Issue with India’s GDP calculation: Is India’s growth rate overestimated?

Source: This post on issue with India’s GDP calculation has been created, based on the article “Is India’s growth rate overestimated?” published in “Indian express” on 30th March 2024.

UPSC Syllabus Topic: GS Paper 3-Indian economy-mobilisation of resources, growth, development.

News: This article explains that India’s method of calculating GDP growth has issues, making the growth seem higher than it is.

What is the current issue with India’s GDP calculation?

Old GDP Calculation Methodology

Volume-Based Indices: Initially, India’s GDP calculation relied heavily on indices like the index of industrial production.

Real Growth Calculation: Real growth was calculated directly, and the deflator was applied afterward, making the deflator’s accuracy less critical.

New GDP Calculation Methodology (Since 2015)

Nominal Terms Measurement: GDP is now measured in nominal terms first.

Use of Deflators: The calculation uses deflators, like the Wholesale Price Index (WPI), to adjust for inflation and find real growth.

Issues with WPI: WPI is not an ideal measure for output prices, especially in the services sector, which constitutes two-thirds of the economy.

What are the problems with the GDP Deflator?

Use of Wholesale Price Index (WPI): Instead of a Producer Price Index (PPI), India uses WPI, which doesn’t track producer prices accurately and excludes service prices.

WPI’s Commodity Skew: WPI is biased towards commodities like oil and steel, and does not reflect the broader economy.

Mismatch with Consumer Prices: There’s a disconnect between WPI and the Consumer Price Index (CPI). For example, from September 2022, CPI inflation remained over 5%, while WPI inflation declined due to falling global commodity prices.

Impact on Real GDP: This mismatch led to an inflated real GDP. For instance, during April-December 2023, WPI inflation averaged -1.0%, artificially raising the real GDP figures.

Single Deflation Methodology: India uses one deflator for both inputs and outputs in manufacturing, which can misstate growth when input and output prices diverge.

What’s the impact of these issues?

Overestimated GDP Growth: The flawed deflator method leads to higher reported GDP growth. For example, the real growth in the manufacturing sector was inflated due to the fall in WPI.

Distortion in Sectoral Growth Rates: Sectors like manufacturing show inflated growth. Official numbers for the first three quarters of 2023-24 were much higher than they would have been with a more accurate deflator.

Misleading Economic Indicators: These inaccuracies can mislead policymakers and investors about the actual health and growth pace of India’s economy, impacting economic decisions and long-term planning.

What should be done?

Adopt Consumer Price Index (CPI): Switch to using the CPI for deflating GDP, as it’s closer to producer prices than WPI.

Implementation of Double Deflation Methodology: India should adopt double deflation, where outputs are deflated using an output deflator, and inputs using an input deflator, especially important for sectors like manufacturing.

Develop Producer Price Indices (PPI): Establishing a PPI in India would also aid in more accurately deflating GDP figures, aligning with international standards.

Question for practice:

Discuss the issues with India’s current GDP calculation methodology and their impact on reported GDP growth and sector growth rates.