Macro-Validation of India’s GDP Estimates · Arvind Subramanian India Policy Forum July 10, 2019 1. Outline •Background •Approach •The central puzzle •Results and key objections

Validating India’s GDP Growth Estimates

Arvind Subramanian

India Policy Forum

July 10, 2019

1

Outline

• Background

• Approach

• The central puzzle

• Results and key objections

• Methodological critiques

• Way Forward

2

Objective

• Shared objective that as a rising emerging market economy and one of the world’s largest and most important, India must have the best possible data system

• Important for:• Understanding the economy

• Policy navigation

• Incentives for action

• Reputation

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Early Flagging (Economic Survey, Feb. 2015)

How to reconcile surging growth

with other macro-indicators such

as investment and imports

Divergence between GVA

manufacturing and IIP

4

Background | Approach | The Central Puzzle | Results & Key Objections | Methodological Critiques | Way Forward

Doubts Persist (Economic Survey, July 2017)

• How is 7.5 percent GDP growth consistent with weak export, credit and investment growth?

• Comparison with cross-country experience

5


Two Critical Questions

• Can we validate the current GDP growth estimates?

• If not, is the over-estimation small or large?

6


Focus

• Technical, not political

• CSO methodology change, not more recent controversies

• Period covered in analysis: Real GDP growth in 2012-13 to 2016-17• Last two years of UPA-2

• First three years of NDA-2

• Notation: Pre-2011 will mean 2002-2011; Post-2011 will mean 2012-2016

7


Approach

• A validation exercise, not a new way to estimate GDP

• Method: check consistency of GDP with macro indicators

• Use demand-side, not production-side indicators• Exploits macro relationships between aggregate demand and growth

• Avoids need to select (possibly unrepresentative) sectors

8


Approach

• National Income Identity• Y= C + I + G + (X-M)

• Key variables are X and I• Theory tells us X and I tend to be exogenous drivers of Y

• Evidence supports that growth has been based on X and I, across Asia, including India pre-2011

• C and M are endogenous, depend on income

• C cannot be sustained without rising I and X

• Strategy• Since goal is to validate CSO figures for Y, use (reliable) proxies for demand variables

• Chosen variables:• Exports

• Proxies for investment (credit and imports, and also electricity consumption) 9


Pre-2011, India “normal” fast-growing country

• Growth 7.7 percent supported by…

• Booming investment, exports, credit and imports

• Indicators slightly higher than other countries growing at 7.5 percent

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

India Median (Other Countries)

GDP Export Investment Import Credit

10


Post-2011: Major shocks

• De-globalization: global trade growth collapses, so do India’s exports

• Twin Balance Sheet crisis: intense corporate stress, soaring nonperforming loans

• Oil and terms of trade: declining oil prices, boosts terms of trade and increases GDP growth

• UPA-2 Policy Disintegration (2012 and 2013): macro imbalances rise and policy credibility collapses, culminating in the 2013-14 balance-of-payments mini-crisis

• Severe and consecutive agricultural droughts (2014 and 2015): drag on growth

• Demonetization (2016): adverse impact on informal, cash-based sector11


Central puzzle …

Growth in Demand Indicators and GDP, Pre-and Post-2011 (%)

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Investment Credit (Indy.) Export Import Credit GDP

Pre-2011 Post-2011

12


Central puzzle: Almost no impact on growth!


-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Investment Credit(Indy.)

Export Import Credit GDP

Pre-2011 Post-2011

9.5 16.7

12.1

17.410.1

0.8

13


Central puzzle: Almost no impact on growth!

• Shocks caused key macro “engines” to stall: • Investment (and credit to industry)• Exports• Imports• Credit

• Illustrative magnitudes: A 12 percentage point reduction in export growth can reduce GDP growth by 3 percentage points!

• Yet measured GDP growth slowed only marginally• 7.7 percent to 6.9 percent


-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%



Pre-2011 Post-2011

9.5 16.7

12.1

17.410.1

0.8

14


Possible explanation 1: Major NDA-2 Reforms

• Transformational GST

• Potentially transformational bankruptcy procedures (IBC)

• Transformational welfarism via public provision of essential private goods and services (PPEPGS): cooking gas, toilets, housing, power, bank accounts (JAM), emergency medical insurance

• Growth impact of GST and IBC more medium-term and beyond the analysis period

• PPEPGS profoundly enhancing of quality of life but less direct impact on growth

15


Possible explanation 2: Productivity Surge

• Could productivity really havesurged:

• in the last two years of UPA-2?

• when exports and investmentgrowth were slowing sharply?

• when profits were fallingsharply?

Real Profit Growth of Corporate Sector (Annual avg., %)

-5%

0%

5%

10%

15%

20%

25%

30%

Before tax After tax

2002-11 2012-16 16


Possible explanation 3: Consumption surge

Consumer Confidence Survey (economy better than a

year ago)Index of Industrial Production, Consumer

Goods, (Annual avg.;%)

0

1

2

3

4

5

6

7

8

9

10

2002-2011 2012-2016

Confidence and actual indicators contradict consumption surge

17


Possible explanation: Consumption/Productivity surge

• Consumption surge must be met from three sources:

• Imports (also slowed)

• New capacity (but investment collapsed)

• Better utilization of existing capacity (but declined sharply)

Capacity Utilization(4-quarter moving average)

18


Summarizing the puzzle


-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%



Pre-2011 Post-2011

9.5 16.7

12.1

17.410.1

0.8

Pre-2011, India was a normal fast-growing economy, driven by investment and exports

Post-2011, a highly unusual economy with weak:

investment

profits

exports

credit and

(probably) consumption

Yet somehow it sustained a growth boom of 7 percent

19


Exploring the puzzle

• Two approaches

• Compare India’s experience pre- and post-2011 with that of large EMs

• Rigorously compare India’s growth-indicator experience with that of broader sample of countries, before and after 2011.

20


Growth and Indicators: Comparison with other EMsMacro-demand Indicators decline more in India

(percentage points post-2011 vs. pre-2011)But GDP growth declines much less

-18%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

Export Investment Import Credit

6-Country avg. India

-2.0%

-1.8%

-1.6%

-1.4%

-1.2%

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

GDP

6-Country avg. India

6-countries are Brazil, China, Indonesia, Korea,

South Africa, and Turkey 21


Growth and Indicators: Comparison with ChinaDemand Indicators decline by more in India

(percentage points post-2011 vs. pre-2011) But GDP growth declines much less

-18%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

Export Investment Import Credit

China India

-4.0%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

GDP

China India

22


Econometric strategy• Simply, combining the 2 comparisons above:

• India across time

• Other countries across time

• Does India become unusual?

• Regress GDP growth on key macro-demand indicators (X, Credit, M, and Electricity) for high and middle income countries for pre- and post-2011 periods

• Check to see if India is “on the line” under old GDP methodology

• See if it is “off the line” under new GDP methodology

• If so, is the deviation significant? 24


Key Regression Result: Confirms Intuition/Analysis

India normal country pre-2011 India positive outlier after 2011

25


Robustness check: is 7 percent plausible?

• Since 1980, how many countries have achieved 7 percent GDP growth, over any 5 year period, with India’s post-2011 combination of investment (3.2%) and export (3%) growth?

• Answer: None

• Median values of I, X necessary to achieve 7 percent is way above India’s

Combinations to Achieve 7 percent Growth

Median Values

India

(2012-16)

GDP 6.9% 6.9%

Export 9.8% 3.0%

Investment 11.8% 3.2%

Import 12.2% -0.8%

Credit 11.9% 3.3%

26


Robustness check: is over-estimation significant?

• What is the median 5-year GDP growth with India’s combination of I and X? • Answer: 3 Percent.

• Large over-estimation--~4.5% percent—not inconsistent with cross-country evidence

Growth rates of countries with India’s combination of investment and export growth

33

13

4

00

5

10

15

20

25

30

35

<3.5 3.5-4.5 4.5-5.5 >5.5

Num

ber

of

Ep

iso

des

Real GDP Growth27


Mechanisms: Deflators and Formal Manufacturing• Move from volume to value-based

measurement plus oil price decline plus lack of double deflation causes over-estimation in manufacturing

• Wedge between GVA and IIP manufacturing growth rises sharply post-2011

• But this can explain only part of overall over-estimation

Wedge Between GVA and IIP (Formal Mfg.) Growth, Pre- and Post-2011

-15

-12

-9

-6

-3

0

3

6

9

12

15

18

2000-0

1

2001-0

2

2002-0

3

2003-0

4

2004-0

5

2005-0

6

2006-0

7

2007-0

8

2008-0

9

2009-1

0

2010-1

1

2011-1

2

2012-1

3

2013-1

4

2014-1

5

2015-1

6

2016-1

7

2017-1

8

2018-1

9

Old methodology (average

wedge: 1.0 percentage point)

New methodology

(average wedge: 5.9

percentage points)

28


Mechanisms: Overall GDP Deflator Underestimated Substantially?Wedge Between CPI and GDP Deflator, 2002-2011

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Ken

ya

Cam

bo

dia

Jap

an

Ko

rea,

Rep

.

Guat

emal

a

Uru

guay

Isra

el

El Sal

vad

or

Un

ited

Sta

tes

Cam

ero

on

Bulg

aria

Net

her

lan

ds

Ph

ilip

pin

es

Den

mar

k

Egy

pt,

Ara

b R

ep.

Alb

ania

Co

sta

Ric

a

Cro

atia

Bo

livia

Pak

ista

n

Bra

zil

Mal

aysi

a

No

rway

Ro

man

ia

Wedge Between CPI and GDP Deflator, 2012-2016

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Bo

livia

Aust

ralia

Pak

ista

n

Ho

ng

Ko

ng

SA

R, C

hin

a

Ch

ina

Sin

gap

ore

Ph

ilip

pin

es

Sp

ain

Uru

guay

Par

aguay

Do

min

ican

Rep

ub

lic

Un

ited

Kin

gdo

m

Cyp

rus

Den

mar

k

Ital

y

Ban

glad

esh

Po

lan

d

Po

rtuga

l

Ger

man

y

Bulg

aria

Co

sta

Ric

a

Sw

eden

Pan

ama

Ro

man

ia

India (2.9%)

India (0.6%)

29


Mechanisms: Overall GDP Deflator Underestimated Substantially?

• For given nominal GDP growth, if GDP deflator growth under-estimated by 2 ¼ - 2 ¾ percent, real GDP growth over-estimated by same extent

• Nominal GDP growth can be mis-measured for other reasons related to quality of MCA-21 database etc.

• Pattern and magnitude of GDP deflator anomaly identical to GDP growth anomaly: normal pre-2011, strikingly unusual post-2011

30


Objection (to Large Over-Estimation) 1: The “disaster”

• Logic is:

• “4.5 percent would be a disaster

• India is not a disaster

• Therefore, growth cannot be at 4.5 percent”

31


Deeper origins of objection

• Difficulty in adjusting three cognitive benchmarks:

• How can we be back to pre-1980s growth? “Hindu growth, redux”

• How can we fall so much from boom period? “Boom, not bust”

• How can we be so much below our “potential?” “No New Normal”

32


Response• 4.5 percent represents some under-performance, certainly not a disaster,

even good

• Much better than pre-1980s • Represents 3+ percent per capita, more than TWICE pre-1980s per capita

growth of 1-1.5 percent

• 4.5 percent at $5,000 per capita (purchasing power parity) much more impressive than 3 percent at $1,000 per capita (PPP)

• India would still be second-fastest growing amongst $1 trillion-plus economies although it could be doing better given the “convergence” dynamic that poorer countries should be growing faster as Bangladesh, Vietnam etc. have shown

33


Response

• We have not adjusted to fact that Twin Balance Sheet (TBS) problem—afflicting the financial system and private investment—can have serious and persistent growth consequences. • Crisis versus slow-bleed

• In light of shocks, de-globalization and especially TBS—which is ongoing—potential may have to be revised downwards

• Growth under-performance can be rectified going forward with efforts to clean up the financial system and boost exports and investment

34


Objection 2: Rising tax-GDP ratio Inconsistent with Falling GDP Growth

• Inferring real growth from revenue performance tricky. Must account for:

• Tax policy changes

• Enforcement changes (e.g. demonetization)

• True, tax-GDP increased by 1 percentage point from 2011-2016, but 0.8 percentage point increase due to increase in petroleum taxes as excises hiked massively since 2014

• Direct tax performance consistent with sharp decline in GDP growth

• Nominal and real growth collapse, post-2011

• Post-2011, real revenue growth less than real GDP growth

Growth in Center’s Direct Taxes (Annual avg.; %)

0%

5%

10%

15%

20%

25%

Nominal Real

2002-11 2012-16

35


Technical/Methodological Issues• How can GDP be estimated with just four variables?

• Overlooking productivity growth

• Overlooking revenue performance

• Growth cannot be “low”

• Start the clock not in 2002 but 2004 because 2002 was a drought year

• Correlations can flip because of changes in structure. Flipping has happened before

• There are other outliers

• Other checks 36


Start analysis in 2003-04

• Because 2001-02 was a drought year, GDP growth under-estimated in pre-2011 period

• Results unchanged for every starting year from 2002-03 onwards

37


Correlations can flip because of changing structures

• Correlations can change, Yes

• But why should any major macro indicator such as exports, imports, credit, steel, index of industrial production etc. be so negativelycorrelated and become so within a short space of time?

38


There are other outliers

• In regression analysis by definition, positive and negative outliers

• India is amongst highest amongst “flipping” outliers

• In India’s case, the cumulative weight of evidence—shocks, comparisons with other countries’ experience, mechanisms, behavior of GDP deflator—makes case for scrutiny compelling

39


2011 just random/arbitrary dividing line

• Two checks.

• Dividing pre-2011 sample into two equal five-year periods

• Comparing coefficients as 2011 line shifted backward

40


Conclusions• Used a framework not to estimate but validate GDP growth estimates from the demand side

• Variety of mutually consistent and re-inforcing evidence indicating that over-estimation could be large.

• India’s sustained high GDP growth post-2011, despite large negative macro-economic shocks, unlike large EMs;

• India’s outlier relationship between GDP growth and macro indicators after 2011, despite a normal relationship before 2011;

• India clocking much higher GDP growth than other countries with same export and investment performance

• A large differential between manufacturing growth between national accounts and IIP, post-2011;

• Unusual correlations between macro-indicators and growth post-2011 compared to pre-2011; and

• GDP deflator under-estimation, which for given nominal GDP, implies real GDP growth over-estimation; 41


Way Forward• Outstanding issues: Is problem only with real or also nominal GDP growth? What

about MCA-21 data? Other ways of validating real and nominal GDP growth?

• Critical question: Can we accept that there has been substantial mismeasurement in GDP growth, warranting a re-visiting of GDP estimation procedures?

• Real opportunity: In this re-visiting, exciting opportunity to use GST data to come up with expenditure side estimates of GDP for the first time in Indian history

• That is the best gift India could give to our great, lovely, and loveable “TN,” whose spirit and work—and obsession with good measurement—imbues this year’s conference

42


Documents

Macro-Validation of India’s GDP Estimates · Arvind Subramanian India Policy Forum July 10, 2019 1. Outline •Background •Approach •The central puzzle •Results and key objections