assignment on current economic conditions

Symbiosis Institute of Business Management MBA [Ex. Edu.] Batch 2012-2015

Semester IV

Group Members Anurag Verma: Roll No: 35413 Amol Surwade: Roll No: 35407

Sushant Jog: Roll No: 35481

Business Analysis – IV

Assignment Date of Submission: 10/04/2014

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MBA [Ex. Edu.] Batch 2012-2015, Semester – IV

Assignment: Business Analysis IV

Contents 1) What is the main issue with India today-growth or inflation? Why? .............................................3

2) Why is it believed that high growth is normally accompanied by high inflation? ...........................4

3) What is stagflation? Why is India experiencing a stagflationary environment? .............................6

4) Will you use Nominal or Real GDP to measure the growth rate? Why? .........................................8

5) What is IIP? How does it help to understand growth levels in India? ............................................9

6) How is Inflation measured in India? What is the difference between CPI and WPI? .................... 11

7) Why is it the case that WPI inflation is far lesser than CPI inflation in India? ............................... 13

8) Why did the RBI Governor not raise rates on 1st April 2014 policy review even when the inflation

continues to be a concern? ............................................................................................................... 14

9) If inflation is so high and the growth rate low, why is it that FIIs continue to push funds into India

stocks? ............................................................................................................................................ 15

10) If you were the Finance Minister of the new Government, what would be the chief 3 policies

you would try to announce in the budget in June 2014? .................................................................... 16

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1) What is the main issue with India today-growth or inflation? Why?

Since 1991, the Indian economy has pursued free market liberalization, greater openness in trade and increase investment in infrastructure. This helped the Indian economy to achieve a rapid rate of economic growth and economic development. However, the economy still faces various problems and challenges. Fuelled by rising wages, property prices and food prices, inflation in India is an real and increasing problem. Inflation is currently between 8-10%. This inflation has been a problem despite periods of economic slowdown. For example in late 2013, Indian inflation reached 11%, despite growth falling to 4.8%. This suggests that inflation is not just due to excess demand, but is also related to cost push inflationary factors. For example, supply constraints in agriculture have caused rising food prices. This causes inflation and is also a major factor reducing living standards of the poor who are sensitive to food prices. The Reserve Bank of India have made reducing inflation a top priority and have been willing to raise interest rates, but cost push inflation is more difficult to solve and it may cause a fall in growth as they try to reduce inflation. Ahead of the 2014 elections, the issue of high inflation is uppermost in the minds of politicians, policymakers and the people. Consumer prices in India have risen at an average annual pace of 10 per cent during the past five years, and Indian households are bracing for another 13 per cent increase next year. To check inflation, the Reserve Bank of India has raised interest rates and will review India’s monetary policy framework in line with recommendations by the Urjit Patel Committee, which is expected to submit its report at the end of the year. It is also essential to manage artificially induced national and international mechanisms. The central bank and Ministry of Finance are working together to analyse and understand the reasons and find ways to encourage investment and curb inflation. 2013/14 has seen a slowdown in the rate of economic growth to 4-5%. Real GDP per capita growth is even lower. This is a cause for concern as India needs a high growth rate to see rising living standards, lower unemployment and encouraging investment. India has fallen behind China, which is a comparable developing economy

http://www.ft.com/cms/s/0/50bc75b8-5ea9-11e3-8621-00144feabdc0.html#axzz2n0CN8G61

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2) Why is it believed that high growth is normally accompanied by high

inflation?

The relationship between inflation and growth remains a controversial one in both theory and empirical findings. Originating in the Latin American context in the 1950s, the issue has generated an enduring debate between structuralists and monetarists. The structuralists believe that inflation is essential for economic growth, whereas the monetarists see inflation as detrimental to economic progress.

It is argued that the developed countries do have very well developed financial markets and less government interventions in goods markets. Such economies are mostly demand driven, in which case stimulus to demand results in rising prices and a clear tradeoff is observed at low level of inflation. On the other hand, the developing countries are more vulnerable to supply shocks causing high variability in inflation and disturb the consumption, investment and

production behavior. Further, the government interventions in financial and goods markets and

macroeconomic rigidities such as rigidities in labour laws cause market failure and

macroeconomic instability.

Therefore, prices do not give correct signals about the policies and the course of actions of the economic agents. In the short run, the

relationship between growth and inflation is usually positive. Policies that raise

output (for example, expansionary fiscal and monetary policies) also raise prices. Inflation is undesirable because it adversely affects some sections of the population (especially the poor and those whose earnings are not indexed to prices), distorts relative prices, leads to an

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appreciation of real exchange rates, erodes the value of the financial assets and creates instability. The ultimate policy objective is a higher level of well-being for the population, but a conflict arises in the means of achieving it—by higher growth or by lower inflation. There is a trade-off involved and both cannot be achieved together. A tightening of fiscal and monetary policies may achieve lower inflation but only at the cost of growth. The government needs to find the right balance between contractionary and expansionary policies to maximise the well-being of its people. Macroeconomic stability and the necessary infrastructure are among the preconditions for sustained growth. Among the ways inflation can affect growth, an important avenue is the effect of inflation on investment. Low or moderate inflation is an indicator of macroeconomic stability and creates an environment conducive for investment. Countries with low or moderate rates of inflation have higher growth rates over the long-term compared with countries with high inflation rates. However, low inflation does not constitute a sufficient condition for growth. The Indian experience appears to support the above view. In India inflation has generally been kept under control. There have been two episodes of high inflation since 1980 but price rise has been controlled by various fiscal, monetary and administrative measures.

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3) What is stagflation? Why is India experiencing a stagflationary

environment?

Stagflation is the term that describes a "perfect storm" of economic bad news: high unemployment, slow economic growth and high inflation. The term was born out of the prolonged economic slump of the 1970s, when the United States experienced spiking inflation in the face of a shrinking economy, something economists had previously thought to be impossible. The word stagflation is a contraction of "stagnant" and "inflation." When the economy is stagnant, it means that the gross domestic product (GDP) -- the standard measure of a nation's total economic output -- is either growing at a very slow rate or shrinking. The natural result of economic stagnation is increased unemployment. Businesses lay off employees to save money, which in turn decreases the purchasing power of consumers, which means less consumer spending and even slower economic growth. Stagflation is not entirely new to the Indian economy, though. Such episodes did take place in the early 1990s, the late 1970s and 1974-75, for instance. But the reasons, then, were mostly ‘external’ in the form of global oil shocks or balance of payments crises: The resulting currency devaluations ended up disrupting domestic production activity as well as stoking cost-push inflation. This time, the causes have been essentially ‘internal’, to do with government policy failure and inaction. These created negative corporate sentiment to begin with, manifesting itself through an investment slowdown from around the second half of 2013-14. By the time the Government woke up to announce grand reforms sans any follow-up efforts at actual implementation, investments had ground to a halt. With new jobs and incomes drying up, its second-round effects are now being felt in consumption spending as well. The rupee’s

weakening, even if attributed to ‘external’ factors, has only superimposed itself on a largely internal-induced crisis.

Negative or very little growth in industrial output and near double-digit retail inflation, as revealed by the Government’s latest economic data, points to a phenomenon of stagnation coexisting with high inflation — or,

http://money.howstuffworks.com/currency.htm

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quite simply, ‘stagflation’. For policymakers, it represents a nightmarish situation where use of conventional monetary tightening tools to fight inflation may only exacerbate an already serious economic slowdown. On the other hand, lowering interest rates to stimulate the economy could lead to households putting their money into land or gold, as against bank deposits and other financial savings instruments offering only negative inflation-adjusted returns. Interest rate cuts, moreover, are problematic when the country is simultaneously running a huge current account deficit in its external transactions that has to be bridged through capital inflows. Today, the Indian economy is suffering from a fundamental absence of growth impulse, be it from investment, consumption or exports. Together with the cost-push inflationary pressures from a sliding rupee — not to speak of under-investments in infrastructure and farm sector productivity, whose chickens are now coming home to roost — the end-result is stagflation. This phase is unlikely to end without decisive action from the Government going beyond making big-bang reform announcements. It is not lack of money but of confidence in the Government’s ability — to clear the regulatory maze erected by its own departments or to mediate between diverse stakeholders from landowners to workers — that is currently holding back investments. Unless that confidence returns, which will happen only when businessmen actually see things moving, there is little way out of the current mess.

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4) Will you use Nominal or Real GDP to measure the growth rate? Why? Let’s understand first what GDP is and then will decide which one to choose for growth rate GDP (Gross Domestic Product) GDP is the total money value of all final goods and services produced in an economy during a particular year by normal residents as well as non-residents in the domestic territory of a country but exclude the incomes received from abroad.

GDP =

Money value of all Goods and Services +

Income earned locally by Foreigners –

Income Received by Nationals abroad

In order to calculate the Money value we can choose prices which are based on the prevailing ones or which are relative to a base year. Nominal GDP uses the Current Prices for measuring the money value. Real GDP measures the money value using the prices of a base year. The growth rate cannot be measured on the basis of current prices because if today prices are high and tomorrow they are down then it does not show the correct picture. We vote for Real GDP measure for calculating the growth rate because here the prices are based on some base year from which the relative performance is measured.

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5) What is IIP? How does it help to understand growth levels in India? Index of Industrial Production (IIP) IIP is a zoomed in view of major components of GDP i.e. it measures growth in the industrial sector. It is also one of the essential short term indicators of the industrial activity in an economy. It conveys whether the industrial output of a country has increased or decreased and to what extent with respect to a fixed base reference. The IIP numbers are calculated in 3 ways as described below: 1) Use Based – The industry is categorized broadly as Consumer Goods, Durable and Non-

Durable goods, Basic and Intermediate goods 2) Sector Wise – Industry is categorized sector wise such as Electricity, Mining, Manufacturing

etc. 3) Detailed Sector – Industry is categorized in to various details sectors. IIP data is released every month in India. Office of Economic Advisor, Ministry of Commerce and Industry released the first estimate of Index of Industrial Production officially with the base year 1937 covering 15 important industries. After many revisions, the base year currently stands at 2004-05. Over time, the items that are included in computing this index and their relative weights have been changed many times.

To arrive at the IIP estimate, data is accumulated and sourced from as many as 15 agencies like Central Statistical Organization, department of Industrial Policy and Promotion etc. As more data is made available and responses are received from the manufacturing and other units, the estimates are revised twice subsequently.

In computing the IIP, production data across 543 items that are grouped into 287 item groups is taken into consideration and appropriate weights are assigned to reflect a representative index. These are then broadly clubbed into 3 main categories - mining, electricity and manufacturing. Mining and electricity are seen as the enablers of manufacturing - and as such, are very important for growth in overall industrial activity - which in turn impacts overall GDP growth.

How is IIP index calculated : IIP index is calcualted with the Laspeyre's formula . The calculation involves following steps: (1) Identifying the weights of the various sectors on Product level , Product Group level and Industry level. These weights will be identified on the basis of the total output in sales or gross output value. The weights and the sectors are updated periodically to incorporate the changing market scenario and the economic dynamics. Weights on the product level can be updated annually while those of Industry level can be updated every 5 years. (2) Once the weights are calculated the IIP number is calculated ,The index is a simple weighted arithmetic mean of production relatives calculated by using Laspeyre’s formula I=Σ(Wi*Ri)/ΣWi, Where I is the Index, Ri is the production relative of the i-th item for the month in question and Wi is the weight allotted to it based on Gross Output.

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The item-wise indices are vertically aggregated at 2-digit of industrial classification based on weighted average, weights are proportionate to Gross Value Added. How does IIP help to understand growth levels in India A shrinking IIP is unfavorable to the overall GDP of a country while a rising IIP suggests that the industrial activity is expanding and capacity addition is taking place in the economy. The graph here shows annual growth rate of Indian IIP from 1995 to 2013. Those of us who track stock markets over the years will notice a very sharp correlation between trends in IIP and long term trends in the stock market

The period 1996-1997 saw a sharp deceleration in IIP growth, and we know this was quite a bad phase for the stock markets. A sustained upward momentum in IIP growth rates is clearly visible from 2003 onwards and this peaked at a massive 20% growth rate in some quarters in 2007. This also coincided with one of the biggest equity bull markets we have seen in recent history. IIP skidded sharply thereafter in 2008 and bounced back in 2010, only to fall back sharply in 2011. The stock market pretty much mirrored this movement. Since 2012, although IIP growth rates are still very muted, we can see an upward trajectory in the direction of the growth chart. This should perhaps give us some comfort that though growth in industrial activity is still nowhere near what we saw in the 2005-2007 phase, at least the direction now seems to be upward rather than downward.

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6) How is Inflation measured in India? What is the difference between

CPI and WPI?

For an economically diverse country like India, a single measure of inflation does not suffice so it is measured by the Wholesale Price Index (WPI) and Consumer Price Index (CPI). At present, India has four consumer price indices that account for four diverse groups, viz., agricultural labourers, rural labourers and industrial workers and urban employees. Another term that was also considered is GDP Deflator. Wholesale Price Index (WPI) A new series of WPI was launched in 2010 with 2004 as base year. The 100 point index is subdivided into three different groups and it includes 676 items:

1) Primary Article Group, which include food and non-food agricultural products. It has 22% weightage and has 102 items in its kitty.

2) Fuel and Power Category; 19 items with 13% weightage 3) Manufactured products; 555 items with a weightage of 65%

India is one of the few countries where the WPI is considered as the headline inflation measure by the central bank. This preference over the CPI is often explained in terms of three criteria – national coverage, timeliness of release (now only limited to food products) and its availability in a disaggregate format.

Consumer Price Index (CPI) It is a measure of change in retail prices of goods and services consumed by defined population group in a given area with reference to a base year. Presently the consumer price indices compiled in India are:

1) CPI for Agricultural Labourers (CPI-AL): A person is treated as AL if he or she follows one or more of the agricultural occupations in the capacity of the labourer on hire whether paid in cash or kind. A variant of this is food indices for AL, which is separately available along with CPI for AL

2) CPI for Rural Labourers (CPI-RL): A person is treated RL if he or she does manual work in rural areas in agricultural and non-agricultural occupations in return for wages in cash or kind.

3) CPI for Industrial Workers (CPI-IW): This covers Industrial workers employed in any one of the seven sectors namely factories, mines, plantations, railways, public motor transport undertakings, electricity generation, and distribution establishments as well as ports and docks. The index covers only manual workers irrespective of their incomes.

4) CPI for Urban Non-Manual Workers (CPI-UNME): An urban non manual employee is defined as one who derives 50 percent or more of his income from gainful employment on non-manual work from urban non-agricultural sector.

Among the above indices, CPI-IW measures the cost of living for a fixed basket representing the consumption behavior of one industrial worker and CPI-AL that of an agricultural worker. CPI-UNME is mostly used for the purpose of regulating dearness allowance of some of the state

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government public and private employees. Central Board of Direct Taxes also uses the index for advance tax liability of tax payers from capital gains. CPI-IW is the most well-known of these indices as it is used for wage indexation in government and organized sector.

Here is the comparison summary between WPI and CPI

W.P.I C.P.I

Wholesale price index measures inflation at

each stage of production

Consumer price index measures inflation only

at final stage of production

Wholesale price index is the middle point of

the sum of all the goods bought by the traders

Consumer price index is the middle point of the

sum of all the goods bought by consumers

Wholesale Price Index (WPI), is based on the

price prevailing in the wholesale markets or

the price at which bulk transactions are made

The Consumer Price Index (CPI), is based on

the final prices of goods at the retail level.

There are only few countries that uses WPI to

calculate inflation rates

Many nations have already shifted to using

CPI.

There are 676 elementary items included in

WPI, some of which are insignificant &

outdated goods that are considered in WPI

CPI, on the other hand, have well-selected

variables.

Category Weights – Base Year is 2004-05

with Energy Products having 14.91% weights,

food 14.3% while services are not included.

Category Weights – Base Year is 20105 with

Energy Products having 9.49% weights, food

49.7% while services are included with 26.3%

weightage.

GDP Deflator The GDP deflator is another indicator of inflation, which is often considered to be broader than the CPI and the WPI. In-order to calculate this index, we uses two more terms: Nominal GDP which uses the Current Prices for measuring the money value.

Real GDP measures the money value using the prices of a base year. GDP Deflator = 100 * (Nominal GD / Real GDP)

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7) Why is it the case that WPI inflation is far lesser than CPI inflation in

India?

Last year, RBI governor gave this statement; “To some extent, the divergence between WPI and CPI can be attributed to statistical differences stemming from coverage, classification of items and the relative weights of their constituents. However, there could be other reasons for this as well. For example, higher transaction costs, taxes, etc. are reflected in the CPI but not in the WPI.”

WPI also referred as headline inflation, as the name suggests it measures the trend in wholesale prices across various heads of primary articles, fuel & power and manufactured products. The current series for WPI has a base year of 2004-05. The weightage given to primary articles is close to 20%, while fuel and power has weightage of approximately 15%, rest 65% weightage has been assigned to manufactured products. Though this index broadly covers the inflation across different segments of the economy, it is manufacturing based. Also being a wholesale price index, an individual consumer may not be a direct and immediate beneficiary of a fall in the inflation number. Data collection issue still exists and the flow of data is not timely. The WPI doesn’t take the price of services into consideration, which now accounts for 60% of the GDP (gross domestic product). Also, it is too general and cannot be used for specific purposes. Basically WPI is not a true reflection of inflation for a common man. However, in spite of having lacunae it is still used for policymaking. For a common man, a fall in WPI does not warrant immediate celebration. The trickle-down effect takes time to work. The table shown below reflects the percentage of food products given in WPI and CPI

WPI CPI - New Series wef Feb 2012

Base Year 2004-05 2010

Elementary Items 676 200 (Weighted items)

Weightage of Food products 14.3 % 49.71 %

Weightage of Energy products 14.91 % 9.49 %

Weightage of Miscellaneous Items Services not

included 26.31 %

Food price inflation accounts for much of the gap between the two indices at the moment. We note that food represents half of the CPI basket (as opposed to 14% of the WPI, or 31% if you include the less-volatile manufactured food items) and retail food prices are heavily government influenced. That is the reason we have a lesser value of WPI inflation as compared to CPI Inflation.

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8) Why did the RBI Governor not raise rates on 1st April 2014 policy

review even when the inflation continues to be a concern?

In the first bi-monthly monetary policy statement for 2014-15, the RBI Governor Raghuram Rajan decided to pause and not disturb status quo. The repo rate and the rate at which RBI lends money to banks remained at 8 per cent. Here is the excerpt from the RBI Monetary Policy Statement 2014-15: “Our policy stance is firmly focused on keeping the economy on a disinflationary glide path that is intended to hit 8 per cent CPI inflation by January 2015 and 6 per cent by January 2016. At the current juncture, it is appropriate to hold the policy rate, while allowing the rate increases undertaken during September 2013 through January 2014 to work their way through the economy. Furthermore, if inflation continues along the intended glide path, further policy tightening in the near term is not anticipated at this juncture” There are other several reasons for not raising the rates:

1. Retail inflation measured by the consumer price index (CPI) moderated for the third month in succession in February 2014, driven lower by the sharp disinflation in food prices, although prices of fruits, milk and products have started to firm up. Excluding food and fuel, however, retail inflation remained sticky at around 8 per cent. This suggests that some demand pressures are still at play.

2. There are risks to the central forecast of 8% CPI inflation by January 2015

3. Policy stance will be firmly focused on keeping the economy on a disinflationary glide path that is intended to hit 8% CPI inflation by January 2015 and 6% by January 2016.

4. GDP growth is projected to pick up from a little below 5% in 2013-14 to a range of 5 to 6% in 2014-15 albeit with downside risks to the central estimate of 5.5%

5. Lead indicators do not point to any sustained revival in industry and services as yet, and the outlook for the agricultural sector is contingent upon the timely arrival and spread of the monsoon.

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9) If inflation is so high and the growth rate low, why is it that FIIs

continue to push funds into India stocks?

A late revival in economy in 2013 has investors and experts excited. The gross domestic product (GDP), a measure of goods and services produced in the country, increased 4.8% in the July-September quarter of 2013-14, as against 4.4% in the previous quarter. This was higher than the estimates of most economists and equity analysts. Already, brokerage houses have revised their 2013-14 GDP growth estimates from 4-4.5% to above 5%. The sentiment has been helped by the government's aggressive approach to controlling the current account deficit (CAD), a situation where imports exceed exports. The government has been successful in restricting gold imports, and as a result CAD, which was 4.8% of GDP in 2012-13, is likely to come down to 2.5-3% this financial year. Fuelling hope further is the possibility of regime change at the Centre and the likely emergence of the Bharatiya Janata Party as the ruling party after the 2014 general elections. Its prime ministerial candidate, Narendra Modi, is being cheered by industrialists and market experts as harbinger of change in the Centre's approach towards economic and industrial policies. The results of the recent assembly elections in five states (in which the BJP got clear majority in three and emerged as the single-largest party in one) has further established the public sentiment in favour of the BJP. Equity markets cheered the victory with both the NSE Nifty and the BSE Sensex gaining over 1.5% on December 9, the day after the poll results were announced. Of course, there is also no dearth of factors that can spoil the party. The fiscal deficit (a situation where government expenses exceed revenues) continues to be a worry. The government has set the target for 2013-14 at 4.8% of GDP, but most experts say it will not be met.

High inflation and interest rates continue to be a drag. The fear that the US Federal Reserve, or Fed, will further scale down its liquidity-injection programme, triggering a sell-off by foreign institutional investors, or FIIs, also looms large over both the rupee and stock markets. The Fed has already said that it will scale back the programme, called quantitative easing, or QE, by $10 billion to $70 billion a month from January. Over the years, investment by FIIs in listed Indian equities has gone up substantially and currently stands at about 40% of the overall free-float market capitalization. Therefore, a large-scale sell-off of Indian equities by FIIs would hurt them more than any other investor group. Given these positive trends and buoyant business expectations, Indian equities could provide about 20% returns in 2014, taking the Sensex to 26,500 by December 2014. Despite the likely delay in the investment cycle picking up, the expectation of it happening is likely to help investment-theme stocks to outperform consumption-theme stocks in 2014.

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10) If you were the Finance Minister of the new Government, what

would be the chief 3 policies you would try to announce in the budget

in June 2014?

Today in India the average Indian citizen is excluded from the benefits of simple financial

services whether it is a bank account, insurance and pension. Post general Election, irrespective

of any government I would like to implement following 3 policies during Jun 2014 Budget.

1) Revive Investment in Slowing Economy

For an economy like India which has tremendous potential, FDI has had a positive impact.

FDI inflows supplement domestic capital, as well as technology and skills of existing

companies. It also helps to establish new companies. All of these contribute to economic

growth. I’ll definitely focus on this policy with high priority.

2) Actions on how the Fiscal deficit can come down to 3 percent of the gross domestic

product (GDP) over 36 months.

3) Educational Reforms

Although India has benefited from a high % of English speakers, there are still high levels of

illiteracy amongst the population. It is worse in rural areas and amongst women. Over 50%

of Indian women are illiterate. This limits economic development and a more skilled

workforce. If a dedicated focus is given to this reform then definitely economy can be

improved.

assignment on current economic conditions

Economy & Finance

disinflationary

semester iv

business analysis

gross domestic

understand

wholesale

consumer price

iip growth