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Real or nominal? Making sense of FM's 'near zero' GDP growth comment

A zero nominal growth rate of GDP would mean the real rate of growth of GDP would be in negative territory.

Topics
GDP growth | Nirmala Sitharaman | India GDP growth

Subhomoy Bhattacharjee 

Finance Minister Nirmala Sitharaman
The ministry of statistics and programme implementation calculates the GDP using both the WPI and CPI broadly in the ratio of 60 to 40 to construct its deflator for each sector.

India could log a rate of “near zero” in the current financial year, said Finance minister on Tuesday. She didn’t say whether her estimate is about the nominal rate of or that of real rate of growth. The finance ministry has yet not released its estimate of the rate for 2020-21. The (RBI) has released its real GDP estimate for 2020-21, stating it will decline by 9.5 per cent.

The economy contracted in the April-June quarter, but demand picked up subsequently in the festival season, said Sitharaman at the India Energy Forum of CERAWeek. Infrastructure, fintech and all employment-generating and asset-creating industries would be priority sectors for the government to give a fillip to grow.

Who is correct?

A zero nominal growth rate of GDP would mean the real rate of growth of GDP would be in negative territory. To arrive at the finance minister’s estimate (assuming it is nominal rate) from the RBI estimate one has to assume that she is penciling in a general price inflation rate of about 8 per cent or which is also known as the GDP deflator. However, this deflator is never expressed as a per cent but as an index number, as we shall see now.

Nominal GDP is the market value of goods and services produced in an economy, unadjusted for inflation--meaning all measurements are at current prices. Real GDP is nominal GDP, adjusted for inflation to reflect changes in real output. In other words, it is the GDP measured at constant prices. To arrive at the real GDP we therefore need the GDP deflator. This is the measure of the general price inflation. This measure is different from the two most common indicators of inflation, the wholesale price index (WPI) and the consumer price index (CPI). The principal reason for the use of GDP deflator is that it is a broader measure which reflects the prices of all domestically produced goods and services in the economy whereas, CPI and WPI are based on a limited basket of goods and services, so they have limitations.

ALSO READ: Near zero GDP today, among fastest growing next year: FM on Indian economy

The ministry of statistics and programme implementation calculates the GDP using both the WPI and CPI broadly in the ratio of 60 to 40 to construct its deflator for each sector. The ministry has a separate deflator for each sector of the GDP, but to travel the distance from RBI’s negative 9.5 per cent to zero of the finance ministry, the GDP deflator shall have to be 154.3.

Why did Sitharaman speak about a nominal rate of GDP growth?

There could be two reasons.

1. In the present circumstances a zero growth rate, on the face of it, appears less scary than say a negative 9.5 per cent, which RBI has written in. The International Monetary Fund (IMF) predicts it shall be even worse at negative 10.5 per cent.

2. At the cost of oversimplification, the steps of estimating GDP are as follows. Firstly, the nominal absolute GDP of various sectors are estimated. Nominal GDP estimation uses the price of various products and services as of the period of calculation. Subsequently, for each of these sectors the components of GDP deflator is used to adjust for the impact of inflation affecting that sector. This gives the real absolute GDP component for that sector. Then the real (inflation adjusted) GDP components are added to get the real GDP of the overall economy. At this stage because of the pandemic induced delays in the gathering of estimates of data from the sectors it is quite possible that only the nominal GDP growth rate has only been arrived at. The real GDP numbers will take a bit more time to be known.

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First Published: Wed, October 28 2020. 17:14 IST
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