COLUMN ECONOMY Dr Bharat Jhunjhunwala
Finance minister Jaitley should understand that the economy cannot be
pulled by pep talk; correct policies are desperately required
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BLURB
The government has embarked on a policy of cutting expenditures to
control fiscal deficit. A logical result is that the growth rate in
the provision of government services has declined. Other indicators of
the economy point in the same negative direction. Therefore, the
growth rate of 7.5 per cent announced by the government is hugely
suspect
TEXT
The Union Government recently announced that India has become the
world’s fastest growing economy with the GDP growth rate having
reached 7.5 per cent in the last quarter of the previous financial
year — that is, January to March 2015. The claim is suspect because
other indicators of growth do not support such a rosy picture.
GDP or “Gross Domestic Product” is essentially a measure of the size
of the economy. How would we measure the size of a farm? We would look
at the amount of various production activities undertaken there. One,
the vegetables and grains that were produced and consumed by the
farmers’ family. Two, the grains that were produced and sold in the
market. Three, the investment made in, say, a shed for the cattle.
Four, the amount of grains and other items produced on the farm and
sold in the market. These all would consist of the “production” that
is done at the farm.
GDP of a country is calculated similarly. Statisticians estimate the
amount of goods consumed by the citizens. They undertake surveys to
find out how many pairs of clothes, cars, TVs, furniture, vegetables
and other items are consumed by an average family. This includes
consumption of services such as movies, computer games, tourist
visits, cricket matches, restaurants etc. The consumption undertaken
by a family is multiplied by the number of families in the country.
That gives an estimate of the total amount of goods produced and
consumed in the country.
Two, an estimate is made of physical investments made by businesses in
factories, offices cars etc. The ministry of statistics compiles this
data from the balance sheets of the companies and through surveys.
This gives an estimate of the goods produced for the purposes of
investment. Three, the consumption done by the government is
estimated. The money spent in making highways, defence equipment and
radio stations is calculated. These too are things that are produced
in the country and add to the size of the economy.
Four, the value of goods that are exported is calculated. These goods
are produced in the country but are not captured in the consumption
and investment figures mentioned above. They are added to GDP because
they were produced in the country. On the other hand, value of goods
that are imported is subtracted from the GDP because these goods were
not produced in the country even though they were consumed here. A
family may buy a dozed washington apples. The value of these apples
would get included in the estimates of consumption arrived at through
surveys as indicated above. But these apples were not produced in the
country. Hence their value cannot be added to the production
estimates. Thus, the imports are deducted from the GDP estimates.
Finally, GDP is the total of consumption, investment, government
expenditures and net exports. This gives an estimate of the size of
the economy.
Estimation of each of these items is made by first making a list of
items to be included for assessment. Let us say shoe is an item of
consumption included in the list. Then the number of shoes consumed by
a family is estimated. Then the cost of production of the shoes is
estimated. The GDP is arrived at by multiplying the number of shoes,
the cost of shoes and number of families in the country.
The government has revised the methods of calculating GDP recently.
This is a normal procedure. The items consumed by a family undergo
change with time. Twenty years ago, there was no consumption of mobile
phones. The GDP arising from consumption of mobile phones today would
go unaccounted if we had continued to work on the list of items of
consumption made in, say, 1995. Therefore, the government updates the
list of items consumed every five to ten years. A new list of goods is
made. GDP figures can be inflated if fast-growing items like mobile
phones are given more weight and slow-moving items like bicycles are
given less weight.
The GDP was estimated on the basis of “factor cost” till now.
“Factors” are the raw materials used in manufacture. The “factor cost”
of shoes would include the value of leather, threads, adhesives, and
laces that go into the production of shoes. The price at which the
shoe is sold in the market is not considered in factor cost. The
government has now changed the basis to “market price” that is the
international standard. This means that the price at which the shoe is
sold would be taken for estimation of GDP. Obviously, this would be
much greater. And there is considerable flexibility in determining the
“market price.” Government officials can determine higher market price
than that is actually prevailing and thereby artificially increase the
GDP estimates. Such stratagems appear to be adopted by the government
in pushing up the GDP figures and claiming a 7.5 per cent growth rate
for the last quarter. I say this because other economic indicators
indicate a downward movement.
One, RBI data indicate that in 2014-15 non-food bank credit increased
by just 8.9 per cent in April 2015, compared to the increase of 14.2
per cent in April 2014. Growth in loans given to industries declined
to 6.4 per cent from 12.3 per cent last year. Two, many large
companies in the BSE Sensex have declared a drop in their profits in
the last quarter. For example, L&T, Sun Pharma and Mahindra & Mahindra
have reported a decline in net profits of 27 per cent, 44 per cent and
39 per cent respectively. Knowledgeable sources say this tendency is
widespread.
The services sector contributes about 60 per cent to the GDP. Within
this, the contribution of government services such as police and
defence is an important part. The growth of government services has
declined to 0.1 per cent in January to March 2015 period against 19.7
per cent in October to December 2014. The government has embarked on a
policy of cutting expenditures to control fiscal deficit. A logical
result is that the growth rate in the provision of government services
has declined. Other indicators of the economy point in the same
negative direction. Therefore, the growth rate of 7.5 per cent
announced by the government is hugely suspect. The growth rate for
October to December 2014 was revised downwards to 6.6 per cent from
7.5 per cent. It is quite likely that the growth rate for January to
March 2015 will meet the same fate. Finance minister Jaitley should
understand that the economy cannot be pulled by pep talk. Correct
policies are desperately required.
The writer is a former Professor of Economics at IIM Bangalore