Questions on India's GDP

When India’s GDP numbers were announced for the last quarter, the IMF said those numbers didn’t sound very accurate. Nithin Sasikumar wrote this excellent article on the concerns raised. He put two disclaimers right at the beginning. #1:

“Now I should point out that the IMF didn’t call us untrustworthy. They simply said that we can do better at how we calculate GDP.”

And #2, his post is not about the politics of GDP calculations.

 

Before going into the issues and concerns, he starts by explaining what GDP is, and why it is so important to calculate correctly. Simply put, you take all the economic activities in the country in a year (“sales from IPL tickets in Jaipur, biscuits being sold in Pune, setting up of a new factory in Chennai”) and sum up their values to get the GDP. It gives an idea of the overall state of the economy. It becomes one of the criteria for governments to frame policies, decide what to spend on, how much to increase taxes, and for the RBI to decide on interest rates.

 

The next question: how does one calculate the GDP? There are 3 options:

(1) Expenditure method: how much was spent (private, government, corporate investments, add exports and subtract imports).

GDP = Consumption + Investment + Government Spending + Exports – Imports

(2) Income method: Sum up the income of individuals and companies.

(3) Output or production method: Add the value of all goods and services.

 

Next comes the topic of nominal GDP v/s real GDP. Nominal GDP is just the sum of the value of all goods and services. This approach doesn’t convey if more goods or services were produced? Or the prices of things went up? Real GDP adjusts the nominal GDP for inflation to make comparisons easier.

 

Now we can come to the concerns raised wrt how India’s GDP is calculated. The major one is that the inflation factor is too old (it is based on year 2011-12) and thus not so relevant. After all, back then, e-commerce was much smaller, digital payments were non-existent, and the share of the informal sector was much larger. The best practice is to update the base year every 5 years.

 

The second concern is that India uses the WPI (Wholesale Price Index), not the PPI (Producer Price Index) to calculate the inflation factor. This too is a valid point since WPI only looks at manufactured goods, not services whereas PPI considers both goods and services (e.g. healthcare, banking, Swiggy).

 

And lastly, in theory, the production and expenditure methods of calculating GDP should produce the same answer. But for India, they don’t. This last point isn’t recent – the “discrepancy” has been there for decades. Why?

“One theory is that it’s to do with India’s massive informal or unorganised sector.”

Since the unorganized sector is under the radar, its contribution is guesstimated (ignoring it altogether would mean the GDP value would be very wrong). And since it is guesstimated differently in different systems, we get different values.

 

The government is working on updating the base inflation year to be 2022-23. It is also starting to take steps to switch to the PPI way instead of the WPI way. The last one though (unorganized sector) can’t be solved since that sector is still quite large, and no matter how you guesstimate it, one can never be sure how inaccurate it may be.

 

I found this a great explainer on the whole topic. Plus, it didn’t get political, as promised by Sasikumar at the beginning.