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Macronomics: Decoding GDP and the Scary Drop in Personal Consumption

Deepak Shenoy7 min read
Quick Facts
What is "Macronomics: Decoding GDP and the Scary Drop in Personal Consumption" about?
What category is this article in?
Premium
Who wrote this article?
Deepak Shenoy, Capitalmind's research team.
When was this article published?
Published 2 December 2013.
How long does this article take to read?
7 min read
What topics does this article cover?
Macronomics
What does the "A Summary" section say?
GDP growth seems to have reversed at a headline level, but the inflation impact is very high. The rupee depreciation has caused the trade deficit to shrink which is a large contributor to this GDP number. Consumption and government expenditure are growing at treacherously low numbers. Agriculture contributes to GDP in a big way, relative to its past. A small trading and portfolio allocation strategy follows the analysis. As usual, we try to talk less and demonstrate more in charts.
What does the "The Indian GDP Growth Story" section say?
At Capital Mind, we wrote a piece on the Indian GDP which hides a couple things that are temporary:
What does the "Factor Cost Versus Market Prices" section say?
GDP is estimated in two ways. One, from production of various industries, which is GDP at “factor cost”, and another, from expenditure of various sectors of the economy which is GDP at Market Prices. Effectively, if you add indirect taxes and subsidies to the GDP at factor cost, you will reach the same point as “market prices”.
What does the "The GDP Deflator" section say?
The effect of inflation is in the “GDP Deflator”. Let’s look at an economy that in Year 1 can make a 100 widgets, at Rs. 10 per unit. The GDP is Rs. 1,000.
What does the "The Trailing 12 Month GDP - and The Drop in Private Consumption" section say?
If you look at a single quarter, it doesn’t tell you that much. Let’s look at the last four quarters - the Trailing Twelve Months (TTM) and add up the GDPs for them. The TTM GDP Growth will tell you a story of a longer term trend and smooth over any specific quarter moves.
What does the "Contributions: Agri Bumps up Nominal Growth But Inflation Is High" section say?
Let’s look at the various elements that comprise the GDP and see how they contribute to the growth:
What does the "Contributions: Private Consumptions and and the Trade Deficit" section say?
What’s interesting in this quarter is that looking at things from an expenditure angle at market prices, at both real and nominal levels, we can see how hugely the trade deficit has helped the GDP.
What does the "What’s the Point?" section say?
Macroeconomics is often confused for something that can give short term trading insights. It’s not designed for that purpose, though often players react in the short term to what is a gradual and longer-term trend. Markets could react immediately based on
What does the "Extension of Trial Subscribers till December 15 and an Offer!" section say?
Many of you subscribed to our 30 day trial on November 5, when we released Capital Mind Premium. We’re glad to extend all trials till December 15 (if your trial expires after that, you can ignore this) as we have a lot of interesting content coming up till then.

This is an archive of a Capital Mind Premium post sent by email. If you haven’t already, Subscribe now!

This week, we have a piece on the Indian GDP and its implications to us. On Nov 30, we had a GDP Data Release and in there were statistics that contained, among other things, lots of little numbers. We try to make sense of those numbers.

A Summary

  • GDP growth seems to have reversed at a headline level, but the inflation impact is very high.

  • The rupee depreciation has caused the trade deficit to shrink which is a large contributor to this GDP number.

  • Consumption and government expenditure are growing at treacherously low numbers.

  • Agriculture contributes to GDP in a big way, relative to its past.

  • A small trading and portfolio allocation strategy follows the analysis.

  • As usual, we try to talk less and demonstrate more in charts.

The Indian GDP Growth Story

At Capital Mind, we wrote a piece on the Indian GDP which hides a couple things that are temporary:

  • The high inflation could have lifted GDP growth numbers (It’s difficult to tell inflation from real growth in a large economy)

  • The reduction is in the trade deficit is due to restrictions on Gold imports and high duty. (Temporary measures as these have to be opened up)

Now Capital Mind Premium has even more dope for you. But first:

A Summary of GDP Growth

We’ve improved a little bit, but you can see nominal GDP growth go up much faster - this is the higher inflation impact, which means we’re running even faster just to stay in the same place. Let’s now look at more advanced ways to look at this data.

Factor Cost Versus Market Prices

GDP is estimated in two ways. One, from production of various industries, which is GDP at “factor cost”, and another, from expenditure of various sectors of the economy which is GDP at Market Prices. Effectively, if you add indirect taxes and subsidies to the GDP at factor cost, you will reach the same point as “market prices”.

When you want to look at nominal growth you would typically look at GDP at market prices, and nominal growth would be reflected in the factor cost.

When we say Nominal it means the Gross Domestic Product at current prices. “Real” growth is the growth if we measured everything in 2004-05 prices, or at constant prices. Effectively, Real growth is Nominal growth after removing the impact of inflation.

The GDP Deflator

The effect of inflation is in the “GDP Deflator”. Let’s look at an economy that in Year 1 can make a 100 widgets, at Rs. 10 per unit. The GDP is Rs. 1,000.

In the next year, it goes to Rs. 12 per unit (20% inflation) and they make a 110 units (10% “real” growth). The Nominal GDP is now Rs. 1320 (Rs. 12 x 110).

If the GDP has gone from 1,000 to 1,320, the nominal GDP growth is 32%. But we know that real growth - increase in the number of widgets - is only 10% (100 to 110).

There is therefore a “deflator” that makes the 32% nominal into 10% “real”. This deflator is just the Nominal GDP divided by the Real GDP. We typically look at the difference and say that the deflator might be (32% minus 10%), but that would be wrong. The difference tells us it’s 22%, but we know prices went up 20%.

The deflator is simply Nominal GDP divided by Real GDP (multiplied by 100). The “slope” of this nominal GDP - in effect, the change over the previous year - is the effect of inflation in any particular year. Let’s look at this graph from 1951.

As we can see, the effect of inflation has been rising in the last few years - and if we assume that 5% is what breaks us, then we’ve been above since 2006.

And on a closer note, on a quarterly basis, we see this impact change over the last few quarters.

This number had been falling till the last quarter, and has suddenly jumped up.

Much of this change is because the inflation measures are, for the most part, based on the Wholesale Price Index, which Capital Mind readers know has been running substantially below Consumer Prices in the last few quarters. In October prices have gone up further, and October isn’t even included in the GDP number.

Impact: The GDP deflator has been benign in the last few quarters but it will rear its ugly head again, very soon. A higher inflation impact will eventually eat into “real” GDP.

The Trailing 12 Month GDP - and The Drop in Private Consumption

If you look at a single quarter, it doesn’t tell you that much. Let’s look at the last four quarters - the Trailing Twelve Months (TTM) and add up the GDPs for them. The TTM GDP Growth will tell you a story of a longer term trend and smooth over any specific quarter moves.

While we’ve moved up from the recent downtrend, there’s two parts that are scary - Government Expenditure and Private Consumption. Both are at or near their lows.

Contributions: Agri Bumps up Nominal Growth But Inflation Is High

Let’s look at the various elements that comprise the GDP and see how they contribute to the growth:

Agriculture has the second biggest contribution to GDP in nominal terms, but it’s at number four in “real” GDP. Meaning, the effect of inflation is worst there - and food prices have been inflating at an alarming rate recently. It just means that we aren’t producing all that much more food, it’s just priced higher. Let’s hope the good monsoon will change this (the effect is in Dec and Mar quarters).

Here’s how the chart looks for YoY growth:

Contributions: Private Consumptions and and the Trade Deficit

What’s interesting in this quarter is that looking at things from an expenditure angle at market prices, at both real and nominal levels, we can see how hugely the trade deficit has helped the GDP.

(Note: Inventories includes valuables)

The trade deficit has fallen since the rupee has depreciated over 10% in the quarter.

What’s the Point?

Macroeconomics is often confused for something that can give short term trading insights. It’s not designed for that purpose, though often players react in the short term to what is a gradual and longer-term trend. Markets could react immediately based on

Positives

  • The GDP growth **“headline” number **is more than the previous quarter.

  • We see agriculture coming back as a contributor to GDP growth, with 0.5% this year. If the monsoon impact is good, we should see a bigger “real” growth in subsequent quarters. This could mean more sales of tractors, two wheelers and FMCG goods. (Smaller items that don’t need credit and have a national distribution)

  • The shrinking trade deficit due to rupee depreciation has contributed to the GDP in a big way. Exporters, especially of low margin goods like textiles, continue to be a good purchase.

Negatives

  • The** inflation impact** is very high and reflects in the derivative numbers shown in the charts above. With headline GDP remaining high, it’s likely rates will go up.

  • Portfolio wise, you would brace for this by avoiding longer term bonds, and avoiding financial or high-debt stocks.

  • With oil remaining at this level, the oil subsidy can cripple the government’s ability to spend as the deficit expands to levels of 5% of GDP.

  • Government expenditure continues to slow. This will definitely impact the infrastructure industries which I would avoid for now.

  • Private consumption which is 60% of the GDP is at it’s** lowest real growth rate** on a trailing 12 month basis since 2005, adjusted for inflation. This is very negative for consumer discretionary stocks (auto, durables) as the impact will be visible over the next few quarters.

Positioning a portfolio for this GDP number would be to focus on exporters, those stocks that benefit from rural growth or inflation (FMCG, two wheelers) and ultra-short term bonds.

A trading strategy would be to additionally set up short positions on those dependent on government spending, high cost consumer durables and financials/real estate companies.

Tell us what you think! Mail us at [email protected]. Capital Mind Premium will provide this data to subscribers with interactive charts, and data downloadable in CSV format, in our proprietary tool we’re building.

Extension of Trial Subscribers till December 15 and an Offer!

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Tagged:Macronomics