The latest GDP numbers for the economy reveal an interesting phenomenon. The growth rates in both nominal and real terms are almost the same, at 7.8-8 per cent. This means there is hardly any difference in the growth rates when production is reckoned at current prices and at constant (base 2011-12) prices. Normally the growth in GDP in nominal terms tends to be higher than that of real GDP.
The answer lies in the queer case of inflation in India, where CPI inflation is moving in the positive direction, and quite prodigiously, WPI inflation is in negative territory. Technically the difference between the nominal and real GDP of any country is the GDP deflator and that is a derived number.
The way the GDP numbers are calculated is that output is reckoned in nominal terms, which is at current prices; this is how they are available in the market. This is the data that comes from balance sheets of companies or tax collections which are always at current prices. Real GDP in a way reflects the physical volume of goods and services denominated in monetary terms which takes out the inflation effect. To arrive at the real numbers, which is what is quoted when we talk of GDP growth, price deflators are used.
For every component of nominal GDP there are appropriate price deflators. And in this calculation, the WPI indices are generally used. Hence, if WPI inflation is in the negative zone, which is what it was in Q1, then growth at both constant and current terms would tend to converge. For Q1, the WPI registered -2.7 per cent growth with the three components primary, fuel and manufactured goods witnessing negative inflation of -1 per cent, -7.1 per cent and -2.7 per cent, respectively.
Given the overall wholesale price environment, it does look like that this will be the trend during the course of the year as global commodity prices have a role to play here. This will in turn bring about near convergence in these two rates. If this is the case, then the normal assumption that economists work with, which is that nominal GDP growth will generally be 4-5 per cent higher than real GDP growth will definitely not hold. In FY23 for instance, the difference between nominal and real GDP growth rates was 8.9 per cent while it was 9.4 per cent in FY22. Does this create a problem?
The answer is yes. When we talk of becoming a $5 trillion economy, the reference is to the size of the economy in nominal terms. Low nominal growth will come in the way of achieving this target; the time taken to reach this mark will be more. More so if low global inflation continues for another year, which cannot be ruled out as the IMF does not see a major bounce-back of the world economy in 2024, prices will remain benign in the absence of a China shock. Under normal conditions of ‘deflator’ inflation at 4-5 per cent, it would take us four more years to reach the target. The challenge becomes stiff under such deflationary conditions.
The other issue relates to various policy ratios that are calculated. The fiscal deficit ratio has been projected at 5.9 per cent for the year with GDP growth of 10.5 per cent. As budgetary numbers are always in nominal terms, the GDP at current prices is used as the denominator. With the growth rate now coming down to 6.5 per cent (going by RBI forecast of real GDP), the denominator effect will automatically raise the fiscal deficit ratio as the GDP will be of a lower order under ceteris paribus conditions. Another fallout on the fiscal side will also be that the debt-to-GDP ratios will tend to look higher and this would hold for both the Centre as well as States due to this statistical effect.
Now, the Budget has been drawn up under rather conservative assumptions of growth being 10.5 per cent. But disinvestment has been targeted on the aggressive side and it does look like that revenue receipts on both taxation and disinvestment will be challenged this year. This is so as tax collections are contingent on GDP increasing at a faster tick which provides buoyancy to the system. Add to this the announcement on reduction of price of LPG for the rest of the year and probably some other pre-elections sops on the cards, managing the fiscal balances will be something to watch. Therefore, fiscal slippage cannot be ruled out this year purely due to this statistical factor.
Another ratio that is often quoted against the GDP is the current account deficit. While there is no official deficit target announced, it was largely believed that it would be 1.4-1.6 per cent in FY24. There are already risks to this ratio with export of goods falling while services exports growth has slowed down. The global environment for trade and investment does not look too bright this year with conservative to aggressive monetary policies being pursued by central banks. Now with the denominator of this ratio, GDP in nominal terms, being lower than was expected the current account deficit is likely to be pushed ahead. While the ratio will still be comfortable, the impact of a lower nominal GDP stands out.
Therefore, while less attention is paid to the nominal GDP growth as it is the real GDP growth that is focused on which holds the clue to consumption and investment, it is critical from the point of view of targeting fiscal plans as well as external balances. Had the WPI and CPI would be moving in the same direction, this problem would not have surfaced. However, with food inflation spiking CPI and low global prices keeping WPI down, this anomalous situation has arisen. This means that care must be taken when interpreting any of these ratios as the denominator effect can exert undue influence.
The writer is Chief Economist, Bank of Baroda. Views are personal