CSO estimates and demonetization: An analysis

CSO estimates and demonetization: An analysis

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Context

There has been a consistent debate on how much demonetization has impacted our economy and the GDP especially. Several rating agencies have marked the GDP down by 60-110 basis points.

But CSO has released the new second advance estimates which peg FY-17 GDP growth at 7.1%. However several commentators are hinting that the numbers are fudged.

Skeptics are asking

6. How did the GDP growth for FY17 turn out to be so high when growth estimated by most private forecasters is 6.5%-6.8%?
7. Is the CSO implying that vacuuming up 86% of cash in circulation had no impact on the economy?

Unfounded Criticism

•  India’s GDP estimation method certainly needs improvement, but the CSO has been both transparent and consistent with its methods, allowing little room for suspicions of window-dressing or fudging of numbers.
• And a closer analysis of the CSO’s estimates suggests that, contrary to perception, they do factor in the impact of the note ban.

CSO does admits impacted by the note ban

To gauge the actual level of economic activity, Gross Value Added (GVA) is the more suitable indicator than the GDP.

• The GVA for FY17, as per CSO data, does show a dent from demonetisation. At 6.7%, it has registered a sharp decline of 110 basis points from 7.8% (revised estimate) for FY16. This GVA growth is pretty close to private forecasts.
• The two-wheeler sales collapsed by 22% year-on-year in December.
• banks reported anaemic loan growth at 5%
• cement despatches fell by 9% and
• Realtors saw a 40% dip in home sales and real estate and services saw growth collapse from 10.4% to 3.1%.

The other indicators show a positive growth

• What lifted the GDP is the strong 12.3% surge in indirect taxes that the CSO estimates for this fiscal powered by higher excise duty on fuel and service tax.This method is consistent with international practice of adding back net taxes by the output method.
• Other major indicators grew
  • steel output grew by 15%,
  • Power generation surged by 6%,
  • Refinery output expanded 6.4%.
  • Agriculture rebound by a 6%due to a good monsoon
• If bank credit slumped, companies doubled their borrowings from the bond market.
• Bumper 11.9% hike in ‘public administration, defence and other services’ has lifted the GVA after the Seventh Pay Commission.
• The urban discretionary purchases bounced back quickly as consumers switched to digital payments and some formalization of the neighbourhood Kirana stores helped increase in the growth.Other businesses shifted from the unorganised to organised players due to digital payments.

Analysts also suspect that, in some cases, companies mopped up demonetised notes from their distribution channels and pumped them with inventory instead. This would show up as ‘sales’ in the company’s books and as ‘output’ in GDP estimates

Informal Economy in GDP

A third criticism of the CSO estimate is that it fails to capture the performance of the informal economy, which clearly bore the brunt of the note ban.This criticism is partly valid.

• Over 40-45% of the Indian economy is informal and hardly any data points relating to it are available at a quarterly frequency.
• So CSO arrives at its quick estimates of the GDP by taking the available data from the organised sector and extrapolate it to infer informal activity.
• The GVA for agriculture is guesstimated based on kharif and rabi crop prospects.
• The GVA for services is inferred from sales tax collections, deposits and credit, telephone connections and so on.
• Manufacturing GVA uses the index of industrial production and listed company filings.

Due to such guesswork, it is quite likely that the quarterly GVA estimate, which mainly uses data from the formal sector, painted a rosier picture of growth than the ground reality.

But then, if the CSO — with its access to multiple data sources — has no way to estimate the quarterly performance of the informal sector, neither does anyone else.

Conclusion

CSO consistently follows the same method for measuring the informal sector and publicly discloses it; this is the only estimate we have to gauge economic activity. Both the methodology for estimating informal sector performance and GDP revisions are well-documented and disclosed on the Ministry of Statistics and Programme Implementation website.

More accurate estimates of what really transpired in the Indian economy post-demonetisation will be available when the CSO publishes its first revised GDP estimates, with more ground-level data, in January 2018.