What is GDP? What is the difference between real and nominal?

Since the novel Coronavirus or COVID-19 last December, the global media industry is full of reports suggesting negative impact of the pandemic on global economy as well as various countries.
World Bank, International Monetary Fund (IMF) – the leading international agencies – predict severe impact on world economic growth Gross Domestic Product (GDP).
India’s GDP too expected grow at a slower pace of 3-4% as against earlier forecast of +7%, the fastest in the World.
The word GDP is important for any economy as it helps ascertain strength and probable measures needs to be undertaken to resurrect its deviation.

So the question arises here is: what is GDP?

GDP is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.
As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health.
As we know, GDP as an economic indicator is used worldwide to show the economic health of a country.
For low-income or middle-income countries, such as India, high year-on-year GDP growth is essential to meet the growing needs of the population. Hence, the GDP growth rate of India is an essential indicator of the country’s economic development and progress. Besides measuring the health of the economy and helping the government is framing policies, the GDP growth rate numbers are also useful for investors in better decision-making related to investments. Different countries have different methods to calculate GDP. Let’s take a close look at the GDP growth rate calculation in India.

GDP calculation…..
The central statistical office, or CSO, is responsible for compiling data for calculating GDP. It aggregates the GDP data by coordinating with several federal and state-run agencies. Once the data collection process is completed, the task of calculating the GDP begins.
There are two methods to arrive at the GDP number:

Known as GDP at factor cost, the first method looks at the economic activity
The second method is the expenditure-based method (at market prices).

Further, the nominal GDP is calculated using the current market price, and real GDP is arrived after adjusting inflation.

Among the four sets of GDP numbers, GDP at factor cost is the most commonly used figure and reported in the media. While the GDP at factor cost reveals which industry sector is doing well, the expenditure-based GDP is indicative of the status of different areas of the economy; how the trade is doing or whether investments are on the decline.

For the calculation of GDP at factor cost, data is taken from eight sectors, namely agriculture; mining and quarrying; manufacturing; forestry and fishing; electricity and gas supply; construction, trade, hotel, transport and communication; financing, real estate and insurance; and business services and community, social and public services. For the calculation of expenditure-based GDP, all the spending incurred on final goods and services are added that include consumer spending, government spending, business investment spending, and net exports.

Economists use a process that adjusts for inflation to arrive at an economy’s real GDP. By adjusting the output in any given year for the price levels that prevailed in a reference year, called the base yes, economists can adjust for inflation’s impact. This way, it is possible to compare a country’s GDP from one year to another and see if there is any real growth.

Real GDP is calculated using a GDP price deflator, which is the difference in prices between the current year and the base year. For example, if prices rose by 5% since the base year, the deflator would be 1.05. Nominal GDP is divided by this deflator, yielding real GDP. Nominal GDP is usually higher than real GDP because inflation is typically a positive number. Real GDP accounts for changes in market value, and thus, narrows the difference between output figures from year to year. If there is a large discrepancy between a nation’s real GDP and its nominal GDP, this may be an indicator of either significant inflation or deflation in its economy.

Of all the components that make up a country’s GDP, the foreign balance of trade is especially important. The GDP of a country tends to increase when the total value of goods and services that domestic producers sell to foreign countries exceeds the total value of foreign goods and services that domestic consumers buy. When this situation occurs, a country is said to have a trade surplus. If the opposite situation occurs–if the amount that domestic consumers spend on foreign products is greater than the total sum of what domestic producers are able to sell to foreign consumers–it is called a trade deficit. In this situation, the GDP of a country tends to decrease.

The government releases quarterly GDP numbers every two months, and the final numbers for the whole year are issued on May 31.

GDP provides an economic snapshot of a country, used to estimate the size of an economy and growth rate. Though it has limitations, GDP is a key tool to guide policymakers, investors, and businesses in strategic decision making.

Investors watch GDP since it provides a framework for decision-making. The “corporate profits” and “inventory” data in the GDP report are a great resource for equity investors, as both categories show total growth during the period; corporate profits data also displays pre-tax profits, operating cash flow and breakdowns for all major sectors of the economy.

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