7 Things To Know About New GDP Formula

India recently announced that the economy is expected to grow by 7.4% in 2014-15 against estimates of well below 6%. The economy grew 7.5% in the December 2014 quarter, higher than China's 7.3% making it the fastest growing major economy.

However, the data has sent analysts and economists into a tizzy. This is because the government has used a new formula for calculating Gross Domestic Product (GDP). This has pushed analysts to pull out calculators and rework their expectations for future growth.

How the GDP Formula Affects The Growth Figures:

• How is GDP calculated:

The Gross Domestic Product is a measure of the economy. It is calculated by adding the total investment, spending - private as well as government - and net exports. However, your spending is somebody else' income. So, the GDP can be calculated by tallying the total income earned in the country or by adding up everybody's expenditure and investment.

• Rise in productivity:

Now, even this expenditure method can be calculated using two ways - considering the price you paid in the market or the actual cost of producing goods and services. This is where the key change happened now. India used to calculate GDP using the actual cost of goods and services called as 'factor cost'. Now, it has shifted to the 'market price' mechanism. What this does is measure the increase in the inherent value of goods and services. For example, suppose you produced a good worth Rs 100 earlier for which you spent Rs 80. Today, the demand for the good is higher. As a result, it is valued at Rs 120 today. However, your cost of production remains the same at Rs 80. So, the new GDP calculation at market price - Rs 120, in this case - measures the rise in value of the good. This value addition can be because of improvement in productivity and efficiency. This means, in the last few years, India has witnessed a rise in productivity even though basic quantity of production did not rise.

• New base:

Every growth data is a comparison. However, to get an effective idea of the trend in growth, the comparison has to be with the same set of numbers. This is called the base. Earlier, the GDP data was compared to figures from 2004-05. This base year has now been shifted to 2011-12. This change in base year is done every five years. This is because the structure of the economy changes every few years. For example, India is now a service-oriented country. A few years back, it was manufacturing-oriented, while many decades back, the country was dependent on agriculture. So, the new base year is expected to reflect the revised structure of the economy.

• New data collection:

The country is vast. It has crores of people and industries working within the boundaries of the economy. Measuring this every quarter is not an easy task. For this reason, the government selects a sample of companies to measure growth. This data is then extrapolated to estimate the country's growth. The government has now updated this sample collection. Earlier, it relied on the Index of Industrial Production (IIP) survey data. Now, it relies on data from ASI or the Annual Survey of Industries, a much larger data sample. The bigger the sample, the more accurate the estimate. This survey also covers the smaller and medium-sized companies, which were not included earlier. This could contribute to the faster growth in GDP.

• Sector-wise changes:

The widening of the data collection sample has led to inclusion of new companies in the sample. This in turn led to a rise in the growth of the industries measured in the GDP formula, in comparison with the old data. The manufacturing sector saw the largest increase in growth figures over the past 14 quarters. In fact, the April-June quarter saw manufacturing growth jump by 1.6% in the new data series. Other sectors which saw such upgrades are energy, mining and financial services sector. Even the construction industry saw a marginal rise in growth as per the new data.

• Classification of companies:

This is because the government has changed the classification of companies under industry-categories. For example, if a big company deals in manufacturing as well as mining and trading, each of its business units would be classified in a different category. Not now; the company would be classified under the manufacturing category. As a result, the contribution of each major sector - like services, manufacturing, mining, agriculture and so on, has changed. The share of manufacturing in the GDP is up, while services' contribution fell.

• Inflation effect:

There are two types of GDP data - nominal and real. This is because of inflation - the rise in prices over time. Inflation eats into the value of money. GDP data which takes into account inflation is called real GDP. It is calculated by adjusting the nominal GDP according to inflation. Recent data shows that nominal GDP growth slowed down to 9% levels from 13% levels in the September quarter, a difference of 4%. In contrast, real GDP growth fell less than 1% between the September and December quarters. This is because of the fall in inflation. Higher the inflation, lower the real GDP growth. So, when inflation falls, real GDP rises faster.

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