The Mystery Behind India's Revised GDP Numbers In Two Charts
- Latest jump in official Indian GDP growth estimates is a result of using surprisingly low GDP deflator numbers in 2013 and 2014.
- If 2012 rate of inflation in GDP deflator is used for 2013 and 2014 as well, GDP growth rates become 5.5% and 5.0% rather than reported 6.9% and 7.4%.
- The halving of GDP inflation is not improbable, but neither the markets nor RBI is sure whether it is just a blip or a more permanent trend.
- In short-run, better GDP numbers may affect the urgency of an interest rate cut. But if low inflation becomes persistent, the investors can expect lower long-term interest rates & expectations.
- The stocks in capital-intensive sectors are likely to benefit. Transition of the yield curve will affect the government bonds market. Movement of INR will be affected by policy/ external factors.
India recently revised its official GDP numbers and the revision upgraded the GDP growth rates in 2013 and 2014 (estimated) to 6.9% and 7.3% respectively. With this release, Central Statistics Office (CSO) implemented many changes in its methodology to follow the guidelines of UN System of National Accounts, 2008. But the data update also changed the base-year used to split the growth in value of goods and services produced into changes in the quantity (or volume) and changes in the prices. To make the matter worse, CSO update provides the revised series only for last 3 years. This is one of the reasons that the analysts are finding it hard to make sense of this sudden jump in GDP numbers.
It seems like that this jump in GDP growth is coming because of the GDP deflator used. GDP deflator is the estimated price index for the goods and services produced in Indian economy with respect to the base year (2011) and is used to convert the value of each year's GDP into equivalent 2011 Rupee. Using the revised data, the figure below shows the percentage changes in deflators used for GDP and its components.
As can be seen, the inflation in GDP deflator series for year 2014 is just 3.8% as compared to 7.6% and 6.3% in 2012 and 2013.
Since GDP deflator is usually estimated using a wide range of data much of which is not publicly shared, it is hard for anyone to find out whether the numbers used are correct. It is possible that the rate of price rise in Indian economy has slowed down significantly. Both CPI and Wholesale Price Index have shown downward trends recently. Similarly, the price index of imports is driven by oil prices which have come down. The exporters don't need to raise their prices despite rising domestic costs and wages, because of the depreciation of Indian Rupee against US Dollar (one of the major export markets). But despite the direction being correct, the magnitude of the drop is surprising and needs closer scrutiny.
If official GDP deflator series overestimates the slowdown in price rise, how would the actual GDP numbers look like? We
can calculate the counter-factual series by using the official data on change in GDP deflator in 2012 as a baseline case. The chart below compares the difference in GDP growth estimates in last 2 years (2013 and 2014) that are due to use of lower GDP inflation estimates. If the inflation in GDP deflator was same in 2013 and 2014 as in 2012, then the GDP growth rates would be 5.5% in 2013 and 5.0% in 2014.
The effect of changing prices on GDP growth rates is not simply a manifestation of accounting methodology. In addition to the terms-of-trade effect, the anchoring of inflationary expectation can have real effects through investment and other channels. Hopefully CSO will provide an explanation of this sudden drop in GDP deflator or we will see other official price indicators showing the similar significant slowdown in rate of inflation.
This is the reason why the markets didn't react enthusiastically. BSE index barely responded to the news and there was minimal change in government bond yield.
Reserve Bank of India has said that they will study the new numbers in detail before deciding on the direction of the monetary policy. In fact, many investors and industry leaders were expecting an interest rate cut from RBI before this release. But India registering 7.4% GDP growth in 2014 and becoming the fastest growing major economy will reduce the likelihood as well as the amount of interest rate cuts that RBI will be making in near future.
Unlike the central banks in developed countries (Federal Reserve, ECB, BoE), RBI hasn't been as transparent in communicating its forward guidance. In past few quarters, the investors have even misjudged the probability and even the direction of the rate cuts. If the numbers are correct and drop in GDP inflation is resulting from RBI's target CPI remaining in 4%-6% range (something that RBI governor has mentioned he is comfortable with in medium term), then more interest rate cuts may not be ruled out.
This should result in better performance of the stocks in capital-intensive sectors which rely of investment. Similarly, overextended industry conglomerates and banks will also benefit from a lower level of interest rates. The resulting expectation anchoring is also likely to bring down the yield curve.
The impact of interest rates change on capital flows and thus on Indian Rupee will be determined by domestic macroeconomic factors (policy reforms) and external dynamics (US Fed raising interest rates). If the investors realize that the interest rates cuts are the result of taming of inflation rather than indicator of slack in Indian economy, the capital inflows are likely to continue in medium term.
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