It’s not just the GDP. There’s also the mystery of 10% growth in consumption expenditure

Who do you believe? The Central Statistics Office which pegged India’s Gross Domestic Product growth for the third quarter (October to December) of financial year 2016-’17 at 7% and private final consumption expenditure growth at a whopping 10.1% over the third quarter of 2015-’16? Or what you see and read about the effects of demonetisation since November 8, 2016?

To put things in perspective, the released data shows that growth in private final consumption expenditure doubled during the quarter which saw higher denomination notes being withdrawn. This growth was 5% in the second quarter of July-September, which reached a multi-year high of 10.1% in the third quarter. Everything about this increase in growth rate is counterintuitive.

When the government froze 86% of India’s currency on November 8, one thing was sure – the economy would be hurt in the short term. Cash accounts for 40% of India’s GDP and 75% of employment. No one could, however, guess the exact magnitude of this short-term hit.

What the data showed

As data became available in the next few months, it seemed to bear out the above fears. Sample a few:

First, India’s non-food credit growth fell to a multi-year low of 5.3% for the fortnight ended December 23, 2016. While retail lending has been strong, there is nothing to indicate that consumers surged to borrow money from banks to spend during the third quarter – at least not on a large enough scale to propel private final consumption expenditure to 10%.

Second, consumer companies had indicated that the impact of demonetization would be negative in the near term. A presentation on consumer giant Hindustan Unilever Limited’s website outlines the impact of demonetization. Slide 4 titled “however temporary pain likely in the short term” summarises the impact on various sections as follows:

“Consumers: Impacted by lower cash on hand, cautious with their spend. Initially spend only on basic necessities.”

The impact was visible in the third quarter results. Hindustan Unilever, for example, reported a 4% decline in sales volumes for the quarter ended December 31, 2016. ITC, another consumer giant, had this to say in its press release for its third quarter results:

“The operating environment was extremely challenging during the quarter. FMCG sales were adversely impacted as a result of lower consumer offtake and reduction in trade pipelines particularly in the aftermath of the Government’s decision to withdraw specified high denomination currency notes.”

Even Asian Paints, considered a bellwether of sorts since demand for home decoration paints is fairly resilient, didn’t escape unhurt. In its press release for its third quarter results, the company stated,

“The decorative business segment in India registered low single digit growth in the quarter with demand impacted to a certain extent on the back of demonetization.”

Hindustan Unilever, ITC, and Asian Paints are among India’s largest fast moving consumer goods companies. If they visibly felt the hit of demonetisation, then where were the consumers who drove the surge in private final consumption expenditure?

Third, the impact of demonetisation was also visible on two-wheeler sales:

“During the demonetization period sales of two-wheelers slid 22 percent in December 2016 as compared to the figures, which came in December 2015, marking the highest monthly contraction since SIAM started recording the data since 1997.”

Admittedly, Maruti – India’s largest car manufacturer – did report a 3.5% increase in car sale volumes during the third quarter, but this was lower than the 18.4% growth in car sales volumes registered in the second quarter.

Can we trust the 7% GDP growth for FY17?

The private final consumption expenditure growth data was part of the Central Statistics Office’s press release on the second advance estimates of national income for the current financial year and quarterly estimates of GDP for its third quarter.

In its second advance estimate, the CSO maintained that India is on track to achieve 7.1% GDP growth in this financial year. This is the same number as the first advance estimate released by CSO in January. The difference between the first and second estimates is that the CSO had more data – primarily from the organised sector – on economic activity during the third quarter. The CSO will now announce provisional growth data in May, after it has data for the full financial year.

What is new in the second advance estimate?

The ministry of statistics and programme implementation says:

“The sector-wise estimates are obtained by extrapolation using various indicators like (i) Index of Industrial Production of last 9 months of the year, (ii) financial performance of Listed companies in the private corporate sector available upto quarter ending December (ii) 2nd Advance estimates of crop production, (iii) expenditure of Central & State Government for the last 9 months, (iv) growth rates of various indicators of service sector e.g. sales tax, deposits & credits, passenger and freight earnings of Railways, civil aviation, number of telephone connections, etc. available for last 9 months.”

With access to more data, experts expected that the first advance estimate of GDP growth would be lowered. Nothing of that sort happened in February. To be fair, India’s huge unorganised sector is notoriously difficult to measure. This sector is also the most vulnerable to the cash crunch. Perhaps the CSO will get a better idea by in the next three months of the impact of demonetization on this sector. Hopefully by then, the CSO might also relook at this suspiciously large jump in private final consumption expenditure growth that isn’t backed by too much evidence.