Ouch…? The GDP deflator may not hurt!

One of the major takeaways from the Gross Domestic Product (GDP) numbers released on August 31 was the high GDP deflator. Simply put it is the difference between the nominal and real GDP growth rates. Hence while the real GDP growth rate was 13.5%, in nominal terms growth was 26.7%. The difference between the two is the GDP price deflator which was at 13.2%. This is not an indicator used often when we talk of inflation and is hence the third dimension on prices which goes beyond Consumer Price Index (CPI) and Wholesale Price Index (WPI) inflation.

If the three inflation indices are juxtaposed the picture is like this. The CPI inflation is around 7% and is what is targeted by the RBI when formulating the monetary policy. Hence this number is probably the most important inflation metric. It looks at inflation from an individual’s perspective and includes goods and service but excludes things like steel, cement, chemicals, etc. The WPI inflation number has been in double digits for two years now and is in the range of 12%. This is a producer price index and excludes services. It gives an indication of the pricing power of industry and every time we talk of global prices going up or down, it gets reflected in this number. As individuals we are not really affected by a large part of this inflation. The third is the GDP deflator which is an imputed number. The GDP is calculated in nominal terms and then scaled down using various indices of which WPI is the main one. This derived number hence covers prices of all goods and services that go into the GDP and is comprehensive. Presently it is at around 13%.

Now with the nominal GDP growth rate being what it is, there is concern on the inflation front because it is realized that the 7% number is not really relevant when it comes to households but the GDP deflator. But there are certain advantages in having a high nominal GDP number which is bumped up by inflation. All policy indicators for example are benchmarked with the nominal GDP and this is where the difference comes in.

Let us assume that this number of 13.2% remains through the year. This will help in pushing up the nominal GDP growth number. The Budget was based on a GDP number of Rs 259 lakh crore. If nominal GDP grows by 20% instead of the 11% assumed it would be around Rs 284 lakh crore in FY23. This is based on the assumption of 7% growth in real GDP and 13% inflation. There will now be an automatic bias for the denominator to increase which is used when looking at the fiscal or debt ratio. The fiscal deficit ratio was to be 6.4% this year; and with an enlarged base will now work out to 5.8%. Further, if the government sticks to the 6.4% mark, the fiscal deficit can go up by an additional Rs 1.5 lakh crore. This is why high inflation is good for the fiscal arithmetic as there is more space given to the government. States will be happy with this development as a good number of them will be struggling to meet their targets which range between 3-4% of fiscal deficit. Inflation surely helps them.

The same holds for the debt to GDP ratio which is what is looked at closely by global rating agencies. With GDP being higher, the total liabilities to GDP ratio can improve from 59% to 54% if other things don’t change. This will show improvement in debt levels without much effort. This is another collateral benefit for the fiscal numbers on account of high inflation.

Here it may be pointed out that throughout this year the GST collections have been very buoyant at over Rs 1.4 lakh crore every month. While a part of the achievement can be attributed to high consumption due to the pent up demand scenario, high inflation has played its role here too in pushing up revenue collections.

The other collateral benefit for the economy on account of this higher GDP number is when reckoning the current account deficit. With the trade deficit widening due to higher growth in imports relative to exports, the same will get reflected in the current account deficit. Estimates range from $ 95-110 bn for the deficit this year. Assuming the deficit to be around $ 100 bn for the year, this would have translated to 3-3.1% of GDP with the nominal GDP assumed in the budget. Now with a higher base, the deficit will get moderated to less than 3% at 2.8%. This difference may seem small but there is a psychological effect on the market when the CAD is less than or more than 3%.

Therefore there are certain unintended consequences of high inflation — not what is denoted by the CPI or WPI but the GDP deflator. A higher nominal GDP brought about by inflation also perversely contributes to acceleration in the path to attain the $ 5 trillion economy status. Ideally when we talk of such targets it is assumed that there is growth in the real GDP with stable inflation of 4-5%. However, in the present situation it does appear that the major driver is inflation rather than real growth, which is a worry. The unfortunate part is that even in FY22 when real GDP grew by 8.7%, nominal growth was 19.5% which is an implicit deflator of 10.8%. Clearly there is need for urgency to correct this anomaly which is running for the second successive year now.

The writer is Chief Economist, Bank of Baroda and author of ‘Lockdown or Economic Destruction’. Views are personal

Published on: Saturday, September 03, 2022, 12:56 PM IST