headline numbers. Certainly, for the reasons outlined above, the GDP numbers need to be taken with more than a pinch of salt and the RBI should be tasked with analysing the reasons for the high GDP and manufacturing growth without credit growth. The RBI and the fiscal authorities may be taking GDP growth for granted and living in hope. Rather, they should be focusing on whether growth is for real and what policy actions need to be taken. Else, a few (or less) years from now India will find itself with low growth, low revenue collection, higher fiscal deficits funded by the central bank leading to high inflation busting the myth of India’s inflation targeting framework.

Rajan Govil is Managing Director of Marketnomix and a former International Monetary Fund Economist.

The views expressed here are those of the author’s and do not necessarily represent the views of Bloomberg Quint or its editorial team.