India's GDP growth - estimates and over-estimates

A deep look at nominal versus real GDP growth rates, and its link with fiscal spending impact

India's GDP growth - estimates and over-estimates

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• The story: Since the past few years, the debates around India's GDP growth have been growing steadily. Post demonetisation, there was a steady slump in the growth rate, and then came the pandemic. The government came out with a support package, which was largely monetary in nature. The Gross domestic product (GDP) statistics are released at both current (including inflation) and constant prices (w.r.t. a base year). The nominal one discounts inflation from the base year of the current GDP series, and provides a realistic basis of comparison.
• Understanding nominal and constant: It it takes tonne of cement to build half a kilometre of road, assume it costs Rs.1,000 a tonne and there is a tax of 10%. If cement prices doubled in a year, then government spending and taxes from it will also double, although the length of road remains the same. Prices do not double in a year normally, but this shows that in years of abnormal inflationary movements, fiscal calculations can go awry. The 2021-22 financial year could be one such year for the Indian economy.
• India's Nominal growth component increasing: The Gross domestic product (GDP) statistics are released at both current and constant prices. The latter discounts inflation (more on this later) from the base year of the current GDP series. While real GDP matters to track the growth of actual output, nominal numbers cannot be rejected, as they are needed due to the need to know about (i) government finances and (ii) terms of trade, or ratio of prices, between sectors. A look at quarterly GDP statistics shows that the nominal growth component, or the difference between current and constant price growth, has increased sharply in the fiscal year that ends in March 2022. At 11.6 and 9.1 percentage points in the June and September quarters, the nominal growth component was the highest since September 2011.
• Nominal growth GDP more aligned with WPI: The nominal growth was higher than the Consumer Price Index (CPI)! On an annual basis, CPI growth was just 5.6% and 5.1% in the June and September quarters. but nominal GDP growth is more aligned with the Wholesale Price Index (WPI) than the CPI.

1. Why so? It is due to the way CPI is designed to measure average household budgets and, hence, has a high food component (39%). The share of agriculture in gross value added (GVA) is just about 15%.
2. The WPI is the best proxy for producer prices in the economy, even though it does not take into account the price of services, which have the largest share in GVA.
3. So, nominal growth has a higher correlation with WPI than CPI. Neither WPI, nor core inflation – the non-food, non-fuel component of the CPI – have come down significantly in the recent period.
4. They will stay at elevated levels compared to historical standards. So nominal growth for 2021-22 could be close to levels seen in the first half of the current fiscal year 2021-22.

• Impact on Union Budget calculations: The key number is the nominal growth projection for the financial year, as nominal GDP is the denominator for revenue collections.

1. Taxes are collected on nominal, not real, incomes. The 2021-22 budget assumed a nominal GDP growth of 14.4% in 2021-22. Eight months into the fiscal year, the budget’s nominal growth projection appears to be an underestimate.
2. At 8.4%, GDP growth in the September quarter (Q2) was surprising, and annual real GDP growth at 9.5% may happen.
3. If WPI growth for the fiscal year ends up close to 10%, nominal growth may be higher than just 5%, which is what the budget assumed. It also means that the budget’s revenue projections could be underestimates.
4. Nominal GDP growth exceeding the budget’s projection would be a first since the current government assumed office in 2014. So there's ahigh probability of actual revenue collections exceeding budgetary projections.
5. But higher inflation also means that we could be overestimating the current fiscal stimulus!

• The good, bad and ugly: A higher-than-expected inflation (and hence nominal growth) is good for revenue collections and fiscal numbers. But it might not be the case for its multiplier value – government spending boosts GDP over-and-above its value – for the real economy.

1. Why? As a large part of the jump in government spending could just be a result of higher inflation rather than a greater demand for goods and services
2. It can be said that a real fiscal boost requires government spending to grow at a value that is higher than nominal growth. It has always been the case since 2014-15 to 2019-
3. 20. In 2020-21, disruption from the 68-day lockdown due to the Covid-19 pandemic that was imposed on March 25, 2020, derailed a lot of government projects, and government spending actually fell. While government spending has increased significantly in the April-September period 2021-22, it is lower than nominal growth for the first half of the fiscal year. So India might be overestimating the fiscal impact on the ongoing recovery.

• Summary: The nominal versus real debate is not just academic in nature, but has real world implications.
• EXAM QUESTIONS: (1) Explain the two ways GDP growth is calculated in India, and the structural difference in the two. (2) What is the impact of higher nominal GDP growth on real fiscal spending by the government? Explain all possibilities. (3) What is more important in GDP growth discussions - real or nominal growth? Explain.

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