Decoding India's GDP puzzle
Government says demonetization had no impact, but reality suggests otherwise
Indian Prime Minister Narendra Modi is celebrating quarterly economic growth figures showing that India has retained its status as the world's fastest-growing large economy, despite the chaos caused by the sudden withdrawal in November of most of the cash in circulation.
India's Central Statistical Organization, the official forecasting agency, says the economy grew by 7% in the October-December quarter, compared with the same quarter of the previous year, overshooting analysts' expectations that growth would fall to less than 6.5%. The CSO retained its previous forecast of 7.1% growth for the fiscal year ending in March.
But this rosy picture does not seem to reflect reality, bringing the reliability of government data in doubt. In the real world, bank credit to industries is contracting, businesses are delaying capital expenditure plans, and sales of cars, consumer goods and homes are down. Few new jobs are being created for the more than 1 million young people who join the labor force each month.
Extraordinarily, the CSO says that private final consumption expenditure grew by 10.1% in the third quarter, year-on-year, compared with 5% in the previous quarter. That is difficult to digest, given that around 78% of all transactions are conducted in cash, which was in extremely short supply during the quarter because of the withdrawal of most high value currency notes.
The CSO estimate suggests that demonetization did not hurt consumer demand; but companies selling cars, fast-moving consumer goods and homes have all reported declines in sales and a piling up of inventories. Kantar World Panel, a global research organization, says that sales by fast moving consumer goods companies increased by just 2.7% in November and 3.5% in December, measured by value, from 9.9% in October. Evidence from large companies supports this analysis: For example, Hindustan Unilever says its India sales fell by 4% in the October-December quarter.
Figures from other sectors tell a similar story. The Society of Indian Automobile Manufacturers says that vehicle sales fell by 19% to 1.2 million in December 2016, compared with December 2015. This was the biggest decline in sales since 2000. Two-wheeled vehicles, which account for three-quarters of total automobile sales, declined 22% year-on-year to 910,235 in December, while car sales fell 8.14% to 158,617 units.
In the property sector, the combined sales of residential properties in India's eight biggest cities, including Bangalore, New Delhi and Mumbai, contracted by 44% to 40,936 units in the October-December quarter compared with the same quarter a year earlier, according to Knight Frank India, a property consultancy. Slowing home sales are likely to put pressure on dependent industries such as cement and steel production, electrical goods and electronic appliances, and on services such as plumbing, housekeeping and interior decoration.
Factory output, as measured by India's Index of Industrial Production, posted meager growth of just 0.2% in the October-December quarter. CSO data says that the manufacturing sector grew 8.3% in the same period. But the CSO's manufacturing data is based on listed companies -- a very small sample to rely on in a country where 90% of the workforce is employed outside the formal sector of the economy, and is highly dependent on cash transactions.
There are other puzzles. Bank credit to the industrial sector fell by 4.3% year-on-year in December, and investment, measured by gross fixed capital formation, had contracted in the previous three quarters. But the CSO data estimates that gross fixed capital formation grew by 3.5% in the quarter ending in December. This sudden and sharp turnaround in investment is difficult to explain given that most companies are operating well below installed capacity, according to the Reserve Bank of India, and have been sitting on their capital expenditure plans.
One of the best performing sectors in the third quarter was agriculture and allied sectors, which grew 6%, bouncing back from a decline of 2.2% a year ago, helped by a good monsoon after two years of near-drought conditions. But official GDP data was also helped by high government expenditure in the quarter, which grew by 19.9% year-on-year, compared with just 4% a year earlier. This was reflected in the fiscal deficit, which surpassed the government's full-year target by 5.7% two months before the end of the financial year.
Economic growth of this kind is unlikely to be sustainable since most government spending is on wasteful revenue account items such as interest payments and salaries and allowances for officials -- none which aid economic growth in the long term. Excluding public expenditure and the value added by the weather-dependent agricultural and allied sectors, GDP growth for the third quarter falls to around 6%.
But apparent GDP growth may also have been boosted by technical factors. For example, recent rises in excise duty on petroleum products have substantially increased indirect tax revenues, which adds to the gross value added figure for goods and services -- the number used to arrive at GDP growth.
Also, the CSO has revised some of its earlier estimates downwards. There is nothing inherently suspicious about revisions, which are made from time to time by all national statistical organisations. But the CSO's changes have clearly had the effect of increasing the apparent rate for of growth in the third quarter.
Most noticeably, the growth rate for private final consumption expenditure in the October-December quarter of 2015-2016 has been revised down from 8.2% to 6.8%. So the 10.1% figure for private final consumption expenditure in the comparable quarter of 2016-2017 not only looks odd compared with the 5% figure for the previous quarter, it also translates into a larger boost to GDP because of the lower base.
To be precise, the base is 140 basis points lower than it would have been without the revision. Roughly 58% of GDP is accounted for by consumption, so a 10.1% jump accounts for about 5.8 percentage points of the 7% reported increase in GDP. However, that is not all. The CSO has also revised down the GDP growth rate for the third quarter of 2015-2016 to 6.9% from 7.2%, further lowering the base.
By including these factors, the CSO is painting a rosier picture of Indian GDP than is really justified. In the process, it is undermining its reputation, which has yet to recover from changes in the calculation of GDP announced in January 2015. Most analysts think the new methodology has resulted in an addition of two percentage points to India's economic annual growth numbers, even though there had been no real improvements on the ground.
More generally, the CSO has added to skepticism about the reliability of its figures by delaying the publication of full GDP data for 2004-2011 in accordance with the new methodology, which would allow independent commentators to see the full effects of the change over time.
To ease the mounting concern about the integrity of the data, the CSO should release the revised historical record as quickly as possible. Meanwhile, the suspicion must be that India's economy is in a worse shape than the government wants to admit.
Ritesh Kumar Singh is a corporate economist and former assistant director of the Finance Commission of India.