BackWhen GDP is a sum of all its parts
There're many parts of the economy that aren't accounted for and not captured in our GDP calculation
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There has been a lot of hue and cry about how the fiscal deficit has been achieved at the cost of growth, which was 4.6% of gross domestic product (GDP) in FY14. Interim dividends getting paid out, a roll-over of subsidy and curtailing planned expenditure have all helped in achieving the fiscal deficit target. Though the criticism may be valid, there’s a case to review the way India calculates key economic variables.
Let’s first look at how the US calculates inflation. It moderates inflation for improvement in products and services. For example, if an analogue TV was available at, say, 10,000, and now a feature packed digital TV is available for, say, 15,000, inflation does not jump 50%. It gets “appropriately" moderated for the improved features. This is a global best practice, which, unfortunately, is not followed in India. We calculate our inflation on a point-to-point basis on price performance rather than adjusting for improvements and features. We do, however, make adjustments for portfolio composition and base year over a longer period of time. There is a very good chance that if Indians start following the “global best practice", our inflation numbers will get moderated.
Let’s also look at how US makes “improvements" to its GDP calculation. In July 2013, the US GDP went up by about 3%, driven by a comprehensive update of the national accounts by the Bureau of Economic Analysis (BEA). What BEA did was that it improved the way research and development spending, housing transfer costs, pensions and artistic originals were accounted in the GDP. Preliminary analysis suggests that by accounting for part of research and development (R&D) spending as capital investments, about 2.1% could be added to US GDP in the base year of 2007. (A side effect would be improved corporate profitability as R&D spending would get capitalized rather than expensed). BEA gave a boost to GDP by appropriately accounting for the capital value of books, movies, records, TV programmes, plays and greeting card designs. While producing a movie takes, say, a year, it is enjoyed over a long period and, hence, its value is created over a long period.
Pensions used to be accounted in the form of defined benefit plans as per the contribution; surplus or deficit was ignored. Now, BEA is accounting to include the actual status of the defined benefit pension plans and not just contributions. A correct assessment of surplus or deficit will additionally bring the focus on unfunded pension plans. BEA has also made adjustments to include costs related to housing transfer such as stamp duty, registration charges, in the overall cost of the house rather than treat these as an expense.
All these improvements are being made to correctly assess the size of GDP. A larger GDP expands the denominator and thus reduces the overall fiscal deficit to the GDP number. Imagine how much understated Indian GDP is as we have not capitalized Ramayan, Mahabharat and Bollywood movies.
There are many parts of the Indian economy that are not accounted for and, thus, not captured appropriately in our GDP calculations. We have a reasonably large parallel economy in which both public and private businesses participate. Anecdotal evidence suggests that a slowdown in the parallel economy has been far less than in the real economy. Just released minutes of the US Federal Reserve noted (albeit in a lighter vein) a decline in parameters such as waiting lists for club memberships, reservations at high-end restaurants and demand for cosmetic surgery as harbingers of a slowdown. In India, such parameters are pointing towards strong growth, which may be in the parallel economy.
While it is likely that GDP calculation correctly takes into account a transaction where at least one party belongs to the real economy, there are enough bilateral transactions that take place entirely in the parallel economy. Our tax-GDP ratio of below 10% strongly suggests that the parallel economy is quite large and thriving. It would be fair to assume that what is invisible to tax authorities is not measured or captured correctly in the GDP data. Maybe the time has come for us to add the invisible parallel economy to our GDP calculations. I am sure that just the way US accounting of intangibles is acceptable to the world, India’s accounting of invisibles will also be acceptable.
It’s also high time that we find a way of including the contribution made by Indian women in our GDP. In many parts of the developed world, women don’t work at home as much as Indian women do. In some sense, the US has a higher GDP as people eat out often; creches for infants is more norm than exception; and using professional house cleaning agencies is common. Even funerals are managed by professional service providers rather than relatives. All these activities contribute to the GDP. But similar activities done by mostly unpaid, and under appreciated, Indian women are not correctly accounted for in our GDP. I am sure that there is improvement possible in accounting for contribution of Indian women in the GDP.
The accounting of debt to GDP is another contentious issue. In the context of the US, where a reasonable portion of their debt is held by foreigners, accounting for debt and debt servicing has a different connotation than in India, where bulk of the debt is owned by locals. India has a debt of about $936 billion, most of which is from Indians (banks, insurance companies, provident funds, mutual funds and citizens of India). The government is made and owned by the people of India. Logically, government debt is a contra entry on the asset and liability side of the Indians. The context of debt owned and owed by Indians is different from US where debt is owned by the rest of the world and owed by the US government, a.k.a. citizens of USA.
This hypothesis was, in fact, tested in Japan for more than two decades. Japan’s debt-GDP ratio is one of the highest in the world, at more than 200% of GDP. In the language of Star Trek, Japan’s debt-GDP ratio has boldly gone where no economist’s imagination has ever gone.
Since the bulk of the Japanese debt is owned locally by Japanese institutions and citizens, it keeps on reaching newer heights. If we had taken a poll of economists and rating agencies in the 1990s, most would have said that a debt-GDP ratio of above, say, 100%, means the country will be in dire straits, that the economy will collapse. Clearly, Japan has demonstrated that that is not so—it’s economy is chugging along despite the high debt-GDP ratio. It is important to differentiate between debt owned and owed in the family versus debt owed to outsiders and owed by the family.
P.S.: My younger daughter believes that higher the debt, higher the deficit, and better the credit rating. I don’t know how to convince her otherwise.
Nilesh Shah is Managing Director and CEO, Axis Capital.
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