Difference between investment rate in nominal and real terms widening

The difference between the real and nominal GFCF rates was five percentage points. The difference stood at over 5% in the previous two quarters of the current financial year

The divergence between investment rate at constant prices and at current prices has been on an increase in recent times. For instance, gross fixed capital formation (GFCF) was 31.8 per cent of the gross domestic product (GDP) at constant prices, while it was way down at 26.8 per cent at current prices in the third quarter of the current financial year.

The difference between the real and nominal GFCF rates was five percentage points. The difference stood at over five per cent in the previous two quarters of the current financial year. There has always been a difference between the two figures, but the divergence has widened in three quarters of the current financial year.

This gives rise to one crucial issue as to which rate should be taken into account to judge the investment rate in the economy. Generally, it is said that if the investment rate in the economy is 30 per cent or above, the economy would be on a high growth path as was witnessed in the first three years of the first stint of the United Progressive Alliance (UPA) government.

In terms of the constant prices, that level of investment rate is already in place. However, it is much below that in terms of current prices.

Former chief statistician Pronab Sen said probably the growing divergence between constant and current prices are to do with consumer price index- (CPI) and wholesale price index (WPI)-based inflation. For GDP, it is largely CPI that is used as a deflator but for investment, WPI is primarily used as a deflator.

For instance, if one takes the third quarter of the current financial year, the deflator for GDP comes at about 170 per cent on the base of 2011-12, while it stood at 140 per cent for the investment rate. This means inflation in GDP stood at 70 per cent in 11 years while that in investment rate it was 40 per cent.

'What deflators are telling you is that inflation in the overall economy grew 70 per cent in 11 years which comes to an average of 6.3 per cent a year. However, inflation in investments grew just 40 per cent in 11 years which is 3.6 per cent a year on average. The difference is huge, that sounds a little strange," Sen said.

To a query as to whether one should look at constant prices or current prices, he said it depends on the question that one seeks.

The data for the third quarter of the current financial year, for instance, means that you are creating new capacities at 31.8 per cent of GDP in the third quarter. But in terms of your current income, the investment rate is 26.8 per cent, which is much smaller than what we should be doing. If we can raise the level of investment rate to 30 per cent at current prices, the GDP could grow by around seven per cent, he said.

Anil K Sood, professor and co-founder of The Institute for Advanced Studies in Complex Choices, said the difference between investment rate at constant and current prices arose from the fact that the deflators for the GDP components are different from the ones used for GFCF components.

If the entire period on the base of 2011-12 to 2022-23 is taken, the compounded annual growth rate for implicit deflator for aggregate GDP works out to be five per cent, whereas it is 3.5 per cent for GFCF.

The differences in deflator levels across years could come about the degree of price inflation each sector experiences and the sectoral composition of the series itself, he said.

"Since the two series are used for different purposes, I would usually ignore the differences. We would, however, need to check if there are any large estimation errors that are causing the variations," Sood said.

In most decision situations, he said he would work with just the nominal numbers as most decision-makers do not use inflation-adjusted numbers.

"In the economic context, we would worry about inflation to understand its impact on relative prices. In addition, we would look at the level of productivity that a sector is achieving, given the level of inflation, as the only way to beat inflation is productivity," he added.