GDP conundrum

Recently released data from the CSO, which claimed that demonetisation had had no significant impact on the performance of the economy, raise more questions than provide answers.

Published : Mar 15, 2017 12:30 IST

The orange business in Nagpur was doubly hit. Demonetisation and surplus production together brought down wholesale prices.

The orange business in Nagpur was doubly hit. Demonetisation and surplus production together brought down wholesale prices.

Official data released by the Central Statistical Organisation (CSO) on the last day of February, which claimed that the national gross domestic product (GDP) rose by 7 per cent in the October-December period, the third quarter of 2016-17, came as a morale booster to the Narendra Modi government. If taken seriously, and without scepticism, it appeared to show that the shock and awe of demonetisation had no negative impact on the growth trajectory of the Indian economy. But the gleeful acceptance of the latest CSO estimate by partisans in favour of demonetisation is truly perplexing.

How could the economy have registered robust growth during a period when 86 per cent of the value of cash in circulation—the key mode of payment, especially for the vast swathes of the economy that is informal in nature—was pulled out suddenly? Anecdotal evidence from a range of sources from across the country also indicated that agricultural activity had ground to a halt, as had production from small-scale units producing a variety of goods. Moreover, there was also evidence that key sectors such as manufacturing and real estate had been hit hard. Those in government, including Finance Minister Arun Jaitley, have obviously seized the latest data as a vindication of the demonetisation move. The political establishment’s gleeful cynicism in accepting what is convenient, even as the claims sit uncomfortably with facts that confirm the opposite, is truly disturbing.

Statistical illusion

When “facts” are at variance with widely observed reality, as is certainly the case with demonetisation, it is time to question the basis on which the “facts” stand. So, why is it that the CSO’s data do not appear to square up with reality? First off, it is important to recognise that the statistical concept of growth of any kind, economic or other, is always relative. When the CSO’s latest estimate arrived, all eyes were on how the economy had fared in the third quarter of the current financial year. But tucked away in the release was the fact that the estimates of GDP for the comparable quarter of the previous year (the third quarter of 2015-16) were revised downward. Of course, there is nothing wrong with later estimates making corrections for earlier estimates, but it is indisputable that the lowering of the earlier estimate creates the statistical illusion of a buoyant performance during a period in which the economy experienced an unprecedented shock.

Observers such as Soumya Kanti Ghosh, Chief Economist at State Bank of India, have pointed out that the “steep downward revision” of GDP estimates for the third quarter of 2015-16 has had the effect of “masking” the impact of demonetisation. Indeed, if the unrevised figures for GDP in the third quarter of 2015-16 are used for comparison with the third quarter of the current year, GDP growth for the quarter would amount to only 6.2 per cent and not 7 per cent. Another puzzling aspect of the downward revision is that it has been done only for the third quarter; the estimates for all other quarters of 2015-16 have been revised upwards.

But this statistical illusion is only one major problem. Another aspect of the problem pertains to the estimates of GDP emanating from the manufacturing sector. The CSO’s latest estimate reveals that growth in gross value added (GVA) in manufacturing increased by 8.3 per cent during the October-December 2016 quarter. However, another set of data, the Index of Industrial Production (IIP), which is also collected by the CSO, show that industrial growth in the three months of that period was up 2.4 per cent, up 5.5 per cent and down 2 per cent, respectively. Interestingly, the IIP data show that compared with figures for a year earlier, industrial growth was in negative territory. Bank credit, which is another indicator, also sits uncomfortably with the GDP estimates. Data published by the Reserve Bank of India (RBI) show that bank credit shrank by 4.3 per cent in December 2016, which raises an obvious question: how could a growing economy do with less credit, especially in a period of widespread cash shortage?

Yet another puzzling feature of the latest data released by the CSO pertains to the sharp increase in private consumption expenditure, especially at a time when the economy was savaged by demonetisation. It needs to be emphasised that consumption estimates in the CSO’s data set are residual in character. What this implies is that consumption is not directly estimated but arrived at as a residue after accounting for all other categories. What is truly puzzling about the private consumption estimate is that the CSO reckons that it increased by a whopping 10.1 per cent in the third quarter of 2016-17. Incidentally, while private consumption expenditure grew at only about half this rate in the second quarter, it grew at 6.8 per cent during the comparable quarter of the previous year. Information from a range of sources, including companies in the consumer goods industry (Nestle, for instance) and the two-wheeler sector (Bajaj, for example, whose leaders have also spoken strongly against demonetisation), indicates that the CSO’s estimates sit uneasily with the facts on the ground.

Similarly, while government consumption (or spending) is shown to have increased by almost 20 per cent in the third quarter of the current year, it grew by less than 4 per cent in the comparable quarter of the previous year. Such a massive spike in government spending ought to be reflected in the capital goods category in the IIP. But the IIP data showed that the capital goods sector shrank by a massive 27 per cent in October and by a further 3 per cent in December; the 15 per cent gain in November was wiped out by the sharp contraction in the other two months of the quarter.

One of the most significant drivers of GDP growth in the current year appears to be agriculture, going by the latest CSO estimate. GVA in agriculture is estimated to have grown by 6 per cent in the third quarter of 2016-17. There are two problems with the estimates. For one, there is an element of a statistical illusion arising from the fact that GVA in agriculture contracted by 2.2 per cent in the comparable quarter of the previous year. But an even more significant surprise is that it does not appear to reflect the across-the-board collapse in agricultural commodity prices after demonetisation took effect. As was evident in reports from across the country, there was widespread distress in rural India following demonetisation.

The fact that demonetisation was initiated right in the middle of the harvesting season (and which also affected subsequent sowing operations) resulted in a steep decline in prices. Given that the value of agricultural output is dependent not just on output levels but also on price levels, the sharp increase does appear odd. At the very least, the data reflect a disconnect with reality. It is possible that extrapolation of previous data may be responsible for this anomaly. Incidentally, this may also be the reason why the output of the informal sector appears exaggerated, contrary to popular expectation after demonetisation.

Of course, a part of the problem with the statistics arises from the new methodology that has been adopted after the Modi government assumed office, in 2015 (“Rejigging statistics”, Frontline , March 20, 2015). This could explain the significant disconnect with reality that the CSO’s latest estimate appears to suggest. Economic activity arising in the informal sector contributes to between a third and half of the overall output in the Indian economy. Given this weightage, and given the serious problems in the way the CSO gathers estimates of output emanating in this sector, it would appear that the latest estimates are not good enough to answer the question that has assumed great significance: was demonetisation a killer blow to informal forms of activity and livelihoods?

The CSO’s estimates of output in the informal sector are captured by “proxy”, rather than relying on direct and verifiable methods of estimation. As Pronab Sen, a former Chief Statistician of India, pointed out, the assumption behind using the formal as a proxy for the informal is that output levels in the two sectors would move together. However, given the fact that the unprecedented cash shortage hit the informal sector much harder—in fact, one could even draw the conclusion that demonetisation actually targeted those engaged in these activities—the methodology of using the formal as a proxy is untenable. In fact, acolytes of the Modi regime ought to be warned that the data are particularly unsuitable for answering the question.

Moreover, the changes in the CSO’s methodology, which increases dependence on data from the Ministry of Corporate Affairs, appear to have tainted the sanctity of the data even further. To reiterate, this data source is based on “returns” filed by medium and large listed companies, which is suspect for two reasons. One, the data are largely voluntary, but even more problematic is the fact that the Ministry has no way of verifying the authenticity of the data it gathers.

It is not just the government’s long-standing critics who have questioned the CSO’s estimates. For instance, the Indian affiliate of the Nomura Group, a financial holding company based in Japan, raised doubts about the estimates. It suggested that the “official data are underestimating the reality as they rely largely on organised sector data”. Remarking that “this does not add up”, Nomura pointed out that “real activity data released since demonetisation suggest that consumption and services were hit after demonetisation because they are more cash-intensive”. It made the telling observation that the “official GDP statistics are significantly underestimating the growth impact of demonetisation”.

The Modi government is well aware that the estimates for the current year will undergo further revisions over the next year. A year later, we may know with a little more certainty the economic consequences of the great misadventure that demonetisation was. But the political establishment is banking on the hope that by then, no one will be interested in them.

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