What is low base effect?

If we take any data point or index, it is often contextualised by comparing it with a reference point, which is usually the same period of last year or the previous month. Now, this reference point or base can have an effect on the result of the comparison, and this phenomenon is commonly referred to as base effect. If the base for which the comparison is made is low, then the outcome is a result of a low-base effect and vice-versa.

When comparing two data points, choosing a reference point will be crucial as the base effect can highly distort or mislead the interpretation of numbers. The base effect could also result in major differences in percentage comparisons. If we chose a reference point that is too low, there could be an overestimation and if the base is too high, it could result in gross underestimation of the situation.

If we take the May industrial production numbers, for example, the growth rate is unusually high as last year's base was impacted due to the coronavirus pandemic. However, IIP growth was up just 1.7% compared to pre-Covid periods, and the manufacturing is in fact lagging. Choosing a different reference point, that is pre-Covid level, resulted in a better understanding on how the industrial activity in the country is actually performing.

Industrial output is only one example and abnormally high or low economic estimates are often the result of a base effect. A year after the pandemic hit, GDP growth rates were unusually high as the lockdowns stalled the economic activity during reference time periods. India’s GDP grew by a massive 20% in the first quarter of FY22 on the back of a low-base when the economy contracted 24% in the same period previous year.