Re-Basing GDP

Context: In the next few months, the Central Statistics Office (CSO) proposes to replace the gross domestic product (GDP) series of 2011-12 base year with a new set of National Accounts using 2017-18 as the base year. In 2015, CSO revised the base year from 2004-05 and the new GDP numbers caused a debate over the credibility of the data.

Relevance: 
Mains: GS III- Indian Economy and issues relating to planning, mobilization of resources, growth, development, and employment.

Background to the debate:

For the past four years, there has been a raging controversy over the current GDP figures on account of questionable methodologies and databases used.

• According to official data, the annual economic growth rate has sharply decelerated to about 5% in the latest quarter, from over 8% a few years ago.
• However, many experts have suggested that the annual GDP growth rates during the last few years may have been overestimated by 0.36 to 2.5 percentage points.
• Periodic rebasing of GDP series every seven to 10 years is carried out to account for the changing economic structure and relative prices.
  • Such re-basing usually led to a marginal rise in the absolute GDP size on account of better capturing of domestic production using improved methods and new databases.
  • However, the underlying growth rates seldom change, meaning that the rebasing does not alter the underlying pace of economic expansion.
• The absolute GDP size in the new base year 2011-12 contracted by 2.3% (compared to the old series) and the annual GDP growth rate went up sharply from 4.8% in the old series to 6.2% in 2013-14.
• Similarly, the manufacturing sector growth rate for 2013-14, swung from (-) 0.7% in the old series to (+) 5.3% in the 2011-12 series.
  • Such large variations in growth rates for the same year may be justified if the material conditions of production warranted.
  • But the higher growth estimates recorded by the new series did not square with related economic indicators such as bank credit growth, industrial capacity utilization or fixed investment growth. Thus began the questioning of the new GDP series.
• The suspicion of official output estimates became particularly intense after the demonetization of high valued currency notes in November 2016.
  • By most analyses, the economic shock severely hurt output and employment.
  • For example, the Ministry of Finance’s Report on Income Tax Reforms for Building New India provided data on fixed investment in the private corporate sector based on actual corporate tax returns.
  • It shows that the fixed investment to GDP ratio in the private corporate sector fell sharply from 7.5% in 2015-16 to 2.8% in 2016-17 (suspected to be on account of demonetization).
  • However, surprisingly, the ratio in the national accounts went up from 11.7% in 2015-16 to 12% in 2016-17.
  • The official GDP for the year 2016-17 grew at 8.2%, the highest in a decade.

The root of the problem:

The source of the problem, according to many economists, is the underlying methodologies for calculating GDP (in the 2011-12 series) which they claim are deeply flawed, as well as the new dataset used in estimating the private corporate sector’s contribution. Some of the recent, prominent criticisms are as follows:

• In a first, the CSO estimated value addition in the private corporate sector using the statutory filing of financial results with the Ministry of Corporate Affairs.
  • The private corporate sector accounts for about a third of GDP and spans all production sectors, and roughly about half of the private corporate sector output originates in manufacturing.
  • The database of the Ministry of Corporate Affairs has been criticized by many as unreliable; hence it is possible that the private corporate sector output has been overestimated.
  • For example, the Ministry’s database on “active” companies- that is companies claiming to have submitted audited financial results regularly for three years- seems to contain many companies that are actually inactive (not producing output on a regular basis).
  • Last year when the National Sample Survey Office (the government’s premier, independent, data-gathering agency), used the Ministry of Corporate Affairs list of active companies to canvass a sample of companies in the services sector, it found that up to 42% of the sample companies were not traceable, had failed to provide the information for the survey, or had failed to provide audited accounts.
  • For estimating GDP of the private corporate sector, questionable methods are also used for blowing-up unverified “sample” estimates for the unknown and varying universe of “working” or active companies.
• State domestic product (SDP) estimation uses many of the same databases and methodologies used in all-India GDP estimation. The methodological changes made in the 2011-12 base-year revision have adversely impacted the quality of SDP estimates on two counts.
  1. the Ministry of Corporate Affairs data does not have factory identifiers (that is, location of production units, but only has the location of the company head office); it has distorted distribution of the SDP estimates across States.
  2. for estimating value-added in the informal or unorganized sector, State-specific labour productivity estimates are unavailable in the 2011-12 series.
     Hence the method used distorts output estimation.

The CSO has denied the claim that the underlying methodology is flawed and that there are serious problems with the new database being used. The official response throughout the debate has been that the 2011-12 GDP series follows global best practices (meaning, following the latest United Nations System of National Accounts guidelines) and applies better methods using much larger datasets; hence the official estimates are blemish-less. This ignores the fact that India has always followed UN guidelines, and that larger data sets are not necessarily better.

Need for a review:

The proposed change over to a new base-year of 2017-18, is, in principle, a welcome decision. However, considering the methodological disputes and data related questions relating to the current national accounts series, as illustrated above, what would the rebasing potentially accomplish? Doubts will persist so long as the underlying methodological apparatus remains the same; feeding it with up-to-date data is unlikely to improve its quality.

• In view of the problems with the current series, a chorus of academic and public voices has proposed setting up an independent commission of national and international experts to review the GDP methodology. The ideal time to do this would be now so that solutions could be found and incorporated into the new GDP series.
• Conversely, if a new rebased series is introduced without any changes it will only entrench the existing methodological problems, and ensuring that the debate will continue for the next half-decade. And as the debate continues, so will the loss of credibility.