ECONOMIC SLOWDOWN AND MACROECONOMIC POLICIES

PLAN OF THE PRESENTATION

INTRODUCTION 2008-09 SLOWDOWN POLICY OMISSIONS AND COMMISSIONS CURRENT SLOWDOWN GOVERNMENT POLICIES:
STIMULATING GROWTH OR CURTAILING IT ?

PLAN OF THE PRESENTATION

INTRODUCTION 2008-09 SLOWDOWN POLICY OMISSIONS AND COMMISSIONS CURRENT SLOWDOWN GOVERNMENT POLICIES:
STIMULATING GROWTH OR CURTAILING IT ?

What is economic slowdown

 economic slowdown happens when the rate of growth (which is

still positive) decreases.

What are macroeconomic policies

 Macro-Economic policy refers to the action that governments

and the central banks take to ensure the economy keeps ticking over Types: -Monetary-Fiscal-Trade-Industrial-

 Full employment  Price stability  External balance  Social Welfare

Objectives of Macroeconomic policy

 Equity- income distribution  stimulate consumption and investment  Exchange rate stability  Balance of payment equilibrium

When the policies go wrong ! Error errrrrr

I when the economy grows at unsustainable pace Eventually economic imbalances arise and inflation increases Then the errors must be reversed In the process of reversal economy overshoots in the wrong direction and faces a slowdown

Policy Error errrrrr

..

II policymakers fail to immediately react to economic problems like slowdown and the policy implemented afterwards gets effective in lags

PLAN OF THE PRESENTATION

INTRODUCTION Pre Crisis Developments 2008-09 SLOWDOWN POLICY OMISSIONS AND COMMISSIONS CURRENT SLOWDOWN GOVERNMENT POLICIES:
STIMULATING GROWTH OR CURTAILING IT ?

ANALYZING THE SLOWDOWN ECONOMY 2007-2009

GDP
12 10 8 6 4 2 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

OF INDIAN
Notice the decline in GDP growth rate from Q4 2006-07

GDP

Q2

Q3

Q4

Q1

Q2 2008-09

Q3

2004-05

2005-06

2006-07

2007-08

Global Crises surfaced here: in Q2 2007-08

World economic crisis surfaced in August 2007 But contrary to the popular belief, the Indian economy had started slowing down before its outbreak

Pre crisis developments ~ an overview of the economy

Downward trend in Y-O-Y IIP growth rate from Q1 2007-08

bellwether of economic performance- IIP Index sharp downward trend from Q1 2007-08 Growth in secondary and tertiary sectors declined from 10.6 % and 11.2% in 2006-07 to 7.5% and 11.1% in 2007-08.

Growth Debilitating factors

A- Declining trend in private capital formation
 In 2006-07, private investment constituted 1/4th of GDP  Between 2006-07 and 2007-08 the decline in growth of private investment was 8.9%.  This resulted in growth debilitating effect of 3.36 percentage points.

B.

Sharp slowdown in Exports

The most important demand-reducing factor It started decelerating from 3rd quarter 2006-07 From 13.2 %in Q3 to 0.6% in Q1 2007-08 to minus 3.1% in Q2 in 2007-08.

Growth Enhancing Factors

 public investment grew by 15.6% in pre crises period  government consumption by 0.8 percentage points  Agriculture GDP grew by 1.3% points.

PLAN OF THE PRESENTATION

INTRODUCTION Pre Crisis Developments Onslaught of global crisis POLICY OMISSIONS AND COMMISSIONS CURRENT SLOWDOWN GOVERNMENT POLICIES:
STIMULATING GROWTH OR CURTAILING IT ?

Financial Contagion and Indian Economy



A.BANKS Banks became wary of extending loans. Traders and exporters found it really difficult to secure credit. This adversely affected the consumer durables, exports and real estate sector the most B. FII

FII Inflows
40000 20000 0 -20000

FII outflow starts here

FII Inflows apr jun aug oct dec feb apr jun aug oct dec feb apr jun aug oct dec feb apr jun aug oct dec 2005-06 2006-07 2007-08 2008-09

 

FII registered a steep fall between October and November 2007 from $3.6 to 2.2 $ billion Bearish trend in the stock market has dampening effect on private propensity to invest

C. FOREIGN TRADE Exports Exports constituted around 22% of GDP. Recessionary tendencies in OECD countries led to a steep decline India s merchandise and service exports.
Imports


International crude oil prices surged and it led to increase in India s crude oil bill from $5.6 billion to $10.96billion between July 2007 and august 2008. The drain from domestic demand on account of oil price increase was about 6% of country s income. Current account deficit reached to 4.3% in 2nd quarter of 2008-09

D. GLOBAL INFLATION  Between September 2007 and October 2008 world experienced a stagflationary phase  Global inflation was driven by energy and agricultural prices: World food price crisis  sharp rise in food price led to fall in demand for industrial products and services and worsened the slowdown

CURRENT ECONOMIC SLOWDOWN

 India GDP growth rate trend
What do you notice !?

SIGNS OF SLOWDOWN
 GDP growth has slowed consistently from 9.4%

for the quarter ending AprilJune 2010, to 7.7% for the quarter ending April-June 2011  growth in the Index of Industrial Production (IIP) touched lows of 3.8% and 4.1% in recent months, compared to 9.4%in March 2011.  According to CMIE data, quarterly investment proposals have reportedly fallen from Rs 7.2 lakh crore in the June 2010 quarter to only Rs 2.6 lakh crore in the September 2011

SECTORAL BREAKDOWN


        

Supply-side components (Growth, y-o-y %) Q1FY11 Q2FY11 8.8 2.4 9.1 10.6 7.7 7.4 10.4 8.4 5.4 7.1 7.8 6.7 8.0 9.6

Q1FY12 7.7 3.9 5.1 7.2 1.2 1.8 10.0

Q2FY12 6.9 3.2 3.2 2.7 4.3 -2.9 9.3

GDP at factor cost Agriculture Industry Manufacturing Construction Mining & Quarrying Services Trade, Hotels, Transport & Communication  Financing, insurance, real estate and business services  Community, social & personal services

12.1

10.2

12.8

9.9

9.8 8.2

10.0 7.9

9.1 5.6

10.5 6.6

Demand side components (Growth, y-o-y%)

Q1FY11 Q2FY11 Q1FY12 Q2FY12

      

GDP at market price Private Consumption Govt. Consumption Fixed Investment Change in Stocks Exports Imports

9.1 9.5 6.7 11.1 9.3 9.8 15.2

8.6 9.0 6.4 10.3 6.5 10.5 11.4

8.5 6.3 2.1 7.9 4.7 24.3 23.6

6.7 5.9 4.0 -0.6 1.5 27.4 10.9

WHAT ARE THE FACTORS BEHIND THE SLOWDOWN IN EACH COMPONENT OF GDP ?????
 Rising Interest Rates  High Inflation  Fiscal Deficit  Policy reform lag  Global woes India not decoupled yet  FII Selling

Fiscal Deficit: It s effect on growth

 Represents the borrowing needs of the government  India is suffering from rising inflation and a slower rate of

growth because of the government's failure to tackle the country's fiscal deficit  The target for FY2012 was 4.6%. However as a thumb rule exceeds 25% by Q2 it becomes a cause of concern. Currently it stand around 75% of the target  Fiscal deficit of 4.6 % could have been achieved this fiscal year if the growth had been faster but even the growth rate for Q2 declined to 7.6%  government planning to spend Rs 56,850 crore extra. it will borrow nearly Rs 53,000 crore more than the budgeted level

Fiscal deficit:It s effect on growth

To fund the deficit government can do the following : 1) Borrow from the market. This reduces the funds available for private investment. In the medium run Government will have to offer higher interest rates to attract lenders. Debt service costs also increase in the subsequent years 2) Increase the taxes As per Ricardian Equivalence , expenditure in one period is nothing but borrowing from subsequent periods. Therefore current increase in expenditure entails future increase in taxes.
3)

Monetization of Deficit

It means printing money to meet the finanacial needs of the government. This leads to inflation in the economy . Example- Hyperinflation in Germany after the first world war

Subsidy Burden
33% of total subsidies- fertilizers- 1% of GDP 36%- food 26%- Oil- 3 times projected Rs 23000. Petrol prices have been decontrolled. But diesel , kerosene and LPG are heavily subsidized  This has led to cumulative under recoveries of 1.32 trillion rupees in the last 8 years. Which will ultimately be subsidized by Oil producing companies or the government
   

Food Security Bill

 Food Security Bill will be implemented in the winter session , 1.2 trillion rupees will go in food subsidy.  But in PDS 57 % gets diverted to unintended beneficiaries  Food subsidy should be subject to conditions  The Food Security act should have a fixed tenure after which it should lapse.

NREGA SCHEME
Boosted consumption and aggregate demand and wages which further fueled inflation. Also : In India, there are three problems:  relatively weak fiscal situation.  Second, we viewed programs such as NREGS and rural pay as a stimulus whereas actually they are not easily withdraw able  third, the revenue component was more than the capital component in the expenditure. All these put together have resulted in fiscal problem

Inflation
 Double digit inflation from Aug 2009 to Aug 2010  food inflation dropped from 9.01% on Nov 24 to 8 % on Dec    

1, at its slowest pace in nearly 4 months inflation in primary articles category -7.74%, non food items -2.14%, fuel price index 15.53% in the year on November 19 In the previous week, annual fuel inflation stood at 15.49% primary articles price index was up 7.74%, compared with an annual rise of 9.08% a week earlier headline inflation stayed above 9% for the 11th month, despite 13 rate increases by the RBI since March 2010

Inflation
 RBI targeting to bring inflation down to some moderate level of 7% by the turn of the current fiscal, if not to the desirable and comfortable level of around 5%

Inflation

India's slowdown is partly its failure to balance the pace of the growth and tame the inflation. [The government's] tight monetary policy has increased the cost of borrowing and thereby slowed down industrial growth by hindering fresh investment

Inflation
Inflation
12 10 8 6 Inflation 4 2 0

Fisher (1993) offered evidence hat 1 percentage point increase in the rate of inflation could cost an economy more than one-tenth of a percentage point of growth.

Primary Articles: 11.40% vs. 11.84% Month on Month Food Articles: 11.06% vs. 9.23% Month on Month Non-Food Articles: 7.71% vs. 14.82% Month on Month Fuel & Power: 14.79% vs. 14.09% Month on Month Manufacturing Products: 7.66% vs. 7.69% Month on Month

Monetary Tightening by RBI

What the government should do?

 There is a limitation on fighting inflation through monetary policies if supply side constraints are pre-dominant.  the policy priority has to now shift from monetary to complementary policies as emphasized by the RBI.  These include improved supply response

for food, storage capacity,cold storage, and public policy intervention

 Creation of National Investment and Manufacturing Zones.    

They ll eleminiate red tape and infrastructure bottlenecks. Land Acquistion Policy reforms FDI in retail will help in logistics, supply chain and increasing agricultural productivity Increase business confidence by liberalizing investment norms Composition of fiscal deficit matters.It should change from consumption expenditure to investtment expenditure Keep fiscal deficit within limits to prevent crowding out of private investment

 Merge fertilizer ministry into agriculture ministry to tackle subsidy burden

High interest rates pulled down manufacturing sector growth to 2.7 per cent in the Q2FY12 from 7.2 per cent in the previous quarter Mining sector contracted by 2.9 per cent in the reporting quarter.

Growth in private final consumption expenditure, the largest component of aggregate demand, moderated further to 5.9 per cent in the Q2FY12 from 6.3 per cent in the previous quarter. The moderation was mainly due to the tapering-off of demand in interest-sensitive sectors and high inflation.

        

This fiscal lower than-expected collections under small savings schemes such as public provident fund and post office deposits and lower cash surplus has forced the government to issue more bonds and increase borrowings Fiscal deficit of 4.6 % could have been achieved if the growth had been faster. Borrowing by government crowds out private investment, Fiscal deficit is a major issue when most of it is being spent on consumption not investment Increase in md while borrowing and ms while spending Lower liquidity higher interest rate India's slowdown is partly its failure to balance the pace of the growth and tame the inflation. [The government's] tight monetary policy has increased the cost of borrowing and thereby slowed down industrial growth by hindering fresh investment the government is trying to address the fiscal deficit through monetary policies, which is pushing up interest rates. Industry is paying the price of these fiscal imbalances with the agricultural sector also suffering despite a good monsoon this year The situation has been made worse by the problems in the Eurozone considering 20 per cent of India's exports are to the European Union