Germane short-term data

Finally, all key economic indicators have one base year, but IIP could remain volatile

It is a capital mistake to theorise before one has data. Insensibly, one begins to twist facts to suit theories, instead of theories to suit facts.

— Sherlock Holmes, aka Sir Arthur Conan Doyle

And what if data do not capture reality?

Same result, and then some leading to erroneous conclusions that complicate policy making.

Just what was happening with the Index of Industrial Production (IIP) and the Wholesale Price Index (WPI) data, which were being calculated on an obsolete base year of 2004-05.

The revisions indicate how off the mark the previous series were, particularly in the case of IIP. For fiscal 2017, the revisions bumped up industrial production to five per cent from 0.7 per cent estimated as per the old series.

Since 2004-05, the Indian economy has undergone a sea change. GDP growth has averaged 7.8 per cent in the last 12 years, which marks a decisive upward shift from five-six per cent in the preceding three decades. And so have the consumption and production patterns.

With IIP out of sync with evolving production structures, it had become volatile, unpredictable and outdated. In the absence of a comprehensive substitute, it remained the key short-term indicator of industrial performance and was until recently used to compute quarterly manufacturing GDP.

From a monetary policy perspective, WPI lost its relevance when the Reserve Bank of India (RBI) announced the Consumer Price Index (CPI) as its preferred inflation gauge. That notwithstanding, WPI continues to be used for computing price deflators. These deflators are then used to convert nominal into real GDP. Needless to add, the outdated base affected the accuracy of deflators and, consequently, the GDP.

Till last Friday, WPI and IIP were the only key indicators of the economy not synced to the 2011-12 base year.

The new IIP series has expanded 30 per cent and now covers 809 items from 620 earlier, and their weights have been rejigged as per the Saumitra Chaudhari Committee Report of 2014. As many as 146 obsolete items were removed and 199 new ones added. Similarly, the new WPI series covers 697 relevant items now from 676 earlier.

UPWARD CURVE: IIP growth averages 3.8 per cent for the past five fiscals compared with 1.4 per cent as per the previous data series. The booster comes from manufacturing, which has more than three-fourth weight in IIP. Photo: Reuters

The new data series show the growth-inflation mix is better than estimated, with inflation down and industrial output up.

IIP growth averages 3.8 per cent for the past five fiscals now compared with 1.4 per cent as per the previous data series. The booster comes from manufacturing, which has more than three-fourth weight in IIP. That’s par for the course because fast-growing contemporary sectors have been included and laggardly, obsolete segments removed.

The change in the basket of commodities and weights have reduced average WPI inflation by a percentage point to 2.3 per cent for the past five fiscals.

However, pacier IIP would not automatically lead to upward revision in manufacturing gross value added (GVA). That would have happened a few years back when manufacturing GDP was computed from IIP. Now it is calculated from balance sheet data from the ministry of corporate affairs.

But lower WPI inflation could create an upside to past GDP growth. Real GVA estimates for manufacturing are computed by deflating the nominal value-added from corporate balance sheets. With WPI the basis of GVA deflators, a lower WPI inflation rate could crank up real GDP growth for fiscal 2017, provided other factors influencing the GDP remain unchanged.

Another significant change in the new WPI series is that it now excludes the impact of excise duty changes. Consequently, the GVA deflator computed from WPI will now not only better capture the underlying pressure on prices but will also be more accurate because, conceptually, the GVA deflator should not include the impact of taxes.

The revisions will not necessarily narrow the inflation gap between WPI and CPI as the WPI still misses out on the services sector, which is more than half of GDP.

In tune with global practice, WPI would eventually be replaced by a comprehensive producer price index (PPI), which covers both the goods and the services sectors. PPI will exclude, apart from excise duty, trade and transport margins as well.

To be sure, PPI remains a work in progress and is some time away.

So will the new IIP series be less volatile?

Not necessarily, because reported data are often lumpy in nature with many not reflecting a specific month’s output — and may refer to previous month/s. The process of missing data generation also creates volatility.

In the five fiscals ended 2017, the standard deviation of monthly growth rates is marginally lower at 3.1 per cent in the new series versus 3.4 per cent in the old one. However, the standard deviation remains unchanged at 2.7 in the two series for fiscal 2017.

In other words, we will have to live with volatility in IIP, which reduces its efficacy as a directional gauge. The remedy, as India’s Chief Statistician Dr TCA Anant pointed out, is to look at three-month moving averages of monthly data.

But let the best not be the enemy of the good. The new data series is contemporary, methodologically superior, and aligned to global best practice. It has narrowed the gaping gap between IIP and industrial GDP, and is expected to sync better with other proxy indicators of industrial activity such as excise collections.

The Central Statistics Office should now focus on improving response rate for industrial data to make data less volatile and accurate.

The author is chief economist, CRISIL