The Climate of Macroeconomic Relationships in India - Case Study Example

--------------------------- --------------------------- --------------------------- --------------------------- Using the AS-AD model and macroeconomic identities evaluate the reasonableness of the concerns of "overheating" in the Indian economy as raised in the article Indian economy is the fourth largest in the world as measured by purchasing power parity (PPP). Due to reduced government controls on foreign trade and investment since the early 1990s, foreign businessmen and investors are swarming to Bangalore and Mumbai to grab a piece of the action. India is the second fastest growing major economy in the world. India's real GDP grew by 9.2% in the year to last September, which was around 6% in the 1980s and 1990s-and a measly 3.5% during the three decades before 1980. As a result of highly interventionist policies, barriers to trade and liberalised capital markets lowered massively and total trade in goods and services has leapt to 45% of GDP, from 17% in 1990. India is classified as low-income economy1 as per The World Bank although India's huge population results in a per capita income of $3700 at PPP and $820 at nominal. The economy is sizzling due to booming investment and consumption. According to survey of 32 countries by Grant Thornton, a London-based accounting firm, Indian businessmen were the most upbeat. Indians are rightly proud of the huge global success of firms such as Infosys, or of Tata Steel's 5.8 billion ($11.3 billion) acquisition of Britain's Corus this week. Reserve Bank governor Yaga Venugopal Reddy has flagged the possibility that the Indian economy may be overheating2. In other words demand is outpacing supply and hence the pace of growth is unsustainable. Wholesale price of oil inflation has risen to 6%, which is above the 5.5% upper limit set by the Reserve Bank of India (RBI). The crude average of the rates for industrial, non-manual and agricultural workers is above 7%. Capacity utilization is higher than at any time in the past decade. The most recent trade data suggest that the rapid deterioration in the trade deficit since H1 2004 is stabilizing and portfolio flows only account for 35 per cent of total capital flows and one of the main determinants is GDP growth. The bank expects the balance of payments to improve in FY06 / 07 and has revised its dollar: rupee forecast to 43-43.5 from 44.53. Credit boom has concerned The RBI also. Bank lending to firms and households has expanded by 30% over the past year. Lending on commercial property is up by 84% and home mortgages by 32%. India's stock market is one of the merging world's most expensive, with a price-earnings ratio of more than 20; this shows rising more than fourfold over the past four years. Asset prices are also rising. In many big cities house prices have more than doubled over the past two years. RBI raised its overnight lending rate by a quarter-point to 7.5%, but left the reverse repo rate at 6%. Over the past couple of years interest rates have risen by less than the rate of inflation, so in real terms they have fallen. When demand outpaces supply in an open economy it is more likely to show up in a current-account deficit than in inflation. India's deficit widened to more than 3% of GDP in the three months to September-a huge swing from a surplus of almost 4% in the first half of 2004. And the true gap between domestic demand and supply is even bigger. According to Yaga Venugopal Reddy, the RBI'S governor, India's current-account deficit is larger once you exclude the money sent home by Indians abroad. Although these remittances do not reflect domestic demand or supply, but are more like a capital inflow. Excluding workers' remittances, India's deficit is running close to 5% of GDP-larger than the equivalent deficit during India's balance-of-payments crisis in the early 1990s. the Economist is making a political judgment: "The economic reforms of the early 1990s spurred competition, forced firms to become more productive and boosted India's trend-or sustainable-rate of growth. But the problem is that this new speed limit is almost certainly lower than the government's one. Historic data would suggest a figure not much above 7%-well below China's 9-10%.4" India's widening current-account deficit is a signal of how supply cannot keep pace with red-hot demand. Short-term capital has accounted for four-fifths of capital inflows into India over the past three-and-a-half years. According to Chetan Ahya, Morgan Stanley's economist in Mumbai, off-budget items, such as oil and power subsidies, amount to another 1.8% of GDP. This puts the total deficit closer to 8% of GDP, the biggest among the main emerging economies. India also has the highest ratio of public debt to GDP, at 80% Evaluate the recommendations suggested in the article paying particular attention to how much each would impact key macroeconomic relationships. (500 words) Rate of growth (the maximum at which an economy can expand without triggering a rise in inflation) estimated by most standard methods arrive at figures of around 7%. But business people, investors and an unusually large number of economists, are convinced that India is undergoing a "paradigm shift". Supply boosting is required in order to keep up with demand. It can be done by speeding up reforms and attacking the many bottlenecks caused by inadequate infrastructure, dreadful public services, skill shortages and rigid labor laws. Main problem with these methods is it takes time as well as money. Greater fiscal prudence and reduced tax evasion has helped the deficit for central and state governments to fall to 6.2% of GDP to some extend. Some of the problems in India's growth are: India's weak fiscal position constrains its future growth by leaving no room for more public spending on infrastructure, education and health. 60% of India's labor force is engaged in low productivity farming, although its GDP percentage is only 19.9%. India's infrastructure-especially its lousy roads, ports and power. According to the World Bank, the average manufacturing firm loses 8% of sales each year from power cuts. India spends 4% of its GDP on infrastructure investment, compared with China's 9%. Electricity and roads problems - Only about half of all electricity generated is paid for, because power is stolen and bills are left unpaid. India's labor laws, which are among the most restrictive in the world. Firms employing more than 100 people cannot fire workers without government permission, which discourages expansion. Today's central government cannot scrap these laws because it relies on the support of the communist parties. The dreadful quality of public services from education and health to the provision of water is another big problem. Half of urban households lack drinking water within the home; one quarter has no access to a toilet, either public or private. In Bangalore water is now available for less than three hours a day, compared with 20 hours in the early 1980s. Problems like these stops workers moving in from rural areas. Young Indians are not equipped for more productive jobs. The quality of education and health care is dire. A survey in 2003 found that only half of paid teachers were actually teaching during school hours. Another survey found that government health centres in poor parts of Delhi had a more than 50% chance of prescribing a harmful therapy for common ailments. In eight of 18 states studied more than half of all children in urban areas are in private schools, which is result of bad public services. due to less public outcry for reform than there should be, the educated middle class do not use public services. Now it is time to think different, think big. It began with a simple realization that no one is as smart as we are. Some of the suggestions to improve condition are: By bringing together experts from every field such as industry and business, development, economic growth, urban planning, resource management, science, technology, governance, finance, etc from all over India to share views and work collaboratively towards common solutions5. Get more young people into school, increasing opportunities for a university education and maximizing the intellectual capacity of the region. Increase educational and training opportunities. Integrate more women into the skilled workforce and promote greater freedom of expression and association6. Generating opportunities for young Indians. New policies and regulatory structures that promote the development of the middle class and small business7. If the best policies are put in place India has huge long-term potential, but without reforms the country cannot fully exploit it8. Workers need to shift from agriculture to more productive jobs in industry and services; this will automatically boost GDP growth assuming the newcomers will all find jobs. Labor laws need to be modified. The creation of an international energy development initiative, a coalition of governments, corporations and private individuals to address the future of energy resources worldwide9. Encouraging governments and businesses in the region to create public/private sector partnerships. Investment by private sectors can be enhanced by regulatory reforms to protect the interests of both investors and consumers. This shows India would require better education, labor market reforms and less red tape. The supply-side constraints of infrastructure, labour laws and public services seem formidable. Better infrastructure and education are needed to make the rural poor more mobile so they have an escape route. These can not only increase growth, but also spread the rewards. It will be better to clear the path ahead rather than risk running an economy beyond its safe maximum speed for India. India's economy can sprint like a tiger provided its way is not blocked. Reference: The Indian Economy, "An Overheated Debate About India Overheating". February 2, 2007 The Indian Economy, "The Future past". May 19, 2007 The Information Company Private Limited. "Overheating concerns overdone:Credit Suisse study".15 April 2006 The Telegraph, "Reddy warns of gloom in bloom". November 02, 2006 The World Bank, "Data statistics". UCLA Today. "Global leaders offer ways to improve Middle East Company". VOL. 26. NO.9 FEBRUARY 7, 2006 Read More