Six months after its release, India’s new series of Gross Domestic Product (GDP) numbers continue to be surrounded by controversy. A growing number of critics have questioned the new estimates of India’s national output even as analysts look at alternative indicators to gauge the health of the economy.

Reserve Bank of India (RBI) governor Raghuram Rajan has stated publicly that it is difficult to take the new GDP numbers at face value. The lack of credibility and the absence of historical data for the new series have forced analysts to rely on projections based on the old GDP series, which has been officially discarded. In a 16 June note to clients, economists Chetan Ahya, Upasana Chachra and Nupur Gupta of Morgan Stanley Asia Ltd used the old GDP series to forecast India’s economic growth rate.

There are three key problems with the new GDP numbers.

Rewriting economics

First, the new GDP series fails basic smell tests. It completely rewrites India’s recent economic history as we know it, and challenges several well-established economic principles. The strong economic recovery which the new series suggests is out of sync with other macroeconomic indicators such as revenue growth of listed firms, credit offtake, tax collections, project announcements and data on India’s balance of payments.

The charts below plot the revenue growth of listed industrial firms (excluding oil and gas companies) along with the quarterly growth in GDP. As the charts show, while the old series moved largely in sync with the performance of listed firms, there is now a wide divergence.

It has been argued that smaller unlisted firms may have performed better, driving up overall growth rates of the corporate sector in recent times. But as macroeconomist Ajay Shah pointed out in a recent blog post, unlisted firms have fared even worse compared with listed firms in recent times.

The new GDP numbers overturn a fundamental principle of economic growth as they suggest the growth acceleration of the past three years occurred even as the rate of investment fell. The rate of investment or the gross fixed capital formation (GFCF), as a percentage of GDP, has steadily fallen from 33.6% in 2011-12 to 31.9% in 2012-13, to 30.7% in 2013-14, and finally to 30% in 2014-15 even as GDP growth accelerated. Such acceleration with declining investments is possible if there is increased capacity utilization of existing plants and machinery. But as successive rounds of Order Books, Inventories and Capacity Utilisation Survey (OBICUS) survey show, capacity utilization has also been steadily falling over this period.

The sharp growth acceleration in 2013-14 when GDP growth reportedly raced to 6.9% from 5.1% a year ago has baffled most observers of the Indian economy. This was the year of the rupee crisis, to battle which the RBI raised policy rates by 300 basis points.

“To my knowledge, nowhere else have such unpleasant events spurred significant economic recovery," wrote Shankar Acharya, economist and former chief economic advisor to the finance ministry.

Growing demand at a time of monetary contraction is not the only puzzling aspect of growth acceleration of 2013-14. As an analysis of 189 nations over 33 years by Reuters columnist Andy Mukherjee showed, never has any large economy had such a handsome improvement in growth even while recording a big improvement in external balances as India claimed to have had in fiscal 2014.

Questionable innovations

The second big problem with the new series lies in questionable innovations used to arrive at the estimates. The Central Statistics Office (CSO), India’s top statistical body in charge of estimating the GDP series, has said that the methodological innovations are in line with the new UN system of national accounts 2008 (SNA 2008). But as critics have pointed out, several of these changes have been mechanically applied without taking into account data limitations in the Indian context.

For instance, a new category called “quasi-corporates" was introduced in the new series to capture that segment of household enterprises which are unincorporated but maintain accounts. The savings of this set of firms is then imputed based on survey data. But in the absence of detailed balance sheet data, such imputations are not credible, argued K.G.K. Subbarao, a former RBI official, in an Economic and Political Weekly (EPW) article published in May. Besides, “the partial set of data available from the surveys does not exactly fit the definition conceived in the SNA 2008", he wrote.

Similarly, the use of service tax as a proxy for growth of certain services, and the use of growth rates of the organized manufacturing industry to estimate growth for unorganized manufacturing could potentially be over-estimating growth. After all, the growth in service tax partly reflects tax deepening (as new services are brought under the tax net) and does not accurately capture tax buoyancy. The assumption that unorganized manufacturing is growing at the same rate as organized manufacturing appears unrealistic. There is evidence to show that unorganized manufacturing has not kept pace with the growth of organized manufacturing over the past few years.

“We used the most current indicators of growth that were available," said Ashish Kumar, director general, CSO. “If we have annual surveys such as annual survey of services, we can use the survey data to compute growth. But in the absence of such surveys, we have to rely on proxies such as tax data."

The new corporate database

The most controversial aspect of the new series relates to the estimates for the corporate sector, and the use of a new methodology to arrive at these estimates. As reported by Mint on 2 April, methodological changes at the eleventh hour inflated the final estimates of corporate sector growth.

The earlier series derived the corporate sector estimates based on a sample survey of companies conducted by RBI. This sample consisted of only a few thousand companies, and hence the estimates were blown up (or multiplied) in proportion to the coverage of the paid-up capital of sample companies to the total number of companies registered with the ministry of company affairs (MCA). The problem with such estimation lay in blowing up the sample estimates because it was widely noted that many companies which are registered with MCA are inactive, or are shell companies, or they do not file returns.

A sub-committee appointed by the CSO to examine the methodology suggested the use of a new database, MCA-21, to construct the new GDP series. But instead of using the estimates generated from the database directly, as agreed upon by the sub-committee, CSO scaled up even these estimates to account for non-reporting companies, which had declared returns in earlier years. This was done on the advice of an advisory committee. This change has been questioned by an independent member of the sub-committee, R. Nagaraj, economist and professor at the Indira Gandhi Institute of Development Research, Mumbai. Higher growth in 2013-14 is largely on account of the discredited scaling up methodology, wrote Nagaraj in a May EPW article.

Agreeing with Nagaraj, former RBI official Subbarao pointed out that although the MCA-21 database is much larger than the sample covered by RBI, detailed accounts are available for only a small set of companies. The MCA-21 database consisted of half a million companies but detailed accounts were available only for around 30,000 firms. The lack of detailed data for the larger set of small companies makes it difficult to trust the corporate sector estimates, argued Subbarao. He pointed out that the new database seems to suggest that the savings-income ratio for unlisted firms was higher than the savings-income ratio for listed firms (which include most big firms in India), which does not appear convincing.

Given the wide-ranging inconsistencies in the new series and the disbelief with which it has been greeted by data users, it is imperative for the government to constitute an independent statistical audit of the entire GDP estimation process.

So far, the government does not seem to have woken up to the gravity of the problem. A committee headed by National Statistical Commission (NSC) chief Pronab Sen has been set up to examine the estimation methodology. But this is a routine review and a part of NSC’s mandate and does not really amount to an independent investigation. Sen has been among the most vocal defenders of the new GDP series ever since it was published.

Speaking at an industry summit in Mumbai last week, former finance minister Yashwant Sinha commented that the new growth rates are more statistical than real, according to a Business Standard report.

“It cannot be that you prepare one year’s figures and say now you’re doing 7.4% or 8% or 20%," Sinha said. “What are the new norms (of computation)? Even the chief economic adviser of the government of India does not understand this. And we’ve put the same culprits (who initiated the change) to sit in judgement over this change."

Unless an independent investigation takes place, it will be impossible to repair what has arguably been the biggest credibility crisis India’s statistical establishment has faced in the history of independent India.

Ravindra Sonavane and Dipti Jain contributed to the story.

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