Reviewing Macro-economic Developments

and Understanding Macro-Economic Policy

Module 5

Contemporary Themes in India’s

Economic Development and the Economic Survey

Arvind Subramanian

Chief Economic Adviser

12017-06-14 Reviewing Macro Developments (Module 2)

MINISTRY OF FINANCE

GOVERNMENT OF INDIA

Overview

I. Why is it important to monitor the economy in real-time: ingredients of any macro-economic assessment through the lens of the last three Economic Surveys

II. Framework for measuring these trends: domestic and external factors affecting the recent trends and future outlook for

(A) Inflation

(B) Output

III. Current scenario as an illustration: Policy response: assessing the stance of fiscal and monetary policy

2

I. Ingredients of Any Macro-

Economic Assessment

3

Ingredients of Any Macro-Economic Assessment

• Inflation

• Growth: Overall and sectoral

• Fiscal deficit

• External Sector1. Foreign exchange reserves

2. Capital flows

3. Exchange rates

• Financial Sector1. Credit growth

• Implications for the appropriate stance of fiscal and monetary policy

(Go to figure)

(Go to Figure)

(Go to Figure)

4

Current Account Deficit Should be Kept Below 3% of GDP; Foreign reserves should be at “comfortable” levels

250

260

270

280

290

300

310

320

330

340

350

360

370

380

May-0

9

No

v-0

9

May-1

0

No

v-1

0

May-1

1

No

v-1

1

May-1

2

No

v-1

2

May-1

3

No

v-1

3

May-1

4

No

v-1

4

May-1

5

No

v-1

5

May-1

6

No

v-1

6

Forex at the advent of financial

Indicator Norms Current Status

Import Cover 3 Months ~12 months

Short term external debt cover ratio 1 1.8

-5.0

-4.5

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

2011-12 2012-13 2013-14 2014-15 2015-162016-17

H1

Current Account deficit

(percent of GDP)

Foreign exchange reserves (USD Billion)

5

FDI Desirable, Portfolio Investment Volatile…

6

-20

-10

0

10

20

30

40

50

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

20

06

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

2014

-15

20

15

-16

2016

-17

US

$ b

illio

nNet FDI Net Foreign Portfolio Investment

Bilateral Nominal or Nominal Effective or Real Effective Exchange Rates

Nominal Exchange Rates: Rs/USD and NEER Real Effective Exchange Rate

7

70

71

72

73

74

75

76

77

78

79

80

60

61

62

63

64

65

66

67

68

69

Apr-

15

Jun-1

5

Aug-1

5

Oct-

15

Dec-1

5

Fe

b-1

6

Apr-

16

Jun-1

6

Aug-1

6

Oct-

16

Dec-1

6

Fe

b-1

7

Apr-

17

NE

ER

(Apr 2

015 =

100)

Rs/$

Rs/$ (left)

NEER

95

97

99

101

103

105

107

Apr-

15

Jun-1

5

Aug-1

5

Oct-

15

Dec-1

5

Fe

b-1

6

Apr-

16

Jun-1

6

Aug-1

6

Oct-

16

Dec-1

6

Fe

b-1

7

Apr-

17

RE

ER

(A

pr

2015 =

100)

Circumstance-Specific AssessmentsEconomic Survey 2014-15

• In the 2014-15 Survey, we contrasted the prevailing macro-economic indicators with the 2013 near-crisis situation to bring out the achievement of macro-economic improvement.

• The 2013 near-crisis situation affected five emerging markets (Fragile Five) so a cross-country, across-time comparison was done.

• In 2014-15, since inflation had been a challenge, we highlighted what we felt was a possibly structural change in the determinants of inflation: namely rural wage inflation.

8

Improving Macroeconomic Stability: Comparing India with “Fragile Five”

The Survey relied on an

overall macro-vulnerability

index (MVI), combing:

1. Fiscal deficit

2. Current account deficit

3. Inflation.

9

0.0

5.0

10.0

15.0

20.0

25.0

20

10

201

1

201

2

201

3

201

4

201

5

Brazil Indonesia South Africa TurkeyIndia Russia Mean MVI

Improving Macroeconomic Stability: Comparing India with “Fragile Five”

• Rational investors take

into account not just

macroeconomic stability

but also growth, which

crucially determines

rewards and returns.

• The Survey captured this

using a rational Investor

Ratings Index.

10

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

201

0

201

1

201

2

201

3

201

4

201

5

Brazil IndonesiaIndia ChinaRussia Mean (BBB)Mean (A Rating)

Fast Credit Growth and Past Crises

11Source: GFSR, IMF (April 2017)

Poor Standards: Assessing India’s and China’s Credit Ratings

5

6

7

8

9

10

11

70

90

110

130

150

170

190

210

2010201120122013201420152016

TSF*/GDP

GDP growth(RHS)

A+

AA-

Rating

upgrade by

S&P in

December

2010

BBB-

China

5

6

7

8

9

10

11

70

90

110

130

150

170

190

210

2010 2011 2012 2013 2014 2015 2016

Credit /GDP

GDP growth(RHS)

BBB-

AA-

India

*Total Social Financing (Source: IMF Article 4 Report for China) 12

Declining Rural Wage Growth: Inflation Momentum Declining Structurally

13

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

May-1

3

Aug

-13

Nov-1

3

Feb-1

4

May-1

4

Aug

-14

Nov-1

4

Feb-1

5

YoY

Month

ly p

erc

enta

ge c

hange Rural Wages

Headline CPI Inflation: A Structural Decline?

14

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

May-1

3

Aug

-13

Nov-1

3

Feb-1

4

May-1

4

Aug

-14

No

v-1

4

Feb-1

5

YoY

Month

ly p

erc

enta

ge c

hange Rural Wages and CPI Inflation

Rural Wages

Headline CPI

Circumstance-Specific AssessmentsEconomic Survey 2015-16 and 2016-17

2015-16

• Background development was turmoil in China. So, we asked

whether there could be a financial crisis in China. Taxonomy of

crises (Module 5)

• Debate on the fiscal deficit target (module 3 and 4)

2016-17

• Demonetization was a key issue (Module 14)

15

II. Recent Economic Trends

and Future Outlook

16

What is the Macro-Assessment Today?

• Government decided in the 2017-18 budget to reduce the fiscal deficit deficit from 3.5 % of GDP to 3.2 % of GDP

• RBI’s Monetary Policy Committee (MPC) has very recently taken a decision to keep its monetary policy stance and key policy (repo) rate unchanged.

• Recent trends in inflation and medium-term outlook

• Recent trends in output growth and growth outlook

17

Real-time macro monitoring

Economic policy is

a bit like driving a

car while only

looking at the rear-

view mirror

17

II.A. Inflation

19

Falling headline CPI inflation, over-performing 2017 target for 8 months & well below medium-term target for 6 months

20

Core inflation excludes food and fuel. True core excludes prices of

food, fuel, and petrol &diesel from transport & communication group.

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Ma

y-1

4

Ju

l-1

4

Se

p-1

4

No

v-1

4

Ja

n-1

5

Ma

r-1

5

Ma

y-1

5

Ju

l-1

5

Se

p-1

5

Nov-1

5

Ja

n-1

6

Ma

r-1

6

Ma

y-1

6

Ju

l-1

6

Se

p-1

6

No

v-1

6

Ja

n-1

7

Ma

r-1

7

Ma

y-1

7

Year

on y

ear,

perc

ent change

Headline CPI

RBI’s medium term target

RBI’s end March 2017 target

Go back

Steady Decline in “True Core”: Are Underlying Inflation Pressures Easing?

21

Core inflation excludes food and fuel. True core excludes prices of

food, fuel, and petrol &diesel from transport & communication group.

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Ma

y-1

4

Ju

l-1

4

Se

p-1

4

No

v-1

4

Ja

n-1

5

Ma

r-1

5

Ma

y-1

5

Ju

l-1

5

Se

p-1

5

Nov-1

5

Ja

n-1

6

Ma

r-1

6

Ma

y-1

6

Ju

l-1

6

Se

p-1

6

No

v-1

6

Ja

n-1

7

Ma

r-1

7

Ma

y-1

7

Year

on y

ear,

perc

ent change

Headline CPI Core CPI True Core

RBI’s medium term target

RBI’s end March 2017 target

1. What is the possible impact of US Fed rate hike?

2. What is the possible impact of the exchange rate movement? (appreciation of 1% in the rupee reduces inflation by about 0.1 percentage point)

3. Are oil prices structurally low after the discovery of shale oil?

Inflation Outlook: Is Over-Performance Likely to be Durable? External Factors

22

Fed Rate Cut

Capital inflows to India

Appreciation of rupee

X and M domestic availability of goods

Inflation

Fed Rate Hike

Capital outflows from India

Depreciation of rupee

X and M domestic availability of goods

Inflation

Spillover Effect of US Monetary Policy

23

Easing Imported Inflation: Appreciating Exchange Rate

24

62

63

64

65

66

67

68

69

Apr-

15

Jun

-15

Aug

-15

Oct-

15

Dec-1

5

Feb-1

6

Apr-

16

Jun

-16

Aug

-16

Oct-

16

Dec-1

6

Feb-1

7

Apr-

17

Rs/U

SD

$

A Structurally Altered Global Oil and Gas Industry?

• Newly discovered Shale oil is competitive at $45-50, and can expand/ contract supply quickly (accordion)

• This has neutered OPEC’s price-setting power

• Effectively, Oil Prices are capped at the marginal cost of Shale.

25

Source: Roland Berger

OPEC spare capacity

(inverted)

Brent USD

A Structurally Altered Global Oil and Gas Industry?

• The new

accordion

26

Inflation Outlook: Is Over-Performance Likely to be Durable: Domestic Factors

• What is the Outlook for the Monsoon and its Impact on Inflation?

• What is the net incidence of taxes post-GST?

• What is the impact of the 7th Pay Commission Award?

• Will the output-gap narrow or expand?

27

Will the economy bounce-back quickly, exerting pressure on inflation or will the recovery be gradual?

DemandSupply

Price

28

II.B. The Real Sector

29

Sharply Decelerating Underlying Growth Since Early 2016-17

3.5

5.0

6.5

8.0

9.5

11.0

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2014-15 2015-16 2016-17

Quarterly GVA Growth (%)

Headline GVA

30

Sharply Decelerating Underlying Growth Since Early 2016-17

Core GVA is obtained by subtracting agriculture and government services from aggregate GVA.

3.5

5.0

6.5

8.0

9.5

11.0

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2014-15 2015-16 2016-17

Quarterly GVA Growth (%)

Core GVA Headline GVA

Go back

31

Headline vs. Manufacturing GVA

32

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

Jun

-12

Sep

-12

Dec-1

2

Mar-

13

Jun

-13

Sep

-13

Dec-1

3

Mar-

14

Jun

-14

Sep

-14

Dec-1

4

Mar-

15

Jun

-15

Sep

-15

Dec-1

5

Mar-

16

Jun

-16

Sep

-16

Dec-1

6

Mar-

17

Yo

Y Q

uart

erly P

erc

enta

ge C

hange

Headline GVA

Manu GVA

Sharp deceleration in new index of industrial production (IIP) growth since June 2016

33

0

1

2

3

4

5

6

7

8

9

10

Jul-

13

Oct-

13

Jan-1

4

Apr-

14

Jul-

14

Oct-

14

Jan-1

5

Apr-

15

Jul-

15

Oct-

15

Jan-1

6

Apr-

16

Jul-

16

Oct-

16

Jan-1

7

Apr-

17

Perc

enta

ge c

hange

(year

on y

ear)

IIP (3month MA) IIP

Aside: Month on Month Seasonally Adjusted Annualized Rate (SAAR) of Growth vs. Year on Year Growth

34

-40

-30

-20

-10

0

10

20

30

40

50

-2

0

2

4

6

8

10

May-1

3Jul-13

Sep-1

3N

ov-1

3Jan-1

4M

ar-

14

May-1

4Jul-14

Sep-1

4N

ov-1

4Jan-1

5M

ar-

15

May-1

5Ju

l-1

5S

ep-1

5N

ov-1

5Jan-1

6M

ar-

16

May-1

6Jul-16

Sep-1

6N

ov-1

6Jan-1

7M

ar-

17

Month

on M

on

th S

easonally

Adju

ste

d

Annu

aliz

ed P

erc

enta

ge C

hangeM

on

thly

Ye

ar

on

Ye

ar

Pe

rce

nta

ge

C

hange

YoY (left)Monthly SAAR (right)

Aside: Monthly Year on Year Growth vs. Seasonally Adjusted Monthly Year on Year Growth (Adjusting for Diwali)

35

-2

0

2

4

6

8

10

May-1

3

Jul-

13

Sep

-13

Nov-1

3

Jan-1

4

Mar-

14

May-1

4

Jul-1

4

Sep

-14

Nov-1

4

Jan-1

5

Mar-

15

May-1

5

Jul-1

5

Sep

-15

Nov-1

5

Jan-1

6

Mar-

16

May-1

6

Jul-1

6

Sep

-16

Nov-1

6

Jan-1

7

Mar-

17

Ye

ar

on Y

ear

Perc

enta

ge C

hange YoY SA YoY

A Sharp Decline in Credit Growth to Industry, but Less Dramatic Than the Headline Number Suggests

*Note: Credit to

industry figures

for April are not

yet available. It

is derived by

imputing the

share of

industry in total

credit

witnessed in

the previous

month. -10.0

-5.0

-

5.0

10.0

15.0

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

Apr-

17*

YoY

Gro

wth

(perc

ent)

Credit to Industry

36

Weak and Declining Investment (I)

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2015-16 (1RE) 2016-17 (PE)

Yo

Y Q

ua

rte

rly G

row

th

Gross Fixed Capital Formation

37

Looking forward: Is the Current Slowdown Temporary or Not?

• We will assess

1. Exports(X),

2. Consumption (C)

3. Investment (I)

4. Government Spending (G)

5. Taxes(T)

38

Exports (X): Rising World GDP Growth Will Lift Exports but Appreciating Rupee Will Undermine Some of It

2.00

2.20

2.40

2.60

2.80

3.00

3.20

3.40

3.60

3.80

4.00

Q1 2

01

3

Q2 2

01

3

Q3 2

01

3

Q4 2

01

3

Q1

20

14

Q2 2

01

4

Q3 2

01

4

Q4 2

01

4

Q1 2

01

5

Q2 2

01

5

Q3 2

01

5

Q4 2

01

5

Q1 2

01

6

Q2 2

01

6

Q3 2

01

6

Q4 2

01

6

YoY

quart

erly p

erc

en

t change

World GDP Growth

95

97

99

101

103

105

107

Apr-

15

Jun-1

5

Aug

-15

Oct-

15

Dec-1

5

Fe

b-1

6

Apr-

16

Jun-1

6

Aug

-16

Oct-

16

Dec-1

6

Fe

b-1

7

Apr-

17

RE

ER

(A

pr

2015 =

100)

Real Effective Exchange Rate

39

Consumption (C): Will there be a sharp bounce-back After Demonetization?

5

7

9

11

13

15

17

19

21

23

25

Mar-

13

Jun-1

3

Sep

-13

Dec-1

3

Mar-

14

Jun-1

4

Sep

-14

Dec-1

4

Mar-

15

Jun-1

5

Sep

-15

Dec-1

5

Mar-

16

Jun-1

6

Sep

-16

Dec-1

6

Mar-

17

YoY

Quart

erly G

row

thGrowth in Personal Loans

40

III. What Should be the Stance

of Fiscal and Monetary

Policy?

41

Fiscal Deficit of General Government(Excluding CPSE and UDAY)

Borrowings of General Government(Including CPSE, Excluding UDAY)

CPSE – Central Public Sector Enterprises.

Government Spending (G): Mild but Steady Fiscal Contraction

in 2017-18 at the Central, State, and Public Sector Levels

2.0 2.2 2.5 2.5 2.7 2.6

4.9 4.5 4.1 3.9 3.53.2

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2012-13 2013-14 2014-152015-16 2016-17RE

2017-18BEState Center

Data for 2015-16 to 2017-18 is for 16 States (accounting for 80-

82% of GDP) for which budgets have been presented.

2.0 2.2 2.5 2.5 2.7 2.6

4.9 4.5 4.1 3.9 3.53.2

0.70.5 0.5 0.9 1.1

1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2012-13 2013-14 2014-15 2015-16 2016-17RE

2017-18BEState Center CPSE

Go back 42

Government Spending (G): Public Sector Investment is

Falling Despite Weak Private Investment

1.9 1.9 1.8

1.9 2.1 2.2

2.32.7 2.3

6.0

6.66.3

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2015-16 2016-17 RE 2017-18 BE

Per

cent of G

DP

Center State CPSE 43

Monetary Policy: Is the Real Policy (Repo) Rate at the Appropriate Level Given Substantially Lower Inflation and Weakening Activity?

Real repo rate is obtained by subtracting inflation from the nominal repo rate.

-1

0

1

2

3

4

5

Ma

y-1

4

Ju

l-14

Sep

-14

No

v-1

4

Ja

n-1

5

Ma

r-15

May-1

5

Ju

l-15

Sep

-15

No

v-1

5

Ja

n-1

6

Ma

r-16

Ma

y-1

6

Ju

l-16

Sep

-16

No

v-1

6

Ja

n-1

7

Ma

r-17

Real Repo

RBI’s Real Neutral Rate (1.25%)

44

Conclusions

•Yours not mine!

45

Recommended Readings

1. Second Bi-monthly Monetary Policy Statement, 2017-18

Resolution of the Monetary Policy Committee (MPC), Reserve

Bank of India(June 7, 2017)

(https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=40

685)

2. Chapter 1, Economic Survey 2014-15 to 2016-17.

(http://indiabudget.nic.in/survey.asp)

46

Appendix:

The GDP Measurement

Debate

47

GDP-New Series: Major Changes

• Moving closer to international practices as recommended by

System of National Accounts 2008.

• In manufacturing sector, moving from an establishment to an

enterprise approach, with use of Ministry of Corporate Affairs

data (MCA 21).

• Sales tax used as a measure of growth in trade index instead of

a physical proxy which tracked volume of tradable goods (Gross

Trading Index)48

Patterns of Real GDP Since 2011-12: New Series Shows a Large Increase in “Crisis” Year (2013-14)

4.7

5.0

5.5

6.4

3

4

5

6

7

8

9

10

11

200

5-0

6

200

6-0

7

200

7-0

8

200

8-0

9

200

9-2

01

0

201

0-1

1

201

1-1

2

20

12

-13

201

3-1

4

201

4-1

5

201

5-1

6

201

6-1

7

GDP mp (2004-05 base)

GDP mp (2011-12 base)

49

Divergence Between IIP Manufacturing (Old Series) and GVA Manufacturing Growth Striking…

-2

0

2

4

6

8

10

12

14

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2013-14 2014-15 2015-16 2016-17

Quart

erly Y

oY

Gro

wth

GVA manufacturing

IIP manufacturing (old)

50

Divergence Between IIP Manufacturing and GVA Manufacturing Growth has Decreased Under the New Series

-2

0

2

4

6

8

10

12

14

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2013-14 2014-15 2015-16 2016-17

Quart

erly Y

oY

Gro

wth

GVA manufacturing

IIP manufacturing (new)

IIP manufacturing (old)

51

WPI-CPI divergence creates measurement problems

-8

-6

-4

-2

0

2

4

6

8

10

12

Ap

r-1

3

Ju

l-13

Oct-

13

Ja

n-1

4

Ap

r-1

4

Ju

l-14

Oct-

14

Ja

n-1

5

Ap

r-1

5

Ju

l-15

Oct-

15

Ja

n-1

6

Ap

r-1

6

Jul-16

Oct-

16

Ja

n-1

7

Ap

r-1

7

CPI(%) WPI (2011-12 series) (%)

52

1. In Manufacturing, Reduction in Input Prices (WPI) Relative to Output Prices, Under Current Methodology, Could Overstates Real GDP Growth

Quantity_Output Quantity_Input Price_Output Price_Input

Time 1 10 7.8 20 10

Time 2 10 7.8 20 5

Time period 1 Time period 2 (Single Deflation)

Nominal ValuesGross Value of output 200 200

Gross Value of input 78 39

Gross Value Added 122 161

Real Values

Gross Value of output 200 200

Gross Value of input 78 39

Gross Value Added 122 161

Real Growth in Time period 2 (in per cent)

Single Deflation (current methodology) Volume extrapolation

GVO 0.0

GVI -50.0

GVA 32.0 0.0 53

2. In Some Services Sectors (20% of Total GVA), Real GVA Growth Measured by Deflating Nominal Growth by Overall WPI Rather than CPI-services Deflator or Some Other Services-Related Deflator

Divergence between Inflation Indices

2013-14 2014-15 2015-16 2016-17

WPI-New Series and CPI 1.3 3.3 7.4 2.7

WPI -Old Series and CPI 0.5 2.6 6.2 0.8

54