It has been widely reported that the latest data release showed a sharp slowdown in Indian GDP growth. Our analysis indicates that this is a misreading of the data, caused by the curious Indian practice of using four-quarter growth rates rather than seasonally adjusted data. After we seasonally adjust the data, we find that Q4 GDP actually rebounded, but rather weakly, and the headline slowdown in YoY Q4 growth is actually the result of the sharp Q3 decline followed by a weak Q4 rebound.
The Central Statistical Office released GDP figures for the Q4 of the last financial year on Wednesday. Although the full year economic growth came in at 7.1%, exactly what was estimated earlier, the Q4 data has been interpreted by many in the press as showing a sharp slowdown. For instance, Business Standard reports a “hard fall”, and warns that “Q4 GDP data point to serious slowdown”. Times of India has reported the same story. The Mint reports that
Gross domestic product (GDP) growth slowed to 6.1% in the fiscal fourth quarter from 7% in the third, according to data released by the government
This refers to the 6.1% change in GDP from Q4 of FY 2015-16 to Q4 of FY 2016-17 and compared to the 7.0% change from Q3 of 2015-16 to Q3 of 2016-17. As we have pointed out earlier, four-quarter growth rates are not a good measure of the short term dynamics of the economy since they effectively add up growth over four quarters and thus smear out the short term movement. The correct way to measure the quarterly dynamics is to seasonally adjust the GDP and then look at quarter to quarter growth rates. We have written about this in more detail in the past, and the necessity of such a procedure was pointed out last year in a study by a group of researchers from the National Institute of Public Finance and Policy in Delhi.
The growth rate of the seasonally adjusted GDP is shown in the chart above. It shows that far from slowing, GDP growth actually accelerated from a revised 4.3% rate in Q3 to 7.2% in Q4. The slowdown in Q3, and the rebound in Q4 are exactly what one would expect, as the currency and banking situation starts to normalise after the Q3 shock of the note ban. However, the strength of the rebound is not very reassuring, especially when we keep in mind that the GDP data probably overstates the rate of growth since the estimates rely mostly on data from the formal sector. The Q3 slowdown is reflected with a lag in the YoY Q4 figure, and the apparent Q4 slowdown seen in the YoY figure, is actually the result of the sharp Q3 slowing followed by a weak rebound.
The true test of economic resilience will come in the first half of the current financial year. There are many head winds in the global economy, such as a possible downturn in China, prospects of more trouble in Europe, and the new protectionism in USA. It is also quite likely that many hysteresis effects from the note ban will play out with long lags. We will need to wait until late 2017, maybe even longer, before we know the full effects of the note ban on the economy.
The Business Standard has reported, quite accurately, that both Q3 and Q4 GDP have surprised, first for being too strong in Q3 and then for being weaker than expected in Q4. Both surprises stem from the same source, the curious reluctance to use the widely accepted procedure of seasonal adjustment, and the consequent inappropriate use of four-quarter growth to measure quarterly movements. Naturally, the four-quarter growth lags the dynamics, and the Q3 slowdown has been observed in Q4, and we look forward to another bout of surprise in Q1 GDP next year, based on a lagged observation of the Q4 rebound.