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Indian Economy in Recent Times - Updated 2011 2

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    (c) S. Morris, IIMA

    Growth, Crisis, Revival andIssues in Macroeconomic

    ManagementSebastian Morris

    March 24, 2010

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    Yf (structure, technology, invReform, ethos, governance etc)

    AS (raw matls,Import price)

    AD (fiscal, monetary

    Policies, exchange rates, worldDemand, investment, sentiment)

    Y*

    Prices

    Income

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    The Current Situation

    (Immediately foll Crisis) Growth has fallen much less than expected

    Large fiscal boost the key to the revival NREGA, Social Sector Expn, Rural Infrast

    Tax breaks on indirect and now indirect replaced bydirect tax breaks

    Pay commission effects continue

    Very lately by exports and exports of services

    Remittances help more steady than was expected

    World Expansion (US, China, Europe)

    Led by manufacturing sector

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    Indian Situation Prior to Crisis High growth

    kick started by GQ spending revival of US and World Demand Exports (20+

    percent)

    Tradable services become significant (vey highgrowth)

    continuing gulf remittances

    nearly open capital account

    supportive monetary policies ex-post though notex-ante

    Sharp rise in the share of investments

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    Response of Monetary policy

    tried to resist monetary expansion sterilization

    Limits reached

    rupee allowed to float upwards negative impact

    on exports expected and began CRR (reserve requirements raised) to curb inflation

    Large monetary squeeze, Pressure on growth but

    little impact in lowering inflation Growth had begun to decline even before the

    subprime crisis

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    Concerns

    High inflation on food and fuel that was passingthrough

    High asset side prices esp. in real estate

    Employment growth

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    RBIs Response to Crisis in India Dollar liquidity problem converted to a rupee liquidity

    problem by the RBI Indian financial sector exposure not very large But Indian businesses who had borrowed internationally stood

    exposed to dollar rise RBIs mistakes

    allowed FIIs to exit vast fall in NFA (15 then 60b $) FIIs punished but not doubly (1BUS$ coming in in 2004 = 400mgoing out in 2008 JRVarma,IIMA)

    But intervention in exchange market was mistaken should haveallowed the rupee to fall temporarily

    Massive crunch on liquidity mm*NFA; massive credit crisis inIndia

    Much time wasted in moving to expansionary monetary policy RBI still worried about inflation!!

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    Impact on the real sector steep fall in investments

    steep fall in exports

    Sympathetic fall in spending is on

    Very large job losses diamonds >400,000; tiles, textiles, export, IT, processing; waste

    processing industries

    Slow down on IT before its sharp decline? Or is there hiddenopportunity to cut wage costs and bounce back?

    Real estate and construction most badly affected

    real estate bubble? 3 times increase in prices overextendeddevelopers, but housing loans more or less safe? But a little later asIT people lose jobs?

    Collapse of commercial real estate as investments fell

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    The recent fiscal response

    Delayed but came out big Spending increase has been very large

    Could have been much more on the investment side

    Inflation continues to be high on primary side; On the

    mfg side it is very low

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    Assessment The Nature of demand

    IT/ BPO spending effects (housing cars, other durables) Very large increase in role of traded sector Absolute advantage of the services sector Large role of remittances large labour market flexibility

    free imports and falling tariffs quell any local monopoly spending effects of gulf remittances

    Step up in investment so Yf is increasing rapidly/can increase rapidly (GCF 37%?) adjusted Investment may be higher than 40%

    Large buoyancy in savings s > i ?

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    Idle capacity in mfg.

    Idle capacity in tradables esp. export industries The Real Side

    steep decline in share of public investments from 52% to less

    than 20% (1.2-2% add on) improvements in the public sector

    large rise in productivity of the corporate /large sector about4+% in labour/ IT shopfloor

    TFP rises Some infrastructural gains (ports, airports, telecom, roads in

    part, village roads, airlines, in part power)

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    Industrial reorganization DUPs have come down tax, rates, delicensing governance improvements

    The issue of large capital inflows and making the task of monetarypolicy difficult

    itself the result of monetary targeting autonomy on M actually weak without imposing large variations in

    credit H = DC+ NFA

    Money GDP Ratio can increase increasing transactions intensity idle cash balances financial market uncertainities

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    Can supply side inflation be fought with a demand sidepull back? If elasticity for demand for money >1 then ?

    The issue of idle reserves from $50b to $150-200b?

    a structural problem of shift in economic and trade weight Should the RBI do disequilibrium pricing

    Dutch disease on mfg

    The issue of rate of growth?

    Is any rate below 10% going to be pro-poor emp elasticity 0.15(1.5%)

    Export led growth to raise elasticity (0.5+)?

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    The contrast with China

    interest rate and exchange rate targeting countercyclical fiscal policy

    monetary subservience

    very high growth pursued moderate inflation nevertheless (investment

    42-43%)

    Every prediction of global whiz kids, WB andIMF proven wrong every year? Yet theadherence to monetarism world wide?

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    Concerns Macroeconomic

    Capital outflows, fickle capital inflows, Outward FDI and the sell-

    offs Infrastructural policies

    energy policies (under investment possibilities) power sector blues continue and deepen

    inputs to agriculture especially power and water are major PPP frameworks not ready in many sectors Regulatory framework contributes to risk

    The constraint of land acquisition

    The agricultural constraint Widening income gaps despite faster growth of poors

    incomes in many parts

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    The mill stone of Planning CommissionsCentrally Sponsored Schemes

    Interregional disparities

    Public failure in crucial areas of humandevelopment and well being: municipalinfrastructure, public health, education,drinking water

    The constraint of urban areas

    sky rocketing real estate prices The emerging skills constraint?

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    Growth Facts GDP and Aggregates

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    Exhibit: Growth Rates Achieved by

    the Indian Economy over the Years (1990-91 Constant Prices)

    0

    0.01

    0.02

    0.03

    0.04

    0.05

    0.06

    0.07

    0.08

    0.09

    0.1

    0.11

    0.12

    0.13

    0.14

    0.15

    1951

    1954

    1957

    1960

    1963

    1966

    1969

    1972

    1975

    1978

    1981

    1984

    1987

    1990

    1993

    1996

    1999

    2002

    2005

    2008

    E

    xp%PerAnnum

    Gross domestic products by expenditure or demand (at constant 1990-91 Prices)

    Private final consumption expenditure

    Government final consumption expenditure

    Gross capital formation

    Agriculture & allied

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    h

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    h

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    h

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    h

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    2000 2002 2004 2006 2008 2010

    YrQ

    -0.15

    -0.05

    0.05

    0.15

    0.25

    Growth in GDP and Sectors

    (1990-91 Constant Price)

    GDPFC

    Agri.& Allied

    Industry

    Services

    h

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    h

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    Growth Rate IIP Various

    IIP (All)

    IIP (Mfg)

    IIP (Capital)

    IIP (Consumer)

    1990 1994 1998 2002 2006 2010 2014

    YrQ

    -0.12

    -0.02

    0.08

    0.18

    0.28

    0.38 h

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    h

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    Fiscal Deficit and Govt Exp

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    h

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    Examining the Inflation Story

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    1990 1994 1998 2002 2006 2010

    Yw

    0

    0.04

    0.08

    0.12

    0.16

    Inflation in WPI (w/w), and Role of

    Primary Artcls and Fuels etc. (% p.a)

    All Comm.

    Prim.+Fuel etc

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    2004 2008 2012

    Yw

    0

    0.04

    0.08

    0.12

    0.16

    Inflation in WPI (w/w), and Role of

    Primary Artcls and Fuels etc. (% p.a)

    All Comm.

    Prim.+Fuel etc

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    1990 1994 1998 2002 2006 2010

    Yw

    -0.05

    0.05

    0.15

    0.25

    0.35

    Inflation in WPI (w/w)(% p.a)

    All Commodities

    Primary Artcls.

    Fuel, Power etc

    Mfg. products

    h

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    1990 1994 1998 2002 2006 2010

    Yw

    -0.01

    0.02

    0.05

    0.08

    0.11

    0.14

    0.17

    Inflation in WPI (w/w)

    (% p.a)

    Prim.+Fuel etc

    Mfg. Products

    h

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    1990 1994 1998 2002 2006 2010

    Yf

    -0.01

    0.02

    0.05

    0.08

    0.11

    0.14

    0.17

    Observed and Fitted Inflation in WPI

    for Mfg (w/w, 52)

    OBSERVED

    Fitted

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    h

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    Regression InflMfg on InflPrimary and InflFuel

    Coeff. St.Cff. t Sign.Constant 0.013 0.002 6.280 0.000

    InflFuel(-1) 0.064 0.028 2.274 0.023

    InflPrimary(-1) 0.274 0.028 9.939 0.000InflFuel(-7) 0.071 0.045 1.573 0.116

    InflFuel(-11) -0.088 0.035 -2.491 0.013

    InflPrimary(-11) 0.226 0.028 7.993 0.000

    R-adj Sq 0.458

    No of

    Observations

    767

    F-Ratio 130.585

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    The LM side

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    h

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    h

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    h

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    h

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    h

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    h

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    h

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    h

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    h

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    Foreign Investments

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    h

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    h

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    The External Side

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    1990 1994 1998 2002 2006 2010

    Yr

    0

    0.3

    0.6

    0.9

    1.2

    1.5

    Nominal Exchange Rates (Index 1999=1)

    Rs/$

    Rs/Pound

    Rs/EuroRs/Yen

    h

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    2003 2004 2005 2006 2007 2008 2009

    yr

    -0.1

    -0.06

    -0.02

    0.02

    0.06

    0.1

    0.14

    Foreign Investments and Foreign DirectInvestments (to GDP)

    Portfolio net

    Direct net

    h

    T d d I i ibil O

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    2000 2005 2010

    Year

    0.11

    0.16

    0.21

    0.26

    0.31

    0.36

    Trade and -Invisibiles- Openness

    (Exp+Imp)/GDPFC

    (Inv E+I)/GDPFC

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    h

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    h

    h

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    h

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    Comparing with Other Countries

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    Comparing with Other Countries

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    h

    h

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    h

    h

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    h

    h

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    h

    h

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    h

    h

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    h

    h

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    h

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    Nominal Lending and Real Interest Rates

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    1975 1985 1995 2005

    Year

    -10

    -5

    0

    5

    10

    15

    20

    Nominal Lending and Real Interest Rates

    (India and China)

    IND.W96

    CHN.W96

    IND.w102

    CHN.W102

    M3 and Domestic Credit Provided by Banksas % of GDP (India and China)

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    1960 1970 1980 1990 2000 2010

    Year

    0

    30

    60

    90

    120

    150

    180

    as % of GDP (India and China)

    IND.M3

    CHN.M3

    IND.DomCredit

    CHN.DomCredit

    h

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    Today

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