IIP base-year revision to up 2010-11 GDP estimate: Crisil

Study identifies 4 key issues in GDP estimation

In a long awaited move, in June 2011, the CSO decided to change the base-year for computation of the Index of Industrial Production (IIP). This revision in IIP calculation, a key component of GDP estimation, is expected to up the GDP estimates for 2010-11 from 8.5% to 8.9%.

Against this background, CRISIL has carried out a study “How robust is India’s GDP estimate?” According to Roopa Kudva, Managing Director and CEO, CRISIL, “Large revisions in GDP estimates in recent years have led to questions on the robustness of these estimates. As the most important economic indicator, GDP estimates influence policy making at the highest level; hence the need for accurate estimation. Our study finds that the current method of computing GDP underestimates the size and growth of the Indian economy, and identifies four key issues with respect to accurate estimation of India’s GDP.”

The issue of IIP base year revision is just one of the many issues plaguing GDP estimation. The study identifies 3 other key issues: First, the current methodology does not accurately measure the contribution of the unorganized sector. Second, estimation of service sector GDP is constrained by the absence of appropriate price indices to convert nominal GDP into real GDP. Third, the GDP estimates do not account for improvement in the quality of goods.

Until recently IIP with the outdated base-year of 1993-94 was being used to generate Industrial GDP. This failed to capture the fast changing industrial structure; hence the IIP base year has been revised to 2004-05. Already the revised IIP data shows a gross underestimation for 2007-08 with IIP estimates moving from 8.6% to 15.6%. In contrast for 2009-10, new IIP base halves industrial production to 5.3% from 10.5%. For 2010-11, the upward revision of IIP will lift the GDP estimate.

Nearly half of India’s GDP originates in the unorganized sector, but the CSO surveys that capture this data are conducted only once in five years. “Given the rapidly changing nature of the economy and increasing self-employment, the absence of annual surveys for the unorganised sector leads to incorrect measurement of its contribution to India’s GDP.” says Sunil Sinha, Head & Senior Economist, CRISIL. Nominal GDP is converted into real GDP using price indices. Estimation of services sector GDP, which accounts for 55% of India’s GDP, is hindered by the absence of appropriate price indices for the services sector.

In India’s rapidly evolving economy, many items like those related to computers and communication, have undergone significant quality improvement. However, market prices understate the value derived from this quality improvement. Hence, to accurately capture the value addition, the price indices should be lowered accordingly.

The price indices in nations like the USA are adjusted downwards to account for the quality improvement and to capture the true value accruing to the consumer. Such a lowering of the price indices would lead to a real GDP estimate that is higher and more accurate. The price indices used by the CSO do not account for quality improvements, and hence they underestimate the GDP.