Is power output a better guide for growth?

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Is the Index of Industrial Production (IIP) a reliable indicator of growth in the gross domestic product or GDP? Or is the real GDP story hidden in data on electricity generation?

The new GDP methodology uses establishments and enterprises for calculating manufacturing output. Earlier, only the establishment approach was used, which meant calculating production plant by plant. In the enterprises approach, activities at headquarters, like marketing, are also account for.

An official of the ministry of statistics and programme implementation (MoSPI) said the establishment approach was used for small companies in the new GDP data because they had a few plants or sometimes a single plant, but for large companies the enterprises approach was used.

The new methodology estimates manufacturing growth sector higher than that arrived at from the IIP in an expanding economy. This happens because advertising and marketing expenses in the headquarters of large companies are now registered as manufacturing, the official explained.

In the event of slowing growth, when these expenses were reduced drastically, growth in manufacturing in GDP might not be higher than the IIP, but there might still be divergence between the two, the official said.

This growing divergence under the new series is one of the reasons that has led analysts to question the continued use of the IIP as an indicator of growth.

On the other hand, electricity generation shows a strong relationship with GDP growth. Dhaval Patel, analyst at CARE, said, “The elasticity between GDP and long-term power demand is close to 1.1, though a factor of 0.9 is taken by ministry/planning based on recent trends.”

In China, too, analysts sceptical of official GDP data tend to use proxies such as electricity consumption, rail cargo and loan disbursements to track broader economic growth.

Past data suggests the industrial sector in India accounts for 47 per cent of total energy consumption. Within the sector, the most energy-intensive industries are iron and steel, which accounts for roughly 21 per cent of industrial energy use, followed by construction (9.2 per cent), chemical and petrochemicals (4.4 per cent).

As electricity consumption by households and in the agricultural sector follows its trend growth, greater electricity generation is on account of increased demand from industry.

But Aditi Nayar, senior economist at ICRA, said “electricity generation and GDP growth may not always be closely correlated, as energy needs are partly fulfilled through captive power generation that uses diesel as feedstock.” The total captive power generation is estimated to be around 34,000 Mw. But this figure does not include power generated through private gensets. If the entire captive power generation in the country is taken into consideration, electricity generation figures are likely to be higher.

In recent months, electricity generation growth has plummeted from 9 per cent in the third quarter of 2014-15 to 3.2 per cent in the fourth quarter. But GDP accelerated from 6.6 per cent in the third quarter to 7.5 per cent in the fourth quarter, suggesting that there may not exist a strong relationship between the two.

In the first two months of the current financial year electricity generation grew at a mere 1.8 per cent. This sharp fall in growth is despite the rise in domestic coal production. Nayar pointed out this could be because of the poor financial health of distribution companies, which were not buying power as a result of which generation was falling.

Electricity generation in India is also affected by the weather. Hydroelectricity, which accounts for 12-15 per cent of total electricity generation, is affected by rainfall in the catchment areas of reservoirs. During times of low generation, energy requirements are partly fulfilled through captive power generation.

Madan Sabnavis, chief economist at CARE, said, “Although there exists a strong relationship between the two, it is not a leading indicator of growth. Any growing economy will have witnessed higher electricity growth, but as the sector accounts for a small share of overall GDP, its impact on GDP growth is likely to be minimal.”

Inferring GDP growth from the IIP or its sub-components such as electricity generation would lead to errors since the IIP accounts for around 26 per cent of industrial growth given in national accounts due to sourcing from MCA-21 and corporate results provided to stock exchanges. Earlier, IIP data was fully used in GDP estimation and replaced only later when annual survey of industries were conducted.

For instance, manufacturing climbed just 2.3 per cent in volume terms in IIP data for 2014-15. However, it rose 7.1 per cent in value terms in GDP data for the same year. Also, the IIP rose just 2.8 per cent, while industrial growth (without construction) stood at 6.6 per cent in 2014-15. This was the reason for many critics of the new GDP data to say industry was not performing as well as reflected in national accounts.