GDP and economic growth

In simple terms

Gross domestic product (GDP) is the total value of the final goods and services produced within a country over a period, such as a quarter or a year. It is the most common measure of the size of an economy, and its growth rate is the most quoted measure of how fast the economy is expanding.

"Final" matters: GDP counts the car, not separately the steel and tyres that went into it, to avoid counting the same output twice.

Three ways to add it up

GDP can be measured from three directions, which should in principle give the same answer:

1. Spending: what households, businesses, government and foreigners spend on output produced in the country.
2. Production: the value added by each industry, such as farming, manufacturing and services.
3. Income: wages, profits, rents and interest earned from producing that output.

In India, household consumption is the largest part of GDP, which is why jobs and incomes matter so much, as the employment and consumption lesson explains.

Nominal and real GDP

Nominal GDP values output at current prices. It can rise simply because prices rose. Real GDP removes the effect of inflation, using a broad price measure for the whole economy called the GDP deflator.

Real growth tells you whether the economy actually produced more. Nominal growth matters too: company revenues and tax collections are in current rupees, so they track nominal GDP more closely.

Estimates and revisions

GDP is estimated, not counted. India's statistics office releases early estimates for each quarter and year, then revises them as fuller data arrives, sometimes over several years. The base year and methods are also updated from time to time. Early numbers can therefore change, and a headline growth figure is better seen as a first estimate than a final fact.

Why GDP growth and stock returns diverge

It seems natural that a fast-growing economy should have a rising stock market. Studies comparing countries over long periods have found the link to be weak. Reasons include:

• The market is not the economy. Listed companies are a subset of the economy, with a different mix of industries. Much economic activity happens in unlisted, small and informal businesses.
• Profits per share, not profits overall. Growth can be financed by issuing new shares, so existing shareholders' slice grows more slowly than total profits.
• Starting valuations. If investors already expect fast growth and pay a high price, returns can be poor even when growth arrives.
• Global links. Many listed companies earn abroad, and foreign investors move money in and out for global reasons, as the foreign investment flows lesson explains.

Why it matters

GDP shapes the backdrop for company sales, jobs, tax revenues and policy. But reading it directly as a forecast for share prices is a mistake. Understanding what it measures, and what it does not, helps you put growth headlines in context.

Limitations

GDP leaves out unpaid work and much informal activity, says nothing about how income is shared, and does not measure well-being. Quarterly figures are noisy and revised. Comparisons between countries depend on exchange rates and methods.

Common mistakes

• Confusing nominal and real growth.
• Treating first estimates as final.
• Expecting fast GDP growth to guarantee high stock returns.
• Ignoring starting valuations.

Try it yourself

1. Find the latest quarterly GDP release and note real and nominal growth.
2. Compare the first estimate for an earlier quarter with its latest revised figure.
3. For a broad index, compare growth in earnings per share over several years with nominal GDP growth over the same period.