Description
Describes the indian economy in terms of GDP, inflation, savings & investment, monetary policy, fiscal policy and balance of payments.
Indian Economy- A Critical Evaluation
Flow of the Presentation 1. 2. 3. 4. 5. 6. 7. Introduction GDP Inflation Savings and Investment Monetary Policy Fiscal Policy Balance of Payments
GDP of India
India gross domestic product (GDP) means the total value of all the services and goods that are manufactured within the territory of the nation within the specified period of time. The country has the second fastest major growing economy in the whole world with the GDP growing at the rate of 9.4% in 2006- 2007. Gross Domestic Product : $ 1.16 trillion (2007-08. Advance Estimates) Average annual growth in GDP : Composition of GDP (2006-07) : ? Since 1990-91 : 6.25% Primary (agriculture etc.) : 17.5% ? In 2005-06 : 9.4% Secondary (industry etc.) : 27.9% ? In 2006-07 : 9.6% Tertiary (services): 54.6% The contribution of the Agriculture Sector in India GDP ? The agriculture sector contributed the most to India GDP after the independence of the country. This sector contributed to India GDP around 18.6% in 2005. The contribution of the agriculture sector has gone down in India GDP in the last few years but in spite of this the sector remains one of the largest economic sector in India. The contribution of the Industrial Sector in India GDP:? The sector of industry accounts for 27.6% of India GDP for it employs around 17% of the total workforce in India. The industrial sector contributed 7.6% to India GDP in 2005- 2006 and the next year, this figure increased to 9.8%. This shows that the contribution of the industrial sector is increasing in India GDP.
? The contribution of the Services Sector in India GDP :? The services sector contributes the most to the India GDP for it accounted for 53.8% in 2005. After independence it was the agricultural sector that contributed the most to the India GDP but in recent years it has been the services sector, which has contributed the most. The agricultural sector contributed 20%, industry sector contributed 26%, and the services sector contributed around 54% to the India GDP in 2005- 2006 ? The contribution of the Infrastructure Sector in India GDP :? The infrastructure sector contributed around 3.5% to the India GDP in 1996- 1997 and the next year, this figure increased to 4.6%. The contribution of the infrastructure sector to the India GDP increased after the India government opened the sector to private sector.
? The contribution of India’s agriculture to the total GDP of the country is experiencing a declining trend. The
?
percentage share of services sector to the total GDP is rising at a faster pace. Keeping in view the poor performance of the agriculture in India’s Economy, the coming budgets are expected to come with more investments on agriculture. Though the services sector in India has huge contribution to the country’s economy, still it has failed to some extent in attracting more investments to the sector. More over the coming budget 2007-08 is expected to draw more attention on consumption led growth, which is needed for strengthening and sustaining the economic growth of the country.
? While the up-and-down pattern in agriculture continued with growth estimated at 6.0% and 2.7% in the two recent years, and services maintained its vigorous growth performance, there were distinct signs of sustained improvements on the industrial front. Services contributed as much as 68.6% of the overall average growth in GDP in the last five years between 2002-03 and 2006-07. Practically, the entire residual contribution came from industry. As a result, in 2006-07, while the share of agriculture in GDP declined to 18.5%, the share of industry and services improved to 26.4% and 55.1%, respectively.
GDP Growth : Investment vis-à-vis consumption ? From the demand-side perspective, unlike countries of East Asia during their high growth phase or China in more recent times, GDP growth in India in the post-reform period was driven mostly by private final consumption expenditure or PFCE growth. PFCE contributed more than one half of the growth every year until 2001-02. After falling below one half in 2002-03, it had again dominated GDP growth in 2003-04. But this pattern appears to have undergone a virtuous transformation with investment rather than private consumption being the main source of GDP growth in the latest two years of 2004-05 and 2005-06. ? Investment, in general being a forward looking variable, reflects a high degree of business optimism. The revival in gross domestic capital formation (GDCF) that commenced in 2002-03 has been followed by a sharp rise in the rate of investment in the economy for four consecutive years. The earlier estimates of GDCF for 2004-05 of 30.1% now stand upgraded to 31.5% in the quick estimates. The 6.8 percentage point contribution of investment to growth in GDP in 200405 exceeded the corresponding contribution of PFCE at 6.1 percentage point for the first time in recent years. The rate of GDCF for 2005-06 as per the quick estimates is 33.8%. This sharp increase in the investment rate has sustained the industrial performance and reinforces the outlook for growth.
?
Agriculture:The structural weaknesses of the agriculture sector reflected in low level of public investment, exhaustion of the yield potential of new high yielding varieties of wheat and rice, imbalance in fertilizer use, low seeds replacement rate, a distorted and an inadequate incentive system and low post harvest value addition were manifest in the lacklustre agricultural growth during the new millennium. After an annual average of 3.0% in the first five years of the new millennium starting 2001-02, growth of agriculture at only 2.7% in 2006-07, on a base of 6.0% growth in the previous year, is a cause of concern. Given its low share, a mechanical calculation of the adverse impact of low growth in agriculture on overall GDP can be misleading. With more than half the population directly depending on this sector, low agricultural growth has serious implications for the ‘inclusiveness’ of growth.
?
Services:Services sector growth has continued to be broad-based. Among the three sub-sectors of services, ‘trade, hotels, transport and communication services’ has continued to boost the sector by growing at double-digit rates for the fourth successive year. Impressive progress in information technology (IT) and IT-enabled services, both rail and road traffic, and fast addition to existing stock of telephone connections, particularly mobiles, played a key role in such growth. Growth in financial services (comprising banking, insurance, real estate and business services), after dipping to 5.6% in 2003-04 bounced back to 8.7% in 2004-05 and 10.9% in 2005-06. The momentum has been maintained with a growth of 11.1% in 2006-07.
?
Industry:The impressive growth of the industrial sector, propelled by robust growth in manufacturing has continued unabated during the current year so far. Since 1951-52, industry has never consistently grown at over 7% per year for more than three years in a row before 2004-05. Year-on-year industrial growth of 10.6% in the first nine months of 2006-07 was the highest recorded since 199596. In seven of the eight months of the current year, the year-on-year growth of the manufacturing sector was in double-digits. Industrial growth would have been even higher than the 10.0% estimated for in 2006-07, had it not been for a relatively disappointing performance of the other two sub-sectors, namely, mining and quarrying (4.5%); and electricity, gas and water supply (7.7%). Capacity additions through investment are critical for accelerating growth in industry. The sustained growth of the industrial sector is crucially dependent on removing the infrastructural impediments, especially in the power sector. (Automobile, steel, pharmaceutical)
Inflation
• Wholesale Price Index (WPI) • Used to measure the change in the average
price level of goods traded in wholesale market • Based on 435 items, which come under three categories:
•Primary
Articles – 22.02% •Fuel, Power, Light & Lubricants – 14.23% •Manufactured Products – 63.75%
• Available on a weekly basis with the
shortest possible time lag only two weeks
Inflation in rising economies
Inflation in India
• Inflation rate accelerated steadily from an annual average of 1.7 per cent during the
1950s to 6.4 per cent during the 1960s • Further to 9.0 per cent in the 1970s before easing marginally to 8.0 per cent in the 1980 • Declined from an average of 11.0 cent during 1990-95 to 5.3 per cent during the second half of the 1990s (1995-2000) and further to 4.9 per cent during 2003-07 • Increased from 4.1 per cent at the end of March 2006 to an intra-year peak of 6.7 per cent at end-January 2007
Causes of Inflation
The main cause of rise in the rate of inflation rate in India is the pricing disparity of agricultural products between the producer and consumers in the Indian market. Moreover, the sky-rocketing of prices of food products, manufacturing products, and essential commodities have also catapulted the inflation rate in India. This is known as Food-Led Inflation. Increase in Fiscal Deficit leads to additional money creation leading to inflation. Furthermore, the unstable international crude oil prices have worsened the situation.
Rising Economies Exporters of Deflation • Low Cost Production • Cheap Labor •Resource Availability
Creators of Inflation • Second moment of Demand • Rising Wages •Currency Appreciation
Inflation in India
• Wholesale Prices Index (WPI) of India touched 6.1% as on January 6, 2007 and the Cash Reserve Ratio (CRR)
touched 5.5% on the same day.
•The rate of inflation continued to soar during the week ended April 19 to touch a 42-month high of 7.57 per cent,
mainly owing to increased prices of vegetables, food articles, certain manufactured items, ncluding steel, and some fuel products. •At this level, the point-to-point inflation based on the wholesale price index (WPI) was up 24 basis points from 7.33 per cent in the previous week, despite the concerted measures taken by the Government and the Reserve Bank of India (RBI) to tame the price spiral. •Even as the RBI revised upwards the inflation “tolerance limit” from near five per cent last fiscal to 5.5 per cent for 2008-09 on account of surging prices of crude oil and commodities in global markets, the Government also took a number of fiscal steps entailing a revenue loss of over Rs. 6,300 crore to hold the price line.
Inflation in India
Effects of Inflation
High Inflation
The RBI raised the cash reserve ratio (CRR) by 75 basis points to 8.25 per cent in three tranches in quick succession. Nearly Rs. 27,500 crore is set to get sucked out of the banking system as banks will have to park a larger proportion of their deposits with the Central bank. According to Crisil’s Principal Economist D.K. Joshi, the steps taken by the Government and the RBI would lead to “easing of inflationary pressure in future and it can come down to 5.5 per cent.”
Choking Growth
Insecurity in Capital Inflows
Savings & Investment
Trends of Investment in India
• • • • • • •
Bank Fixed Deposits Life Insurance Real Estate/ Property Postal Savings Schemes Gold Shares and Mutual Funds National Savings Certificates and Public Provident Fund • Bonds, Chit Funds and Company FDs
Key factors • In the last few years India’s GDP growth has been more than eight per cent, compared with around six per cent in the 1980s and 1990s and only 3.5 per cent during the three decades before 1980. • Economic reforms of 1990 have opened the economy to change and development • Fourth largest recipient of FDI in 2005-2006. Between 2001-02 and 2006-07 FDI inflows increased by two and half times. • Reduction in tax rates and simultaneous improvement in tax collections
Key factors • Money Supply (M3) has grown by a robust 22.5 per cent (year-on-year) as of October 26, 2007 compared to 18.4 per cent the year before • Surplus in India’s Balance of Payment • Fiscal responsibility and Budget Management Act has resulted in declining deficits at both the Center and the State level • Improved economic status of nation and hence increasing investments
Observations • The current trend of growth could lead to a complacent nature with respect to economic reforms • India’s exploding population with a dearth of jobs to sustain one and all • Crude oil prices breaching the $100 mark • India needs to invest more of its GDP on infrastructure development to sustain the growth • Reducing the fiscal deficit • Increased interest rates under direction of RBI
Monetary Policy
Monetary policy of India
A monetary policy is a stabilization policy announced by the central bank to control (i) the supply of money (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain growth and stability of the economy It’s a bi-annual statement with its goal as "macroeconomic stability" - low
unemployment, low inflation, economic growth, and a balance of external payments.
Its main objectives are : •Price stability
•Exchange rate stability •High rate of growth •Ensure flow of credit to the productive sectors.
Tools of Monetary Policy
Open market operations
Reserve Requirements
Discount windows
Open market operations : Under the OMO, the RBI buys or sells government bonds in the secondary market. By absorbing bonds, it drives up bond yields and injects money into the market. When it sells bonds, it does so to suck money out of the system. Reserve requirements are a percentage of commercial banks', and other depository institutions', demand deposit liabilities (i.e. chequing accounts) that must be kept on deposit at the Central Bank as a requirement of Banking Regulations. It includes CRR, Repo rate, bank rate, reverse repo rate etc. The changes in CRR affect the amount of free cash that banks can use to lend reducing the amount of money for lending cuts into overall liquidity, driving interest rates up, lowering inflation and sucking money out of markets.
Monetary policy works through changes in the money supply and interest rates
Highlights of 2008 Monetary policy
Bank Rate kept unchanged.
Reverse Repo Rate kept unchanged.
Repo Rate increased by 50 basis points from 8.5 per cent to 9.00 per cent. Cash Reserve Ratio to be increased by 25 basis points to 9.0 per cent with effect from the fortnight beginning August 30, 2008. GDP growth projection for 2008-09 revised from the range of 8.0-8.5 per cent to around 8.0 per cent, barring domestic or external shocks. To bring down inflation from the current level of about 11.0-12.0 per cent to a level close to 7.0 per cent by March 31, 2009.
Effect of the policy measures
?
?
A hike in CRR &repo rate would suck out money supply from the banking system to moderate credit growth. These steps mean that the cost of borrowings by individuals as well as businessmen will go up significantly. The recent hike in CRR and repo rate by Reserve Bank of India to bring down inflation levels dragged the rate sensitive auto, capital goods, power and realty sectors lower on concerns it will increase the borrowing cost for the companies and may hurt their bottom line.
Impact of RBI’S policy on various sectors
?
?
To maintain a GDP growth of 8 per cent, the capital goods and power sectors need to borrow which will now be at the higher cost. Also, they are feeling the heat of the high fuel cost. Hence, from a short term perspective we are not favoring these sectors Auto sector is already under pressure led by high cost of petrol and diesel. Increase in the CRR and repo rate will lead to increase in the lending rates by banks and will definitely impede the top line as well as bottom line growth of the companies.
Fiscal Policy and BoP
Fiscal Policy • At the beginning of reforms in 1991, fiscal imbalances were identified as the root cause of the BOP crisis and domestic inflation. The fiscal consolidation, which followed in response, however, failed to sustain itself as it lacked a statutory mandate and the required institutional support • The enactment of the Fiscal Responsibility and Budget Management Act (FRBMA), 2003 provided the required mandate and lent credibility to the fiscal reforms process
Fiscal Policy
•As recommended by the Twelfth Finance Commission, and following the example of the Central Government, 26 States have already enacted fiscal responsibility legislations. The fiscal situation of the States has shown considerable improvement, which in fact is even better relative to the performance of the Central Government, post-FRBMA •The fiscal correction path mandated by FRBMA was also helpful in raising the credibility of the Government with respect to fiscal deficits, in which India was at the bottom of global rankings. This has improved perceptions about the long-term macroeconomic stability of the economy.
Other Fiscal Issues • Some argue that the distinction between plan and nonplan expenditure is illogical and even dysfunctional. The distinction has led to
– Tendency to start new schemes/projects at the cost of utter neglect of existing capacity and service levels. – Misperception that non-plan expenditure is inherently wasteful and should be avoided.
• This dichotomy has resulted in fragmented view of resource allocation to various sectors.
Balance of Payments
• Since independence, India's balance of payments on its current account has been negative. • Since liberalisation in the 1990s, India's exports have been consistently rising, covering from 66.2% of its imports in 1990–91 up to 80.3% of its imports in 2002–03 • Although India is still a net importer, since 1996–97, its overall balance of payments has been positive, largely on account of increased foreign direct investment and deposits from non-resident Indians • Until this time, the overall balance was only occasionally positive on account of external assistance and commercial borrowings. As a result, India's foreign currency reserves stood at $285 billion in 2008, which could be used in infrastructural development of the country if used effectively.
In India, External Commercial Borrowings (ECBs) are being permitted by the Government for providing an additional source of funds to Indian corporates and PSU’s • India's reliance on external assistance and commercial borrowings has decreased since 1991–92, and since 2002–03, it has gradually been repaying these debts. Declining interest rates and reduced borrowings decreased India's debt service ratio to 4.5% in 2007.
•
doc_495006858.pptx
Describes the indian economy in terms of GDP, inflation, savings & investment, monetary policy, fiscal policy and balance of payments.
Indian Economy- A Critical Evaluation
Flow of the Presentation 1. 2. 3. 4. 5. 6. 7. Introduction GDP Inflation Savings and Investment Monetary Policy Fiscal Policy Balance of Payments
GDP of India
India gross domestic product (GDP) means the total value of all the services and goods that are manufactured within the territory of the nation within the specified period of time. The country has the second fastest major growing economy in the whole world with the GDP growing at the rate of 9.4% in 2006- 2007. Gross Domestic Product : $ 1.16 trillion (2007-08. Advance Estimates) Average annual growth in GDP : Composition of GDP (2006-07) : ? Since 1990-91 : 6.25% Primary (agriculture etc.) : 17.5% ? In 2005-06 : 9.4% Secondary (industry etc.) : 27.9% ? In 2006-07 : 9.6% Tertiary (services): 54.6% The contribution of the Agriculture Sector in India GDP ? The agriculture sector contributed the most to India GDP after the independence of the country. This sector contributed to India GDP around 18.6% in 2005. The contribution of the agriculture sector has gone down in India GDP in the last few years but in spite of this the sector remains one of the largest economic sector in India. The contribution of the Industrial Sector in India GDP:? The sector of industry accounts for 27.6% of India GDP for it employs around 17% of the total workforce in India. The industrial sector contributed 7.6% to India GDP in 2005- 2006 and the next year, this figure increased to 9.8%. This shows that the contribution of the industrial sector is increasing in India GDP.
? The contribution of the Services Sector in India GDP :? The services sector contributes the most to the India GDP for it accounted for 53.8% in 2005. After independence it was the agricultural sector that contributed the most to the India GDP but in recent years it has been the services sector, which has contributed the most. The agricultural sector contributed 20%, industry sector contributed 26%, and the services sector contributed around 54% to the India GDP in 2005- 2006 ? The contribution of the Infrastructure Sector in India GDP :? The infrastructure sector contributed around 3.5% to the India GDP in 1996- 1997 and the next year, this figure increased to 4.6%. The contribution of the infrastructure sector to the India GDP increased after the India government opened the sector to private sector.
? The contribution of India’s agriculture to the total GDP of the country is experiencing a declining trend. The
?
percentage share of services sector to the total GDP is rising at a faster pace. Keeping in view the poor performance of the agriculture in India’s Economy, the coming budgets are expected to come with more investments on agriculture. Though the services sector in India has huge contribution to the country’s economy, still it has failed to some extent in attracting more investments to the sector. More over the coming budget 2007-08 is expected to draw more attention on consumption led growth, which is needed for strengthening and sustaining the economic growth of the country.
? While the up-and-down pattern in agriculture continued with growth estimated at 6.0% and 2.7% in the two recent years, and services maintained its vigorous growth performance, there were distinct signs of sustained improvements on the industrial front. Services contributed as much as 68.6% of the overall average growth in GDP in the last five years between 2002-03 and 2006-07. Practically, the entire residual contribution came from industry. As a result, in 2006-07, while the share of agriculture in GDP declined to 18.5%, the share of industry and services improved to 26.4% and 55.1%, respectively.
GDP Growth : Investment vis-à-vis consumption ? From the demand-side perspective, unlike countries of East Asia during their high growth phase or China in more recent times, GDP growth in India in the post-reform period was driven mostly by private final consumption expenditure or PFCE growth. PFCE contributed more than one half of the growth every year until 2001-02. After falling below one half in 2002-03, it had again dominated GDP growth in 2003-04. But this pattern appears to have undergone a virtuous transformation with investment rather than private consumption being the main source of GDP growth in the latest two years of 2004-05 and 2005-06. ? Investment, in general being a forward looking variable, reflects a high degree of business optimism. The revival in gross domestic capital formation (GDCF) that commenced in 2002-03 has been followed by a sharp rise in the rate of investment in the economy for four consecutive years. The earlier estimates of GDCF for 2004-05 of 30.1% now stand upgraded to 31.5% in the quick estimates. The 6.8 percentage point contribution of investment to growth in GDP in 200405 exceeded the corresponding contribution of PFCE at 6.1 percentage point for the first time in recent years. The rate of GDCF for 2005-06 as per the quick estimates is 33.8%. This sharp increase in the investment rate has sustained the industrial performance and reinforces the outlook for growth.
?
Agriculture:The structural weaknesses of the agriculture sector reflected in low level of public investment, exhaustion of the yield potential of new high yielding varieties of wheat and rice, imbalance in fertilizer use, low seeds replacement rate, a distorted and an inadequate incentive system and low post harvest value addition were manifest in the lacklustre agricultural growth during the new millennium. After an annual average of 3.0% in the first five years of the new millennium starting 2001-02, growth of agriculture at only 2.7% in 2006-07, on a base of 6.0% growth in the previous year, is a cause of concern. Given its low share, a mechanical calculation of the adverse impact of low growth in agriculture on overall GDP can be misleading. With more than half the population directly depending on this sector, low agricultural growth has serious implications for the ‘inclusiveness’ of growth.
?
Services:Services sector growth has continued to be broad-based. Among the three sub-sectors of services, ‘trade, hotels, transport and communication services’ has continued to boost the sector by growing at double-digit rates for the fourth successive year. Impressive progress in information technology (IT) and IT-enabled services, both rail and road traffic, and fast addition to existing stock of telephone connections, particularly mobiles, played a key role in such growth. Growth in financial services (comprising banking, insurance, real estate and business services), after dipping to 5.6% in 2003-04 bounced back to 8.7% in 2004-05 and 10.9% in 2005-06. The momentum has been maintained with a growth of 11.1% in 2006-07.
?
Industry:The impressive growth of the industrial sector, propelled by robust growth in manufacturing has continued unabated during the current year so far. Since 1951-52, industry has never consistently grown at over 7% per year for more than three years in a row before 2004-05. Year-on-year industrial growth of 10.6% in the first nine months of 2006-07 was the highest recorded since 199596. In seven of the eight months of the current year, the year-on-year growth of the manufacturing sector was in double-digits. Industrial growth would have been even higher than the 10.0% estimated for in 2006-07, had it not been for a relatively disappointing performance of the other two sub-sectors, namely, mining and quarrying (4.5%); and electricity, gas and water supply (7.7%). Capacity additions through investment are critical for accelerating growth in industry. The sustained growth of the industrial sector is crucially dependent on removing the infrastructural impediments, especially in the power sector. (Automobile, steel, pharmaceutical)
Inflation
• Wholesale Price Index (WPI) • Used to measure the change in the average
price level of goods traded in wholesale market • Based on 435 items, which come under three categories:
•Primary
Articles – 22.02% •Fuel, Power, Light & Lubricants – 14.23% •Manufactured Products – 63.75%
• Available on a weekly basis with the
shortest possible time lag only two weeks
Inflation in rising economies
Inflation in India
• Inflation rate accelerated steadily from an annual average of 1.7 per cent during the
1950s to 6.4 per cent during the 1960s • Further to 9.0 per cent in the 1970s before easing marginally to 8.0 per cent in the 1980 • Declined from an average of 11.0 cent during 1990-95 to 5.3 per cent during the second half of the 1990s (1995-2000) and further to 4.9 per cent during 2003-07 • Increased from 4.1 per cent at the end of March 2006 to an intra-year peak of 6.7 per cent at end-January 2007
Causes of Inflation
The main cause of rise in the rate of inflation rate in India is the pricing disparity of agricultural products between the producer and consumers in the Indian market. Moreover, the sky-rocketing of prices of food products, manufacturing products, and essential commodities have also catapulted the inflation rate in India. This is known as Food-Led Inflation. Increase in Fiscal Deficit leads to additional money creation leading to inflation. Furthermore, the unstable international crude oil prices have worsened the situation.
Rising Economies Exporters of Deflation • Low Cost Production • Cheap Labor •Resource Availability
Creators of Inflation • Second moment of Demand • Rising Wages •Currency Appreciation
Inflation in India
• Wholesale Prices Index (WPI) of India touched 6.1% as on January 6, 2007 and the Cash Reserve Ratio (CRR)
touched 5.5% on the same day.
•The rate of inflation continued to soar during the week ended April 19 to touch a 42-month high of 7.57 per cent,
mainly owing to increased prices of vegetables, food articles, certain manufactured items, ncluding steel, and some fuel products. •At this level, the point-to-point inflation based on the wholesale price index (WPI) was up 24 basis points from 7.33 per cent in the previous week, despite the concerted measures taken by the Government and the Reserve Bank of India (RBI) to tame the price spiral. •Even as the RBI revised upwards the inflation “tolerance limit” from near five per cent last fiscal to 5.5 per cent for 2008-09 on account of surging prices of crude oil and commodities in global markets, the Government also took a number of fiscal steps entailing a revenue loss of over Rs. 6,300 crore to hold the price line.
Inflation in India
Effects of Inflation
High Inflation
The RBI raised the cash reserve ratio (CRR) by 75 basis points to 8.25 per cent in three tranches in quick succession. Nearly Rs. 27,500 crore is set to get sucked out of the banking system as banks will have to park a larger proportion of their deposits with the Central bank. According to Crisil’s Principal Economist D.K. Joshi, the steps taken by the Government and the RBI would lead to “easing of inflationary pressure in future and it can come down to 5.5 per cent.”
Choking Growth
Insecurity in Capital Inflows
Savings & Investment
Trends of Investment in India
• • • • • • •
Bank Fixed Deposits Life Insurance Real Estate/ Property Postal Savings Schemes Gold Shares and Mutual Funds National Savings Certificates and Public Provident Fund • Bonds, Chit Funds and Company FDs
Key factors • In the last few years India’s GDP growth has been more than eight per cent, compared with around six per cent in the 1980s and 1990s and only 3.5 per cent during the three decades before 1980. • Economic reforms of 1990 have opened the economy to change and development • Fourth largest recipient of FDI in 2005-2006. Between 2001-02 and 2006-07 FDI inflows increased by two and half times. • Reduction in tax rates and simultaneous improvement in tax collections
Key factors • Money Supply (M3) has grown by a robust 22.5 per cent (year-on-year) as of October 26, 2007 compared to 18.4 per cent the year before • Surplus in India’s Balance of Payment • Fiscal responsibility and Budget Management Act has resulted in declining deficits at both the Center and the State level • Improved economic status of nation and hence increasing investments
Observations • The current trend of growth could lead to a complacent nature with respect to economic reforms • India’s exploding population with a dearth of jobs to sustain one and all • Crude oil prices breaching the $100 mark • India needs to invest more of its GDP on infrastructure development to sustain the growth • Reducing the fiscal deficit • Increased interest rates under direction of RBI
Monetary Policy
Monetary policy of India
A monetary policy is a stabilization policy announced by the central bank to control (i) the supply of money (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain growth and stability of the economy It’s a bi-annual statement with its goal as "macroeconomic stability" - low
unemployment, low inflation, economic growth, and a balance of external payments.
Its main objectives are : •Price stability
•Exchange rate stability •High rate of growth •Ensure flow of credit to the productive sectors.
Tools of Monetary Policy
Open market operations
Reserve Requirements
Discount windows
Open market operations : Under the OMO, the RBI buys or sells government bonds in the secondary market. By absorbing bonds, it drives up bond yields and injects money into the market. When it sells bonds, it does so to suck money out of the system. Reserve requirements are a percentage of commercial banks', and other depository institutions', demand deposit liabilities (i.e. chequing accounts) that must be kept on deposit at the Central Bank as a requirement of Banking Regulations. It includes CRR, Repo rate, bank rate, reverse repo rate etc. The changes in CRR affect the amount of free cash that banks can use to lend reducing the amount of money for lending cuts into overall liquidity, driving interest rates up, lowering inflation and sucking money out of markets.
Monetary policy works through changes in the money supply and interest rates
Highlights of 2008 Monetary policy
Bank Rate kept unchanged.
Reverse Repo Rate kept unchanged.
Repo Rate increased by 50 basis points from 8.5 per cent to 9.00 per cent. Cash Reserve Ratio to be increased by 25 basis points to 9.0 per cent with effect from the fortnight beginning August 30, 2008. GDP growth projection for 2008-09 revised from the range of 8.0-8.5 per cent to around 8.0 per cent, barring domestic or external shocks. To bring down inflation from the current level of about 11.0-12.0 per cent to a level close to 7.0 per cent by March 31, 2009.
Effect of the policy measures
?
?
A hike in CRR &repo rate would suck out money supply from the banking system to moderate credit growth. These steps mean that the cost of borrowings by individuals as well as businessmen will go up significantly. The recent hike in CRR and repo rate by Reserve Bank of India to bring down inflation levels dragged the rate sensitive auto, capital goods, power and realty sectors lower on concerns it will increase the borrowing cost for the companies and may hurt their bottom line.
Impact of RBI’S policy on various sectors
?
?
To maintain a GDP growth of 8 per cent, the capital goods and power sectors need to borrow which will now be at the higher cost. Also, they are feeling the heat of the high fuel cost. Hence, from a short term perspective we are not favoring these sectors Auto sector is already under pressure led by high cost of petrol and diesel. Increase in the CRR and repo rate will lead to increase in the lending rates by banks and will definitely impede the top line as well as bottom line growth of the companies.
Fiscal Policy and BoP
Fiscal Policy • At the beginning of reforms in 1991, fiscal imbalances were identified as the root cause of the BOP crisis and domestic inflation. The fiscal consolidation, which followed in response, however, failed to sustain itself as it lacked a statutory mandate and the required institutional support • The enactment of the Fiscal Responsibility and Budget Management Act (FRBMA), 2003 provided the required mandate and lent credibility to the fiscal reforms process
Fiscal Policy
•As recommended by the Twelfth Finance Commission, and following the example of the Central Government, 26 States have already enacted fiscal responsibility legislations. The fiscal situation of the States has shown considerable improvement, which in fact is even better relative to the performance of the Central Government, post-FRBMA •The fiscal correction path mandated by FRBMA was also helpful in raising the credibility of the Government with respect to fiscal deficits, in which India was at the bottom of global rankings. This has improved perceptions about the long-term macroeconomic stability of the economy.
Other Fiscal Issues • Some argue that the distinction between plan and nonplan expenditure is illogical and even dysfunctional. The distinction has led to
– Tendency to start new schemes/projects at the cost of utter neglect of existing capacity and service levels. – Misperception that non-plan expenditure is inherently wasteful and should be avoided.
• This dichotomy has resulted in fragmented view of resource allocation to various sectors.
Balance of Payments
• Since independence, India's balance of payments on its current account has been negative. • Since liberalisation in the 1990s, India's exports have been consistently rising, covering from 66.2% of its imports in 1990–91 up to 80.3% of its imports in 2002–03 • Although India is still a net importer, since 1996–97, its overall balance of payments has been positive, largely on account of increased foreign direct investment and deposits from non-resident Indians • Until this time, the overall balance was only occasionally positive on account of external assistance and commercial borrowings. As a result, India's foreign currency reserves stood at $285 billion in 2008, which could be used in infrastructural development of the country if used effectively.
In India, External Commercial Borrowings (ECBs) are being permitted by the Government for providing an additional source of funds to Indian corporates and PSU’s • India's reliance on external assistance and commercial borrowings has decreased since 1991–92, and since 2002–03, it has gradually been repaying these debts. Declining interest rates and reduced borrowings decreased India's debt service ratio to 4.5% in 2007.
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