GDP number: Deflator trouble, kindly adjust [ Hindu ]

Number games are usually complex, and calculating India’s GDP is no exception. In a recent report, HSBC declared that India’s GDP is “fraught with methodological concerns” and that the country’s real growth was around 6-6.5 per cent amid weaker global demand and risk aversion –– and not 7.6 per cent. HSBC argues that the primary concern with the calculation pertains to its deflator, so here is a quick explanation on how real growth is misrepresented.
Calculating real growth

The value of all finished goods and services is aggregated using current market prices, and compared to a base year to arrive at a nominal growth rate. However, this figure does not adjust for inflation and represents real growth in the economy. An increase in prices can pump up the GDP number without any real increase in production. A GDP deflator is used to reflect the overall inflation in all goods and services, and to adjust the nominal growth rate with reference to prices during a base year to neutralise any price effect on representing growth in the economy.

India uses two measures, WPI (wholesale price index) and CPI (consumer price index) to factor in its deflator. Different sectors of the economy are deflated by the respective index that is most suitable. In the past, both indexes have fluctuated together, so there was minimal impact on arriving at an accurate representation of real growth.
However, there has been a divergence between the CPI and the WPI from November 2014. While comparing the correlation coefficient between two time periods (January 2012 to November 2014 and November 2014 to May 2016), it plummets from 0.83 to 0.40 respectively. The difference between the WPI and the CPI has spiralled to as high as 9 percentage points, and is currently hovering around 5 percentage points. This chasm between the two is the result of plunging commodity prices.
In theory, all goods and services produced in the country must be deflated by the deflator that precisely captures their respective price changes. However, a recent RBI report exposes a major error in the use of the WPI.
The report states that the “WPI is widely used for many sectors. This tends to overstate the extent of price decline in the GDP deflator when WPI is in deflation. Services, which account for over 60 per cent of GVA (Gross Value Added), are not covered in the WPI; yet the WPI is used as deflator for several service activities such as trade, hotels and restaurant, real estate and transportation.”
Growth in over 60 per cent of our economy could be overstated as nominal growth in these service sectors has been incorrectly adjusted by low commodity prices to calculate real growth.
Bottomline: the GDP figures could indeed be inflated.
(This article was published on July 8, 2016)


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