The denominator effect of a higher-than-expected nominal GDP

Healthy revenues, failing disinvestment, and rise in nominal GDP may take fiscal deficit from the Budgeted 6.8% of GDP to anywhere between 6.9% and 7.3%

The Union Budget of 2021-22 said that India’s nominal gross domestic product would grow 14.4 per cent this financial year, from Rs 194.8 trillion in 2020-21, to Rs 222.9 trillion. The provisional estimate for FY22 turned out to be Rs 197.5 trillion. Assuming that the nominal growth rate remains constant, if we apply the same nominal growth rate, it could take the nominal GDP of 2021-22 to Rs 225.9 trillion. In fact, the First Advance Estimate (FAE) that will be released on 7 January will spell out a clear number. 

But even before that, it has become apparent that nominal GDP for FY22 could well be even higher than this. Rating agency Icra’s current estimate is of 17.5 per cent growth in nominal GDP. This would take India’s nominal GDP for this year to Rs 232 trillion.

While the FAE FY22 may not include the uncertain impact of the third wave of Covid-19 that India is currently facing, there remain potential downsides to growth. 

Among the major economic surprises of 2021, rise in producer inflation would be one of the most glaring. Wholesale price index (WPI) based inflation, or wholesale inflation in India touched 14.23 per cent in November 2021, an unusually high level for the indicator. 

This is not just the highest in the current wholesale inflation series that began in 2011-12. If we look at the previous series, WPI inflation in November 2021 was close to the levels observed during 1991, when India was recovering from a balance of payments crisis, and opening up of its economy. In fact, it was only between August and December 1991, that WPI inflation levels were higher than the current levels, though the two numbers are not comparable as the base years are different.

What this suggests, is that the magnitude of the price jump that producers are facing in recent months is nearly unprecedented. Experts attribute much of this to the reversal in the global commodity price cycle once the economic impact of Covid-19 passed its worst. 

Consumer price index (CPI) based inflation, or retail inflation, has surprisingly cooled down to 4.91 per cent in November 2021, after remaining north of the 5 per cent mark for seven months of the last calendar year. 

Now, real GDP is the value of all goods and services produced at prices prevailing in 2011-12, the base year of current national accounts series. Nominal GDP is their value at current prices. 

Because current prices of wholesale goods have jumped massively this year — record high WPI inflation — it is very likely that nominal GDP will be higher than expected. 

Agriculture, manufacturing, and services are the three broad parts of India’s economy. For the first two, the wholesale price index is used to calculate real and nominal gross value added (GVA).

For most of the services, the consumer price index is used. Trade is one part of services where WPI is used to deflate the GVA. 

In fact, if we look at the movement of GDP deflator, it is closer to WPI than to CPI in the most recent quarters. And looking at the current WPI levels, deflator is set to move up further. 

What impact will it have? 

WPI inflation is nothing but the rise in prices as felt by the producers in the economy—farmers, manufacturers, and so on. When they face high inflation, it means that their input prices have risen. To the extent that this impacts the prices of intermediate and finished goods, this will raise the value of goods and services in the economy at current prices. 

Icra chief economist Aditi Nayar expects the annual average of wholesale inflation to be close to 11.75 per cent, while that of consumer inflation to be 5.5 per cent. With this, she expects that the implicit GDP deflator will be close to 8.5 per cent, and has pegged India’s nominal GDP growth at 17.5 per cent. 

This will take India’s GDP close to Rs 232 trillion. 

Annual fiscal deficit is usually looked at with respect to the nominal GDP. When the denominator —nominal GDP — rises, it will have a dampening impact on the fiscal deficit to GDP ratio. 

But how much? For that, we need to understand how different the fiscal deficit will be from the expected level. 

In the Budget 2021-22, the Centre said it expects the net tax revenue to Centre to be Rs 15.5 trillion, non-tax revenue at Rs 2.43 trillion, disinvestment proceeds at Rs 1.75 trillion. 

Nayar estimates that Centre’s net tax revenue will be higher than the Budgeted number by Rs 1.45 trillion largely due to highly favourable growth in corporation tax collection. Adding the enhanced dividend from Reserve Bank of India, net gains including the non-tax revenue add up to Rs 1.95 trillion. 

Disinvestment may go two ways. If the initial public offering of Life Insurance Corporation of India happens before March 31, 2022, the government may get the expected revenue of close to Rs 1 trillion in its coffers. This would result in higher revenue to the tune of Rs 1.5 trillion (estimate). With the supplementary demands for grants passed by the Parliament adding a net extra outgo of Rs 3 trillion, this entire math would add Rs 1.5 trillion in absolute terms to the fiscal deficit. The impact of excise duties and customs is not considered here. 

If the nominal GDP reaches the level of Rs 232 trillion, this scenario may result in a fiscal deficit crossing 7.1 per cent of GDP this fiscal, higher than the budgeted 6.8 per cent. 

But failure to deliver the LIC IPO may further dent revenues to the tune of Rs 1 trillion. The net gain on the revenue front will be nearly neutralised by poor divestment proceeds. The entire additional expenditure (supplementary demands for grants) burden will get added to stable net revenues. This will stretch the fiscal deficit further. 

If we take Icra's upper bound of the fiscal deficit which considers this scenario, it could reach a level of Rs 17 trillion. At the estimated GDP of Rs 232 trillion, this would be 7.33 per cent of GDP.

Of course, the FAE for 2021-22, which will be released on 7 January, will give the first official estimate of GDP for the financial year, and with it, the first look at where the fiscal deficit would move.