By Pranjul Bhandari, Aayushi Chaudhary & Priya Mehrishi
A puzzle of sorts has arisen (once again) in India’s GDP estimates. The statistics workplace is estimating that immediately after expanding .4% yoy in Q3, development will go back into contraction mode in Q4, contracting 1.1% yoy.
This should really have implications for investors, who are broadly expecting that India is out of the woods and will develop positively more than the next handful of quarters. Furthermore, a unfavorable development clip in Q4 does not sit properly with the higher frequency indicators, which continue to tick greater.
Further investigation reveals that there are some methodological difficulties in the calculation of development, which are possibly not just distorting existing development estimates, but could even leave an imprint on development information for the next handful of years. It could even have distorted development estimates in the previous handful of years.
1. Which information points alerted us to the trouble?
Q3FY21 GDP came in weaker than anticipated, but Q3 GVA was not as weak. There was a surprisingly sharp distinction among the two measures of development (.4% GDP development versus 1% y-o-y GVA development). Note that the distinction among GDP and GVA development is normally reduced, at .2ppt (10-year typical).
This sharp distinction also extended to the FY21 complete-year advance estimate of the statistics workplace (-8% GDP versus -6.5% GVA development). Compared to the earlier advance estimate which was released in January, GVA was revised up (to -6.5% versus -7% previously), but GDP was revised down (to -8% versus -7.8% previously).
Working out the Q4FY21 estimate from the complete-year one suggests that the statistics workplace expects GDP development to contract 1.1%, but GVA to expand 2.5%. This got us confused. Is development ticking up, or sliding down?
2. What explains the divergence among GDP and GVA?
We know that GDP = GVA + indirect taxes – subsidies. We also know that indirect taxes grew sharply in Q3 (GST grew +8% y-o-y central government indirect taxes grew 33% y-o-y). So, for GDP to develop at a a lot slower pace than GVA, subsidies would have had to develop rather strongly. But why would that be? Because the spending budget on February 1, created it all also clear that more than two years, the government intends to spend off previous unpaid dues to FCI, the intermediary for meals subsidies. To be precise, the program is to spend .9% of GDP in FY21 and .3% of GDP in FY22. Repayment of some of these resulted in bloated subsidy development, thereby depressing Q3, Q4 and FY21 development estimates.
3. But shouldn’t the GDP methodology have a way to take care of this?
Yes, if just about every financial agent employed the identical accounting methodology. Let us clarify. For simplicity sake, let us work with two financial agents—the FCI and the central government. If each did “accrual accounting”, we would not have a trouble. The FCI would account for subsidies in the year they accrued, and the government would account for them in the identical year also. In this scenario, GDP would be a superior indicator of underlying development, rather than GVA (due to the fact it strips off the subsidy payments, which have a tendency to inflate GVA).
The trouble arises when the FCI and the government adhere to diverse accounting practices—for instance, if the FCI does “accrual accounting” though the government does “cash accounting”. In this case, there could be a trouble, for instance, if the subsidies in FCI’s books accrued (say) final year, but the government only paid up in the existing year. To arrive at the GDP quantity, the statistics workplace would finish up subtracting from existing GVA more subsidies than what accrues in the existing year. This could lead to an underestimation.
And, certainly, this is what we feel is going on. The FCI has clarified in its accounts manual that “all expenses are accounted for on an accrual basis.” It has gone on to clarify that “income is recognized when there is reasonable assurance for its realisation and is earned (usually when goods are transferred or services rendered), no matter when cash is received.” On the other hand, we know that the Indian government records expenditures on a money basis.
4. Were earlier-year development numbers impacted also?
Yes, probably. If we are ideal with our evaluation so far, there is a likelihood that previous numbers have been impacted also. The government has been owing funds to the FCI more than the final many years, and the quantity picked up swiftly from FY18.
Over these years, the FCI would have accounted for the subsidies in its books and this would show up in GVA. However, the government did not spend up on time. As such, a smaller sized money subsidy quantity was deducted from GVA to arrive at GDP, thereby potentially overstating development.
Indeed, we locate that more than FY18 and FY19, GDP development was .6ppt greater than GVA development (versus the .2ppt typical in the earlier 5 years). True, some of it could be due to the fact of other things like a fall in fuel subsidies or a rise in indirect taxes but, regardless, we feel this deserves investigation.
5. By how a lot could future development numbers be impacted?
The government plans to repay the dues for subsidies more than the next two years, FY21 and FY22. Its FY21 advance estimate for GDP development is -8%, reduced than the GVA advance estimate of -6.5%.
About half of the 1.5ppt wedge, by our calculation, is due to the fact of the distortions developed by the payment of previous subsidy dues, and does not reflect actual weakness in financial activity.
Moreover, it ends up inflating the GDP development quantity in FY22, due to the fact of a low statistical base. However, some of the base effects could be offset by the balance payment of previous subsidy dues (budgeted at .3% of GDP in FY22), which could finish up depressing GDP for the factors explained.
We work all this out cautiously and locate that, on net, the positive base impact effect overshadows the unfavorable payment of subsidy dues effect, major to GDP development becoming overstated by 1ppt in FY22. Finally, the repayment of balance dues in FY22 could effect FY23, once again due to low base effects. We calculate that GDP development may possibly be overestimated by .5ppt in FY23.
6. What, then, is the ‘true’ financial development in India?
In standard occasions, GDP is a more wholesome indicator of financial development than GVA, due to the fact it consists of the government as properly. But with GDP impacted by payment of earlier-year subsidy dues, we feel GVA will superior reflect financial development, not just in FY21 but also more than FY22 and FY23.
7. What occurs to HSBC development estimates?
As explained above, the distinction in accounting procedures by the FCI and the government may possibly overstate GDP development in FY22 and FY23. But it is also attainable that the statistics Office corrects this trouble more than time. In the previous, the statistics workplace has attempted to increase its methodology, even if it implies generating sharp modifications to GDP history. We will as a result wait and watch, at least till the next GDP release scheduled for May, when a lot of revisions have a tendency to come about.
For now, we will stick to our previously published forecasts of -6.3% y-o-y GDP development in FY21, 11.2% in FY22, and 5.8% in FY23, which we feel reflect the ‘true’ development on the ground.
Excerpted from HSBC Global Research, Economics India report (March 4)
Bhandari is chief economist, Chaudhary is economist & Mehrishi an associate, HSBC Securities and Capital Markets (India)