What is the low base effect?
If we take a data point or an index, it is often contextualized by comparing it to a benchmark, which is usually the same period of last year or the previous month. However, this reference point or base can have an effect on the result of the comparison, and this phenomenon is commonly called the base effect. If the base for which the comparison is made is weak, then the result is the result of a weak base effect and vice versa.
When comparing two data points, choosing a reference point will be crucial because the base effect can strongly distort or mislead the interpretation of numbers. The base effect could also lead to material differences in percentage comparisons. If one chooses a reference point that is too low, there could be an overestimation and if the base is too high, it could result in a gross underestimation of the situation.
If we take the May industrial production figures, for example, the growth rate is unusually high as last year’s base was affected due to the coronavirus pandemic. However, PII growth is only up 1.7% from pre-Covid periods, and manufacturing is actually lagging behind. The choice of a different reference point, i.e. the pre-Covid level, has allowed a better understanding of the real performance of industrial activity in the country.
Industrial production is just one example, and abnormally high or low economic estimates often result from a base effect. A year into the pandemic, GDP growth rates were unusually high as lockdowns stalled economic activity during benchmark periods. India’s GDP grew 20% in the first quarter of FY22 on a weak base as the economy contracted 24% in the same period a year earlier.