Understanding double deflation: What it does and why it matters

India's new GDP series uses double deflation to measure real growth more accurately by separately accounting for changes in output and input prices

India’s new gross domestic product (GDP) series has brought the concept of double deflation into wider public discussion. While the basic idea is straightforward, its implications can sometimes appear counter-intuitive. In particular, the implicit gross value added (GVA) deflator may move differently from familiar price indices such as the consumer price index (CPI), wholesale price index (WPI) or producer price index (PPI), and its growth rate can decline even when these indices are increasing. Understanding double deflation therefore requires examining not only the method itself, but also the data, price indices and level of detail used in its implementation. 

Why one price index may not be enough 

GVA is the difference between an industry’s output and intermediate consumption. At current prices, this calculation is straightforward. At constant prices, however, changes in quantities and prices need to be separated. 

A simple approach, known as single deflation, is to deflate nominal GVA using one price index. The difficulty is that GVA itself does not have a directly observable market price. It is a residual obtained after deducting inputs from output, and the prices of output and inputs can move very differently. 

Using only one price index, therefore, implicitly assumes that input and output prices move broadly together. This may be problematic when the two diverge significantly. Double deflation removes this assumption by separately measuring the volume changes in output and intermediate consumption. The UN System of National Accounts describes real GVA as output in volume terms less intermediate consumption in volume terms. Double deflation is therefore an internationally recognised approach and is not an India-specific innovation. However, due to challenges of meeting the requirement of detailed data, both for output and intermediate use, double deflation is difficult to apply for all sectors of the economy. 

India has adopted double deflation for the manufacturing sector, given its input-intensive nature and the availability of rich data from the Annual Survey of Industries (ASI) and PPI. 

For the manufacturing sector, nominal estimates for both output and intermediate consumption at annual level are compiled for various institutional sectors using robust data sources. Estimates for private corporations are based on MCA-21 data, public corporations estimates use annual reports, and estimates for the unincorporated sector use Annual Survey of Unincorporated Sector Enterprises (ASUSE) and Periodic Labour Force Survey (PLFS) data. 

What does double deflation actually mean? 

The method involves three basic steps: (1) Output is deflated separately: Current-price output or nominal value of output is adjusted for changes in output prices to obtain real output. (2) Intermediate consumption is deflated separately: Current-price inputs or nominal value of inputs are adjusted using appropriate prices for the goods and services consumed in production. (3) Real GVA is derived as real output minus real intermediate consumption. 

Since two separate deflations are undertaken to calculate volume-based GVA, hence the name double deflation. 

Why the GVA deflator can appear unusual 

The implicit GVA deflator is calculated as Nominal GVA /Real GVA × 100. Under double deflation, there is no independently observed GVA price index. Output and intermediate consumption (IC) are separately deflated using their respective price indices, and real GVA is obtained as their difference. The movement of the implicit GVA deflator, therefore, depends on the relative movement of output and input prices and their respective weights. As depicted in the illustration below, if input prices increase substantially faster than output prices, real GVA will grow faster than nominal GVA. 

The GVA deflator can consequently decline, or its growth rate can become negative, even when familiar price indices are rising. 

Where do the input prices come from? 

Double deflation requires more detailed information than single deflation. An important feature of production is that the output of one industry can become an intermediate input for another. For example, coal is an output of mining but an input for electricity and manufacturing; cotton yarn is an output of spinning and an input for textiles. 

Therefore, an output PPI is not restricted to only final-use products. The output PPI basket also includes intermediate use products such as bauxite, coking coal, electricity, refined palm oil, cotton yarn, naphtha, phosphoric acid and cement. Granularity matters in double deflation. The impact and reliability of double deflation also depend on the level of granularity at which it is applied.  Out of a total of 30 compilation categories which broadly correspond to combinations of two- and three-digit NIC (National Industrial Classification) industries, double deflation is applied for 28 compilation categories. Real GVA estimates for two compilation categories — manufacture of food products and manufacture of pharmaceutical products — are compiled using volume extrapolation method, not double deflation, due to challenges of mapping of input items. Output and input items from the latest ASI data are mapped with item-level PPI. Such detailed mapping allows granular deflation of output and input values separately within each tabulation category. The above statistical framework aligns with the practice followed in other countries, including advanced economies like the US, Japan and the Eurozone. 

PPI, WPI and producer prices 

Another source of misunderstanding is transition towards a PPI. It is sometimes assumed that WPI reflects wholesale market prices while PPI requires entirely new information from producers. It may be noted that for manufactured products, the distinction between WPI and PPI is less pronounced as prices underlying WPI have also substantially been collected at the ex-factory level since the 2011-12 series. The move towards PPI is nevertheless important because of its granularity and coverage and its conceptual objective to provide price measures that correspond more closely to the valuation principles used in national accounts. 

 

Why real GDP should not be inferred simply from nominal GDP and a familiar inflation rate 

A common shortcut is to think of real GDP growth as nominal GDP growth minus a familiar measure of inflation. This can be misleading. CPI measures consumer prices, while WPI and PPI have different coverage and weights. In the new series, single deflation has been eliminated: Real estimates for agriculture and manufacturing use double deflation, while volume extrapolation is used for the remaining sectors. Under double deflation, real GVA is obtained from separately deflated output and intermediate consumption. The resulting implicit GVA deflator is therefore an outcome of the national-accounts calculation, rather than a CPI or WPI measure used to derive real GVA. Consequently, nominal GDP growth minus CPI or WPI inflation need not equal real GDP growth. 

Better statistics can sometimes look less intuitive 

Richer survey, administrative and price data enable more refined measurement of real economic activity. The

resulting estimates may not always resemble familiar inflation measures such as CPI or WPI. What matters is the quality, appropriateness and consistency of the underlying data. Double deflation is an important step towards better measurement.  

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Saurabh Garg is secretary, Ministry of Statistics & Programme Implementation (Mospi), and Shubhabrata Das is faculty at IIM Bangalore and member, National Statistical Commission. With inputs from Dalip Singh, DG, central statistics, Mospi