Updated: Sep 6, 2020
This is the first part of a series on important macroeconomic indicators that help financial analysts and investors gauge the direction of the economy. The intention is for you to understand the meaning of each indicator, as well learn its interpretation and practical application in taking investment decisions.
The first, and perhaps the most fundamental of all indicators, in the series is Gross Domestic Product (henceforth referred to as GDP). The GDP is an important indicator because it informs us about a country’s wellbeing. In other words, it attempts to answer the fundamental question: Is India more prosperous than before or less?
To answer this question, GDP looks at the total quantity of goods and services available to its citizens for consumption during a year.
Why quantity? It’s because GDP assumes that a nation that produces more quantity of goods and services enjoys a better standard of living compared to a nation that produces less. Thus, America enjoys a higher standard of living compared to India because it produces more goods and services than India.
Now, you may be tempted to ask, and rightly so: “Does a nation’s wellbeing depend solely on the number of goods and services produced?” The answer is absolutely not.
A nation’s wellbeing depends on a host of other factors. These include, among other factors, whether those goods and services are available to a wider section of the population or only to a select few. It also depends on whether the production of those goods and services entails harming the environment and health of the population. There’s also the problem of illegal activities, which are not reflected in official statistics and therefore not included in the GDP.
Thus, as you can realize, GDP has its drawbacks. But because it is one of the easiest measures to compute owing to the relatively easier access to data, economists prefer to use this to measure an economy’s performance.
Anyway, moving on…
What is GDP?
In simple words, GDP is the total market price of all finished goods and services produced within a country’s borders in the current period. In the previous sentence, pay close attention to words emphasized in bold. Let me repeat: The GDP of a country includes all finished, not intermediate, goods and services produced within a country’s borders (not outside), in the current (not past) periods. Makes sense?
Now let’s look at this with an example. Imagine an automaker such as Maruti Suzuki: It frequently purchases inputs such as steel, glass, wires, rubber, and other auto components from various suppliers to manufacture, say, a WagonR.
In the calculation of GDP, an economist would only include the final retail price of the WagonR and not the price of steel or tyres. This is because including the price of steel or tyres used to manufacture WagonR in the GDP calculation would amount to double counting, isn’t it?
Also, remember that only current year’s production is included, not the cars produced last year. Those were included in last year’s GDP. How about a car, say Hyundai, produced in South Korea and imported and sold in India? This is not included in India’s GDP because it was produced outside India’s borders. You get the point!
If we assume that Maruti Suzuki produced 10,000 WagonRs in the current year at a market price of say Rs 4 lakhs per car, then the total contribution to the GDP by WagonRs would be Rs 4 lakhs multiplied by 10,000 cars. That is Rs 400 crores.
Nominal versus Real GDP
Let me introduce a tricky part here: Rs 400 crore is the nominal GDP. In other words, when we want to compare whether India’s GDP has increased compared to a previous year, Rs 400 crore would not allow us to do that simply because the price of the car may have increased over time. We want to know whether India has produced more quantity of WagonR cars compared to the previous year. An increase in price could also increase the GDP, but that would be misleading, isn’t it?
Say next year the price of WagonR increases to Rs 4,25,000 but the quantity produced remains the same at 10,000. Then the GDP would increase to Rs 4.25 lakhs multiplied by 10,000 or Rs 425 crores. This increase in GDP to Rs 425 crores is solely because of inflation, not a result of higher production. We want to know whether production has increased.
To remove the effect of inflation, we look at real GDP – meaning we do not change the price of the car in our calculation. We choose a base year (say 2011-12), take the price of the WagonR during that year and keep it constant in our formula. We only change the quantity.
So, in our case, we take Rs 4 lakh and keep it constant. Next year, if the WagonR production increased to 15000, then we multiply 15000 by Rs 4 lakhs and arrive at Rs 600 crores. Thus, in effect we have removed the effect of inflation from our calculation of GDP. This is called real (as opposed to nominal) GDP.
Remember this difference in real and nominal GDP.
Who comes out with GDP numbers each year?
GDP is part of what economists call the “National Income Statistics”. Don’t be intimidated by the jargon. GDP is a measure of national income, which is why it is called so. It is published both quarterly and annually by a ministry called Ministry of Statistics and Programme Implementation (in short MOSPI).
Under MOSPI, there is the National Statistics Office or NSO. The NSO comprises three offices: The Central Statistics Office (CSO), the computer center, and the National Sample Survey Office (NSSO). The CSO has a National Income Statistics division which publishes the GDP numbers according to a predetermined calendar. You can find the calendar here.
Notice how the calendar includes both advance estimates and revised estimates. The revised estimates are released to incorporate latest availability of data, and therefore updated information, about the economy with the NSO. For any particular year, the GDP figures are updated 4 times: First, there’s the first advance estimates, then first revised estimates, followed by second advance estimates, and finally provisional estimates.
Here is a screenshot of the calendar for 2020.
Where do you find the GDP numbers?
Go to MOSPI website home page at www.mospi.gov.in and under Press Releases, click All. As per the calendar above, you would find various documents in PDF format. For instance, note the First Advance Estimates of National Income 2019-20.
Here's a screenshot from the document:
As mentioned above, the NSO expects India’s real GDP (meaning at constant, base year prices) in 2019-20 to be Rs 147.79 lakh crore or a growth of 5 per cent compared to the previous year. The base year is 2011-12.
Go through the entire document and notice the NSO discuss other interesting tidbits about the economy, including consumption expenditure, capital formation, and so forth.
In a separate post, we will look at Gross Value Added or GVA. As always, feel free to ask questions in the comments below!