Bank of America Merrill Lynch - India Economic Watch: The US$2trn Question - What's Potential?

Bottom line: Growth bottoming out, wait end-Feb for clarity

We await the release of a longer FY12 base GDP series at end-February to fully assess India's growth profile. The CSO today projected growth at 7.4% in FY15, up from 6.9% in FY14 in the new series. It reported December quarter growth at 7.5% and revised the June quarter to 6.5% from 5.7% in the FY04 series and September to 8.2% from 5.3% in the old series. Pronab Sen, chairman of the National Statistical Commission, has long maintained that the 2004-05 GDP data underestimated industrial growth. New GDP data continue to support our call that growth is bottoming out. We expect India to surpass Brazil and Russia in GDP this year to emerge as the second-largest BRIC economy after China (Chart 1). In our view, the US$2trn question is: what is the potential? We placed this at 7-7.5% in the old FY12 series. We will look to a longer-data series based on the FY15 methodology to re-estimate it. Only then can the RBI and the market determine if further rate cuts are required and by how much. Do read our India 2015 report here.

CSO estimates FY15 growth at 7.5% in new GDP series

The Central Statistical Organisation today projected growth at 7.4% in FY15 (far above 6.6% BAMLe), up from 6.9% in FY14 in the new FY12 GDP series (Table 1 and Exhibit 1). It reported December quarter growth at 7.5% and revised the June quarter to 6.5% from 5.7% in the FY04 series and September to 8.2% from 5.3% in the old series (Table 2). We will publish our FY16 growth estimates after greater clarity once the CSO releases its new GDP manual in end-February.

RBI policy depends on potential

Where does this leave the RBI? Monetary policy works on the gap between potential and actual growth rather than the actual growth rate itself. We placed potential growth at 7-7.5% in the old FY12 series. We will look to a longer-data series based on the FY12 methodology to re-estimate it, as the bulk of the higher growth has come from a methodological shift to value added from production in industry. It is only then that the RBI and market can determine if further rate cuts are required and by how much. As of writing, we retain our RBI call of 25bp rate cuts in April and June.

Why? GDP revised to meet international standards

The Central Statistical Organisation periodically revises the GDP series to upgrade to the latest methodology and capture a greater part of the economy. It has upgraded the GDP series to the 2011-12 base year from 2004-05 guided by the recommendations of the international guidelines on the 2008 System of National Accounts on Friday. Major changes include the following (do read our report here):

Corporate sector coverage: Extended by incorporation of annual accounts of companies as filed with the Ministry of Corporate Affairs (MCA) under their egovernance initiative, MCA21. Partnership firms covered under the Limited Liability Partnership Act have also been covered. For "manufacturing‟ enterprises, the MCA21 database has been used to supplement the information available in the Annual Survey of Industries.

Local government: Improved coverage of activities of local bodies – both rural and urban – and autonomous institutions, resulting in better coverage of government activities.

Informal sector: Incorporation of the results of the recent NSS Surveys, viz., the Unincorporated Enterprise Survey (2010-11) and the Employment-Unemployment Survey (2011-12), along with the adoption of an “Effective Labour Input Method” for unincorporated manufacturing and services enterprises, giving due weights to different categories of workers, i.e., owners, hired workers and helpers, for compiling the estimates of these enterprises.

What? Manufacturing share rises to 15.8%

The new GDP series has captured the changing structure of the Indian economy. The share of manufacturing has increased to 15.8% from 11.9% in the 2004-05 series. At the same time, share of trade services is down to 10.9% from 15.2% in the 2004-05 series. Except real estate and construction, the share of all other services has also fallen in the new series. The share of agriculture has increased marginally in the new series to 17.2% from 16.8%.

There is no significant change in the structure of GDP on the demand side. Savings and investment have slowed across the old and new series.

Why? Structural change driven by methodological advance

The main reasons behind this upward revision in growth include the following:

• The adoption of the MCA21 database has led to a higher share of mining and manufacturing in GDP and consequently a higher growth rate relative to the 2004-05 base year series. It is important to note that the share and growth rate of both of these sectors have been declining since FY12 as per the new series confirming the slowdown in these sectors in recent years.

• ‘Enterprise Approach’ is adopted in the new revision in place of establishment approach for mining and manufacturing. As a result, certain companies that were earlier being covered under the trade category are now correctly being reported under the mining and manufacturing category. This has resulted in a falling share of trade services.

• The growth rate for non-financial services has increased due to the use of sales/service tax as an indicator for nominal growth.

APPENDIX: NEW GDP SERIES

The Central Statistical Organisation has revised the GDP series to the 2011-12 base year from 2004-05. The changes introduced in this comprehensive revision have been guided by the recommendations of the international guidelines on the subject, System of National Accounts, 2008. Major changes include:

• Comprehensive coverage of Corporate Sector both in manufacturing and services by incorporation of annual accounts of companies as filed India Economic Watch 09 February 2015 5 with the Ministry of Corporate Affairs (MCA) under their e-governance initiative, MCA21. Partnership firms covered under the Limited Liability Partnership Act have also been covered. For the "manufacturing‟ enterprises, MCA21 database has been used to supplement the information available in the Annual Survey of Industries.

• Improved coverage of activities of local bodies – both rural and urban – and autonomous institutions, resulting in better coverage of government activities.

• Incorporation of the results of the recent NSS Surveys, viz., the Unincorporated Enterprise Survey (2010-11) and the EmploymentUnemployment Survey (2011-12), along with the adoption of an “Effective Labour Input Method” for unincorporated manufacturing and services enterprises, giving due weights to different categories of workers, i.e., owners, hired workers and helpers, for compiling the estimates of these enterprises.

Apart from the above-mentioned major changes, specific changes have also been made in the following industries/sectors:

Agriculture, forestry and fishing

i. Segregation of crop and livestock production;

ii. Adoption of Agriculture Census (2010-11) and Livestock Census (2012);

iii. Revision of yield rates of meat & by-products of different livestock species based on a study conducted by National Research Centre on Meat, Hyderabad.

Mining & manufacturing

i. Estimation of value addition from extraction of sand through an indirect method, in accordance with its use in construction;

ii. “Enterprise Approach‟ adopted for mining and manufacturing activity using the MCA21 database to account for head offices, ancillary activities, etc. not covered under the “establishment approach‟.

Electricity, gas, water supply & other utility services

i. Utility services, including sewage, waste management, recycling and remediation activities, brought under the group “electricity, gas and water supply‟.

Construction

i. Study on the inputs in the Construction sector by Central Building Research Institute (CBRI), Roorkee;

ii. Incorporation of results of NSS All India Debt & Investment Survey, 2013.

Non-financial Services

i. Use of Consumer Price Indices-Rural, Urban and Combined, instead of the CPIAL/RL/IW being used earlier;

ii. Use of Service Tax as an indicator for growth in the respective service(s).

Financial Services

i. Comprehensive coverage of the financial sector by inclusion of information from the accounts of stock brokers, stock exchanges, asset management companies, mutual funds and pension funds, as well as the regulatory bodies, SEBI, PFRDA and IRDA.

ACRONYMS

GDP: Gross Domestic Product

GVA: Gross Value Added

GNI: Gross National Income

NDP: Net Domestic Product

NNI: Net National Income

GNDI: Gross National Disposable Income

PFCE: Private Final Consumption Expenditure

GFCE: Government Final Consumption Expenditure

CFC: Consumption of Fixed Capital

GFCF: Gross Fixed Capital Formation

CIS: Changes in Stock

CE: Compensation of Employees

OS: Operating Surplus

MI: Mixed Income

ROW: Rest of the World

FORMULAE

1. GVA at basic prices = CE + OS/MI + CFC + Production taxes less Production subsidies

2. GVA at factor cost (earlier referred to as GDP at factor cost) = GVA at basic prices – Production taxes less Production subsidies

3. GDP = ∑ GVA at basic prices + Product taxes - Product subsidies

4. NDP/NNI = GDP/GNI – CFC

5. GNI = GDP + Net primary income from ROW (Receipts less payments)

6. Primary Incomes = CE + Property and Entrepreneurial Income

7. NNDI =NNI + other current transfers from ROW, net (Receipts less payments)

8. GNDI = NNDI + CFC = GNI + other current transfers from ROW, net (Receipts less payments)

9. Gross Capital Formation= Gross Savings+ Net Capital Inflow from ROW

10. GCF = GFCF + CIS + Valuables + “Errors and Omissions”

11. Gross Disposable Income of Govt. = GFCE + Gross Saving of GG

12. Gross Disposable Income of Households = GNDI – GDI of Govt. – Gross Savings of All Corporations

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