GDP: The jury is still out

Mythili Bhusnurmath

Senior consultant, National Council of Applied Economic Research 

In the discourse regarding politics vs economics in elected democracies like India, there are just two macroeconomic indicators that have the power to make or break governments: the rate of inflation and the rate of growth. Though the government does pay (and has paid) a political price for high inflation, there is now at least the semblance of an excuse. Inflation control is the domain of the monetary authority, the Reserve Bank of India. More so after the introduction of a new monetary policy framework agreement between the government and RBI and the amendment to the RBI Act 1934, that unambiguously makes the central bank an inflation targeter. 

That leaves the GDP growth rate as the sole economic determinant of government's electoral fortunes. This is not to say that elections are won on the basis of economic performance alone. In India, where factors like caste, class, religion, language, ethnicity play a role, to say economic growth can swing elections would be naïve. 

At best, one can resort to the refuge of economists and say, ceteris paribus (other things remaining the same) higher GDP growth improves the electoral prospects of the ruling party. But since in the real world, nothing remains the same, the connection is tenuous. Though the GDP growth does give the government of the day bragging rights. This despite the fact that the measurement of GDP and its growth rate suffers from numerous drawbacks. 

GDP measurement not perfect 

For one, it relies on broadly-accepted but questionable conventions and methods of calculation that are far from perfect. It includes certain economic aspects but excludes others. Essentially, economic activities are measured in value terms, added up according to pre-determined rules and aggregated as a single number. Since it is a money value of goods and services, unpaid work, for instance, is not included in GDP. So if a homemaker were to employ a maid at home, GDP would go up without any increase in underlying economic activity.  

For another, high GDP growth does not say anything about the welfare consequences of that growth; the important question if welfare has increased is not addressed. Nor does it say if higher growth has come at the cost of greater income inequality, between individuals and/or between regions, as is increasingly the case. These are just some of the drawbacks.

Reading the GDP numbers

With that caveat in mind, how should we read second quarter GDP numbers released by the Central Statistical Organisation on November 30, 2017? With a pinch of salt! Yes, the economy does seem to be climbing out of the hole it had dug itself into, thanks to demonetisation and GST. But these are numbers based largely on the performance of the formal sector; data for the informal sector, that was more seriously impacted by demonetisation and GST, will come with a lag. Also, though growth is better than in the last two quarters, it is still well below the 7.5% recorded in the second quarter of the last fiscal. 

Worse, gross fixed capital formation (GFCF), which is a measure of investment in the country, has declined, from 27.1% of GDP in the first quarter to 26.4% of GDP (in constant prices), in the second quarter. With government spending constrained by the fiscal deficit target, the ability of public expenditure to shore up consumption/investment is limited. Add to that rural distress as agriculture growth slows down this year relative to the last, the prospect of higher oil prices, growing protectionist tendencies and rising geo-political tensions and suddenly the recovery looks much more fragile. Is this being unduly pessimistic? Perhaps! Except that the government's Economic Survey is on record over its unease at the growing wedge between steady growth and underlying weak drivers of growth.  

That's on the downside. On the upside we have the sharp recovery in manufacturing growth, up from 1.2% in the previous quarter to seven per cent in the second quarter. If, as is likely, only a part of this is due to re-stocking, after the de-stocking witnessed in anticipation of GST, manufacturing seems to be in a better shape than before. This is corroborated by the higher PMI (Purchase Managers' Index) recorded in November 2017. What is also noteworthy is that higher growth has come despite the slowdown in government expenditure, suggesting the private sector is slowly re-discovering its animal spirits. 

So despite the apparent improvement in economic performance, it is still somewhat of a mixed bag. The final growth number for the year could be anywhere between 6.5 and 7%; well below both our potential and our need. Growth could be higher in the next fiscal, the last full year before we head to the 2019 General Election. But how much of it is attributed to government policy and how much to luck is debatable. For, this has been a lucky government. If the first two years saw a dramatic fall in oil prices that is estimated to have given us an additional two percentage point growth, the last two years are likely to see strong global economic recovery. The US economy has grown at an annualised rate of 3.3 % in the third (July-September) quarter, the European Union is recovering as is Japan. 

A rising tide, it is said, lifts all boats. India could be a beneficiary. But what matters is whether the government has been able to seize the advantage provided by a benign external environment and translate it into a better life for its citizens. And on that, the jury is still out! 

The upside

• On the upside of a higher GDP, we have the sharp recovery in manufacturing growth, up from 1.2% in the previous quarter to seven per cent in the second quarter. If, as is likely, only a part of this is due to re-stocking, after the de-stocking witnessed in anticipation of GST, manufacturing seems to be in a better shape than before.
• Also, the higher growth has come despite the slowdown in government expenditure, suggesting the private sector is slowly re-discovering its animal spirits.