RBI Releases Paper On Nowcasting Indian GDP growth Using Dynamic Factor Model

Reserve Bank of India placed on its website a Working Paper titled "Nowcasting Indian GDP growth using a Dynamic Factor Model" under the Reserve Bank of India Working Paper Series. A core concern in policy-making is identifying the signs of expansions and contractions in economic activity. At any point in time, diverse economic activity indicators may indicate mixed trends. Therefore, combining all of these together in an appropriate way to arrive at the underlying (or unobserved) trend has traditionally occupied the attention of both governments and businesses. The paper aims to contribute to the existing literature by combining high frequency indicators, which are useful proxies of economic activity, to nowcast GDP growth of India.

To provide an early estimate of the current quarter GDP growth, the RBI researchers construct single-index dynamic factors using 6, 9 and 12 high-frequency indicators. These indicators represent various sectors, display high contemporaneous correlation with GDP, and co-move in line with the GDP turning points. While DF-6 includes domestic economic activity indicators, DF-9 combines indicators of trade and services and DF-12 adds financial indicators in the model.

In addition to conventional economic activity indicators, the paper includes a financial block in DF-12 to reflect the growing influence of financial sector on economic activity. DFs are estimated using a dynamic factor model which extracts a common trend underlying the high-frequency indicators. The extracted trend provides a real time assessment of the state of the economy and helps identify sectors contributing to economic fluctuations.

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