Gauging economic activity

Lag in official data results in delayed response

The slide in the gross domestic product (GDP) growth in the first quarter of the current fiscal year has surprised most analysts. Aside from influencing sentiment in financial markets, the 5 per cent growth in the April-June quarter has implications for both fiscal and monetary policy. But the lag in the release of official data often results in delayed policy response. In terms of fiscal policy, the level of economic activity determines the level of revenue the government can expect. In case the growth is expected to slow, the government can adjust its revenue projection and take a call whether the economy needs adjustment in spending, which can help smooth the economic cycle. Similarly, it would help if the central bank can adjust the monetary policy more proactively and doesn’t always have to depend on official data. 

Since monetary policy works with a lag of two to three quarters in India, depending on official data can delay the policy adjustment and exacerbate the problem. For instance, breaking with convention, the Monetary Policy Committee of the Reserve Bank of India (RBI) decided to cut the policy repo rate by 35 basis points in August. It was reasoned that 25 basis points would have been inadequate and 50 basis points excessive. It can now be argued that if the extent of the slowdown was known, a cut of 50 basis points would not have looked excessive. Slower growth will also keep inflation at lower levels. Although the RBI acknowledged the weakness in high-frequency indicators, it reduced the growth projection for the current year by only 10 basis points to 6.9 per cent. Similarly, the Budget presented in July did precious little to fight the slowdown — though it was more of an acceptance than evidence problem.

At a broader level, both investors and policymakers would be better off if they have more timely means to track economic activity. For example, the Goods and Services Tax collection can become a good indicator of economic activity once the prevailing problems are addressed. Since there are genuine reasons for the lag in the official release of GDP data, the central bank can work on an aggregate indicator that would give an early sense of the state of the economy. Central banks, globally, track lead indicators to assess the economy and make the policy forward-looking. The RBI also tracks high-frequency indicators and, as the latest Annual Report shows, it has worked on a “Coincident Economic Indicator”. This includes the production of consumer goods, auto sales, non-oil non-gold imports and rail freight. 

However, recent record suggests that the RBI needs to work on its models to be able to predict both growth and inflation more accurately. Although some financial institutions do track high-frequency indicators for their clients, it would help the system if the central bank, which has the research capability, processes the available information and regularly puts out an aggregate indicator. It is important to note that this is not to undermine the official collection and release of data, but to improve the understanding of the market. The idea is worth trying since it will also help the central bank in making the policy more forward-looking.