Second Advance Estimates for GDP are Confusing

The Second Advance Estimates (2nd AE) for FY17 GDP, released by the Central Statistical Organization (CSO) today, are confusing. 

These estimates, unlike the First Advance Estimates (1st AE) released on 6th January this year, include the impact of demonetization. Yet, the CSO still projects GDP to grow at 7.1% y-y in FY17, as it had estimated on Jan 6th when the impact of demonetization was admittedly not included. This effectively means that Demonetization has had no impact on GDP growth for this fiscal, which goes against all anecdotal evidence and estimates of almost all independent (non-governmental) organizations. 

What’s going on? 

Table 1: Here are the headline GDP numbers...

Table 2: Here are the Expenditure Components of GDP (2nd AE vs. 1st AE)

Table 3: Here is the Q-Q Movement in the Expenditure Components of GDP (2nd AE released today)

If you look at Table 2 (the expenditure components of GDP - 2nd AE vs. 1st AE), you’ll see that the CSO now expects Private Final Consumption Expenditure (PFCE) to actually be higher (+1.7%) than it did before the demonetization impact was taken into account. This doesn’t make much sense to me. 

The numbers are equally hard to digest when you look at Table 3, which shows PFCE up 11% q-q in FQ317. Such a big sequential jump in the demonetization (Nov 8) quarter is hard to understand even if one takes into account the fact that the festive season (up till Diwali) when most of the consumption/buying takes place, was already done before the note ban. 

Private consumption has undoubtedly been hit post the note ban. The 3rd quarter results of FMCG companies are testament to this fact. Infact, most consumer product companies have been affected. Sales of two wheelers, which are a proxy for rural demand, fell in Nov, Dec and January. In the unorganized sector, the impact is more pronounced, since this sector is even more dependent on cash. 

Having said all this, it’s important to note that most figures we read about in the papers (including the Q3 results of listed companies) are not representative of the huge informal/unorganized economy of India where the impact of demonetization is worse than in the organized sector. 

The CSO estimates suffer from this same problem. CSO’s early numbers do not have a good handle on the informal economy i.e. they are mostly based on data from organized players/businesses (I’m talking about the Value Added Approach to GDP here). While I’m analyzing the Expenditure components of GDP in this post (which are derived from the Expenditure approach to estimating GDP), the Value Added Approach is the most reliable and the one from which most of the early data for GDP is gathered. The Expenditure method is less precise. 

Keeping this preamble in mind, while CSO’s PFCE data could be presenting a rosy picture right now, this may not reflect the reality for most of the country. These numbers could very easily be revised later. 

Let’s also take a look at Gross Fixed Capital Formation (GFCF) or investment. Table 2 show that GFCF in the 2nd Advance Estimates is actually a bit higher (+0.6%) vs. GFCF in the 1st Advance Estimates. This again appears rather odd to me. In a quarter where for at least for half of the quarter, near-term consumption was severely impacted and sales were hit, companies would have been accumulating inventory and would have put the breaks on capital spending. How then can the Q3 GFCF estimate including the demonetization impact be higher than that excluding demonetization impact?

Separately, the sequential (q-q) numbers in Table 3 show GFCF up 2.3% q-q in Q3. This again looks rosy to me. 

Bottom-line: At first look, the 2nd Advance Estimates for GDP look optimistic. It’s possible that due to lack of data for the informal economy in these early estimates, the CSO is underestimating the impact of demonetization.