Published On: Mon, Apr 10th, 2017

The deflator angle to India’s GDP controversy – Shri. V. P Nandakumar

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 The Central Statistics Office (CSO) has recently released estimates that India’s GDP for the third quarter ended December 2016 recorded a growth of 7 percent, sharply beating expectations for a much lower 6.4 percent growth rate indicated in a Reuters poll held just before. The numbers were greeted with considerable skepticism by a section of think tanks, economists, investors, analysts, etc. who expected that the disruption to the economy from the cash crunch following demonetization would show up as a steep fall in GDP growth rates.However, anyone who has been following the GDP growth figures released by CSO in recent years would know that controversy about these numbers is not new and actually pre-dates demonetization. To be precise, the controversies began with the revision in the method of calculation of GDP growth in 2014-15. Two important changes were made for that year.

  1. Change in base year: The government changed the base year for estimating GDP from 2004-05 to 2011-12. However, this is done routinely after every five years to better reflect the changing structure of the economy.
  2. Shift from factor-cost based method to market-cost based method: India’s GDP is now measured by using gross value added (GVA) at market price, rather than factor cost. Simply put, the new formula takes into account market prices paid by consumers. Earlier, domestic GDP was calculated at factor or basic cost, which took into account prices of products received by producers.

The above change in the method of calculation has brought Indian GDP calculations more in line with global practices. For example, IMF’s world economic outlook projections, are based on market cost and not factor cost which often created confusion in the past, with IMF’s projections diverging significantly from the Indian Government’s figures. Therefore, the impression among some that the new GDP calculation method is faulty or that the switchover was deliberately done to show the government in a good light does not seem correct.

Now that the post demonetization GDP numbers have added fuel to the fire, it is perhaps appropriate that we delve a little deeper and try and understand what the issue is about.  The topic is complex and involves intricacies not easily comprehensible to the layman. Therefore, in this article, I shall focus on one aspect of this problem that is easy to understand and seems to offer a credible explanation.

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The deflator angle to India’s GDP controversy – Shri. V. P Nandakumar