GDP and IIP gap may widen to over 900 bps in third quarter, says Moody's

The link between the country’s headline economic growth and pace of industrial production continues to weaken.


In fact, the gap between the two macro variables is likely to reach its highest level since the 2008 Lehman Brothers crisis if the gross domestic product (GDP) estimates for Q3FY20 and latest trend in the Index of Industrial Production (IIP) are any indicator.


India’s headline GDP is expected to grow by 5.5 per cent during the third quarter, according to estimates by rating agency Moody’s while IIP contracted by 3.8 per cent during October 2019, the first month of the third quarter.


This suggests that the growth in GDP at constant prices is nearly 900-basis-point higher than the industrial expansion as captured by the IIP.


IIP is calculated on monthly basis while GDP numbers are available on quarterly basis India’s headline GDP was up 4.5 per cent during the second quarter of FY20 against a contraction of 0.3 per cent in IIP during Q2FY20 and a decline of 3.8 per cent during October 2019.


According to data by the Central Statistical Organisation (CSO), IIP has now contracted for three consecutive months for the first time since June 2012. Such a divergent trend in the headline GDP and pace of industrial production is rare, and historically, both move together. 


A large gap in the headline economic growth and the pace of IIP was last witnessed during the June 2015 quarter. In the last two decades, quarterly GDP growth has exceeded IIP growth by 900 basis points or more only once (on a quarterly basis). This was during the July-September 2009 quarter after the global financial crisis (see chart).


Analysts said the contraction in IIP could make it difficult for the manufacturing sector to provide a lift to the overall GDP during the second half of FY20.

“The recent decline in IIP is largely a reflection of pain in the manufacturing and industrial sector. This will put a downward pressure on overall GDP growth unless the government expands public spending, which incidentally was the largest contributor to economic growth during the July-September 2019 quarter,” said Dhananjay Sinha, chief economist and head strategist, IDFC Securities.


For others, such a large divergence is a sign of an element of growth over estimation in the calculation of GDP.


“If you juxtapose the recent trend in industrial production and retail or consumer inflation with GDP growth at nominal or current prices, growth estimation could be as high as 400 basis points,” said an economist on condition of anonymity. One basis point is one-hundredth of a per cent.


According to him, GDP is first calculated on nominal or at current prices and we subtract price deflator or inflation from it to get GDP at constant prices, which becomes the headline growth figure. For example, nominal GDP was estimated to be 6 per cent during Q2FY20 while price deflator was assumed to be 1.5 per cent, giving a real GDP growth of 4.5 per cent.


GDP deflator is, however, way lower than the retail inflation of around 4.5 per cent during Q2FY20 on average and nearly 5.5 per cent now.


“We assume GDP deflator to be around 4.9 per cent, giving a real GDP growth of 1.1 per cent. So, in our model, GDP was over estimated by around 340 basis points in Q2FY20,” added the economist.


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