1. GROWTH TRENDS AND GLOBAL COST INFLATION
Arvind Virmani
(views are personal)

2. INTRODUCTION Trends vs. Cycles: Tendencies Long Term Trends
Short Term Cyclical fluctuations (Project) => Trend
Classify every uptrend as cyclical (‘overheating’)
Long Term Trends
Medium Term Performance: to
Short Term: Inflation – Global cost push
Role of Policy reform:
Sustaining growth
Raising productivity/ offsetting cost increases
India’s Economic Growth: From Socialist Rate of Growth to Bharatiya Rate of Growth, Working Paper No. 122, ICRIER, February 2004.
Propelling India from Socialist Stagnation to Global Power: Growth Process, Vol. I (Policy Reform, Vol. II), Academic Foundation, New Delhi, 2006.
Policy Regimes, Growth and Poverty in India: Lessons of Government Failure and Entrepreneurial Success!, Working Paper No. 170, ICRIER, October 2005.
“The Dynamics of Competition: Phasing of Domestic and External Liberalisation in India,” Working Paper No. 4/2006-PC, Planning Commission, April 2006.
02 August 2008
General: AV

3. Economic Growth Perspective
Phase I: to
Two sub-phases (50to 65; 66 to 79)
Phase II: to
Start: Policy regime change
End (a) Crises year( ). (b) Reform initiation (c) Adjustment/recovery ( to )
Phase III: to ?
: Statistical significant growth break
Rising trend growth
India’s Economic Growth: From Socialist Rate of Growth to Bharatiya Rate of Growth, Working Paper No. 122, ICRIER, February 2004.
Propelling India from Socialist Stagnation to Global Power: Growth Process, Vol. I (Policy Reform, Vol. II), Academic Foundation, New Delhi, 2006.
Policy Regimes, Growth and Poverty in India: Lessons of Government Failure and Entrepreneurial Success!, Working Paper No. 170, ICRIER, October 2005.
“The Dynamics of Competition: Phasing of Domestic and External Liberalisation in India,” Working Paper No. 4/2006-PC, Planning Commission, April 2006.
02 August 2008
General: AV

4. Figure 1: Three Phases of Growth (Phase III Result of radical reform)
J curve effect. (1) Heavily protected-import liberalisation: drastic change in relative prices. (2) Fall in measured productivity-capital immobility & obsolesence (3) Acceleration after lag: I embodied technology, S curve of diffusion, unfamiliar tech HR adjusting, learning. Adjusted R square = 0.57.
02 August 2008
General: AV

5. Recent Developments: Past five years ( 2003-4 to 2007-8)
Growth Acceleration
GDP
Average Income / Per capita GDPmp (PcGdp)
Avg. Private Consumption (PvtCons)
Aggregate Growth drivers
Supply side
Demand Side
Sector drivers of growth
02 August 2008
General: AV

6. Growth acceleration: ( 2003-4 to 2007-8)
In the next three figures:-
Cyclical movement around Rising trend
HP filtered trend
GDPmp: Avg. growth of 8.9%
Per Capita gdp growth has doubled
To 7.3% (from 3.7% in )
Average income will double in ten years
Avg. Private Consumption Gr rt: Almost doubled
Related to next three figures
02 August 2008
General: AV

7. Fig 2:Growth Acceleration-Gdp
pessimism, Cyclical recovery, cyclical up swing projected to 10% growth, 2007 back to trend below trend because of global developments, particularly oil/commodities but also financial crisis (indirect effect of).
02 August 2008
General: AV

8. Fig 3: Per Capita Income
Per Capita Gdp growth: To 7.3% in to from 3.7% ( to ) ; Average income will double in ten years instead of in a generation.
02 August 2008
General: AV

9. Fig 4: Per Capita Consumption
Avg. Private Consumption Gr rt: Almost doubled during the past five years from previous 12 years (and doubled from what it was 10 years prior to that)
02 August 2008
General: AV

10. Aggregate Demand Growth Dynamics: Investment Led growth
Growth of Demand
Investment growth rate doubled
Pvt consumption & imports accelerated
Govt. Consumption-slowed
Role of private Consumption important but declined below that of Investment for first time
External : Short period of positive contribution (low oil prices) over
Govt Consumption: Lower contribution
02 August 2008
General: AV

11. Fig 6: Investment Led Similar picture for Gross Fixed Investment
02 August 2008
General: AV

12. Fig 5: Investment Led Growth
Growth rate of : Total output (blue-accelerated), Total Investment (red-accelerated sharply), Private Final consumption Expenditure (purple-accelerated) and Govt final consumption expenditure (green-declerated).
02 August 2008
General: AV

13. CONTRIBUTION TO DEMAND
Contribution of Govt final consumption down to 5.4% from average of 11.8% in past 10 years (12% & 11.6%).
02 August 2008
General: AV

14. Supply Side: Investment & Savings
Investment growth led by
Fixed investment i.e. not inventory build up
Private Investment i.e. Profitable
Increase in productive capacity of the economy
Savings rate also rose: Private & Public sectors
Saving rises with income/investment
Lag during sharp acceleration
02 August 2008
General: AV

15. Investment: Total, Fixed & Private (ratio to GDP)
GCF: 5 yr avg. 33.5% of GDP from 23.9% in previous 5 yrs (+9.5%) up to 38.4% of GDP i.e Chinese levels.
GFCF: 5 yr avg. 30.3% of GDP from 23% in previous 5 yrs (+7.3%) up to 34.6% of GDP (9% gr at 3.8 Icor).
I fixed private: Up 6.8% (4 yrs avg) out of total 7.3% (5 yrs avg).
02 August 2008
General: AV

16. Supply Side: Savings Savings rate also rose by 9.8% (2003-4 to 2007-8)
Avg. 33.3% of GDP from 23.6% in previous 5 yrs
Private and Public
Increment (4 yrs) 5.1% & 3.4% respectively
Contributed(60:40)
Saving Rate: 36.1% of GDP in
Maintenance of Investment and Saving Rate at levels enough to give average growth 0f around 9%
Possible with deceleration in gr of profits, saving & investment to 9%.
02 August 2008
General: AV

17. FDI : Inward and outward
Year
Fdi Net $ bi
Inward $ bi
Outward $ bi
02 August 2008
General: AV

18. Sources of Growth
Net domestic product per person, Capital intensity-Capital stock per person, Total factor productivity
02 August 2008
General: AV

19. Sector Drivers Manufacturing Communication
GDP/Value Added
Investment: GCF, GFCF
Communication
Competition and efficiency
Trade, Agriculture, Construction
Labor intensive
02 August 2008
General: AV

20. Drivers of Growth
02 August 2008
General: AV

21. Sector Drivers of Growth
Acceleration in Value Added: Increase in growth rate
Highest for Manufacturing and construction
Followed by storage & agriculture.
Investment Growth: Manufacturing 30.5% per year
Capital stock (end over end ).
Construction(1.92 times)
Manufacturing (1.75 times),
rade, Hotels & Restaurants (1.62 times).
02 August 2008
General: AV

22. Efficiency of Investment. to
2003-4
2004-5
2005-6
2006-7 to
Change
ICOR
2002-3
(act)
(rev)
(est)
2007-8
Manufacturing
11.1
8.6
9.5
10.5
8.3
9.2
-1.9
Construction
1.5
1.3
1.0
1.4
1.2
-0.4
Telecommunication
2.2
0.5
0.6
0.4
-1.7
02 August 2008
General: AV

23. Summary: Medium term gr trend
Growth has accelerated in last five years
While Consumption growth remained robust, the acceleration was Investment led
External sector was a drag on demand because of oil (and other) price increases
Private investment particularly corporate is leading investment and growth
Domestic Saving rate has increased inline with I
Telecom, Construction, Manufacturing were the leading sectors
11th Plan target of 9% average growth will be met
02 August 2008
General: AV

24. INFLATION: Global effects
Kemal Dervis Exim lecture(18/3/08): Global Cost push
Global Commodity Price Shock
All commodity index
Food price Index
Edible oil (Palm): Net Importer
Effect on India: Primary food & edible oils
Iron Ore: Net exporter
Mineral Oil: Net Importer
Impact on Indian Inflation
Comparison: India(Wpi), USA(Pppi), UK(Ppi Manf)
02 August 2008
General: AV

25. Global Cost Push?
June 2008: All Commodity index (+62%), Food price Index(44.4%). India Primary Food =6.4 (latest 5.8%).
02 August 2008
General: AV

26. Global Supply: Edible Oil(Palm)
Inflation: Rise of 66% in January 2008, peak of 102% in March % in June 2008.
02 August 2008
General: AV

27. Global Supply Shock: Iron Ore
Rise of 66% in January 2008.
02 August 2008
General: AV

28. Global Supply Shock: Oil Price
Rise of 70% in January 2008 (up from 46.6% in December 2007). Crude oil(3) avg of Brent, Dubai, WTI.
02 August 2008
General: AV

29. Rate of Growth: Iron Ore & Oil
Oil 92.9% Iron ore 66%
02 August 2008
General: AV

30. Contribution to change in WPI
Contribution of Minerals (iron ore, dark blue) and Fuel (brown) has gone up during 2008.
02 August 2008
General: AV

31. Acceleration in Inflation during 2008 H1 over 2007 H1: Contribution of different commodities
WPI Inflation during H (i.e. from December 2006 end to June 2007 end) was 2.7%.
Inflation during H (i.e. from December 2007 end to June 2008 end) was 9.9%(est).
Of the 7.2% increase in inflation this year, 2/3rd was due to 3 sets of commodities:
Edible oils (including) oils seeds and oil cakes)
Iron and Steel (including iron ore)
Mineral Oils and refinery products
Other contributors include cotton & yarn, food products (grains, F&V, spices, grain mill prds), fertilisers & chemicals.
02 August 2008
General: AV

32. Inflation in India (WPI) and USA(PPI)
WPI has to be compared to PPI. The USA is the largest and perhaps the most competitive global market in the World for goods. Inflation has accelerated more than in India.
02 August 2008
General: AV

33. Inflation: India-WPI Manf, UK-PPI Manf, USA PPI Ind
CPI: Regrettably we do not have an aggregate CPI that we need for monitoring inflation. That is why we gave the private consumption deflator in the survey. I expect that to be about 50% higher this year i.e %.
02 August 2008
General: AV

34. Inflation Convergence: US & India
Private Consumption Price Deflator
19th Junel 2008
Mumbai Isec: AV

35. CPI(unme) & Gdp Pvt Cons deflator
Private Consumption Price Deflator: CPI urban non-manual employees: Reg. co-efficient (a) 0.80 or (b) 1.18 & (lagged)
19th Junel 2008
Mumbai Isec: AV

36. Monetary Policy and Inflation
Cost Push and Monetary accommodation!
Monetary Policy includes exchange rate policy
Important only for its effect on objectives
Monetary Policy Objectives
Production/Growth & Inflation – emphasis varies
Socio-Political Tolerance level of Inflation
Primary Focus Today- Inflation & Expectations
Capital flows main driver of RM gr. (prt. Q )
M3 gr. exceeded peaks of (98.10) in 07.10
M3ma gr. exceeded peaks of and in 07.01
Solutions proposed at that time (some in Working paper #2) to deal with large capital inflows and their negative impact:
Remove restrictions on capital outflow (some actions were taken).
Slow debt inflow through an interest tax, higher reserve requirement or auction of right to borrow (instead ECB QRs tightened)
Remove import controls. Reduce “peak” import duties (non-agricultural) to 7.5% (from 10%). Counter proposals prevailed.
Allow greater symmetry in exchange rate fluctuation through greater upward flexibility.
Sterilize a greater proportion of reserve accumulation through MSS.
02 August 2008
General: AV

37. Monetary Accommodation?
Interbank Call money rates were below the Repo rate during this period (=> No need to raise the Repo rate at that time).
Solutions proposed at that time (some in Working paper #2):
Remove restrictions on capital outflow (some actions taken).
Slow debt inflow through an interest tax, higher reserve requirement or auction of right to borrow (instead ECB QRs tightened)
Remove import controls. Reduce “peak” import duties (non-agricultural) to 7.5% from 10% (counter advise prevailed).
Allow greater symmetry in exchange rate fluctuation through greater upward flexibility .
Sterilize a greater proportion of reserve accumulation through MSS.
02 August 2008
General: AV

38. Real Interest Rate Convergence: US-India
19th Junel 2008
Mumbai Isec: AV

39. Inflation & Interest rates
Inflation Trajectory
Medium Term: Down to normal level in a year
Short Term: Depends on Oil prices
Real Interest rates
Short term: Decline
Medium Term: U shaped pattern to normal in a year
Aggregate Inflation: Who is hurt
Poor- unskilled wage lag.
Every one cannot be hurt unless GDP declines!
02 August 2008
General: AV

40. Growth/Production objective: Policy and Institutional Reform
March 2008 Forecast: 8% to 9% (8.5 -/+ 0.5)
Oil shock and Production(IIP) data:
Revised forecast: 7.75% to 8.75% (8.25% -/+ 0.5)
Productivity enhancing reforms can help moderate cyclical downturn and inflation upturn.
Motivation for revisiting/reviving pending reforms
Energy Sector: Oil shock
Investment Environment
During , growth will be below the trend rate of 8.8 to Likely to revert back towards trend in
02 August 2008
General: AV

41. Medium-Long term implications
Natural Resources
Non-renewable (Oil, selected minerals): Rising relative price => Need for User efficiency, Technical change
Renewable : Land-intensive agriculture crops (cereals)
Extensive margin (e.g. forest clearing) constrained by climate and environment concerns.
Race between productivity and global demand.
Relative prices could stabalise at higher levels
02 August 2008
General: AV

42. Balance of Payments Capital Flows Current Account
Trends and Volatility (FDI, FII, ECB)
Current year: Below trend- FII (Global risk/liquidity preference vs. liquidity).
Medium Term: Surplus capital flows/reserve accum.
Current Account
Invisibles: Non-factor services (software) & prviate remittances low volatility around rising trend
Exports (G&S) to Oil/natural resource exporters will increase, perhaps with a lag.
CAD : U-shape
11th Plan CAD average is 1.9% of GDP. Worst case (high oil prices) 2.5%.
02 August 2008
General: AV

43. Excess Capital Flows-over CAD (% of GDP)
Capital Flows exclude “other capital”. FII/equity and ECB/debt: High variability. FDI Uptrend with variation in growth rate. Current year: (Global risk/liquidity preference vs. liquidity) Net negative (2008 to date). Medium Term: Surplus capital flows/reserve accum
02 August 2008
General: AV

44. Current Act and Goods & Services Deficit
Exports (G&S) to Oil/natural resource exporters will increase, perhaps with a lag. At worst CAD U shaped. Probability of avg. CAD exceeding 2.5% of GDP during 11th Plan is low.
02 August 2008
General: AV

45. Long Term: Sustaining Growth
Reforms essential for sustaining 9% for two decades.
Policy Reform
Structural change: Labor market flexibility
Competition: Decontrol, free entry
Industry(sugar, fertilizer), mining(coal), infrastructure (electricity - open access), financial services.
Education and Skills: Regulated (transparency, rating) entry (freer), controls (minimal)
Urban Land policy (land use, supply, development, utilities)
Sustaining Employment and Equitable Growth: Policies For Structural Transformation Of The Indian Economy,” Working Paper No. 3/2006-PC, Planning Commission, March
02 August 2008
General: AV

46. Sustaining Growth: Institutional reform
Public and Quasi-Public goods & services
National Networks: Drinking Water, Waste (solid and liquid)
Universal Primary education-outcome (not enrolment)
Civic/Urban services
Social service delivery: Empowerment
Debit/credit (smart card): PC WP 2002
Multi-application smart card (UID): 2005, 2006, 2007
Sustaining Employment and Equitable Growth: Policies For Structural Transformation Of The Indian Economy,” Working Paper No. 3/2006-PC, Planning Commission, March
02 August 2008
General: AV

47. References Precursor: Heuristic Theory and Empirics!
India’s Economic Growth: From Socialist Rate of Growth to Bharatiya Rate of Growth, Working Paper No. 122, ICRIER, February 2004.
Two Phases (4 sub-phases), Third phase statistically insignificant.
Heuristic Theory and Empirics!
Policy Regimes, Growth and Poverty in India: Lessons of Government Failure and Entrepreneurial Success!, Working Paper No. 170, ICRIER, October 2005.
The Dynamics of Competition: Phasing of Domestic and External Liberalisation in India,” Working Paper No. 4/2006-PC, Planning Commission, April 2006.
Propelling India from Socialist Stagnation to Global Power: Growth Process, Vol. I (Policy Reform, Vol. II), Academic Foundation, New Delhi, 2006.
“Maco-economic Management of Indian Economy: Capital Flows, Interest Rates and Inflation, Working paper No. 2/2007-DEA, Ministry of Finance, November 2007.
Economic Survey, , February 2008
India’s Economic Growth: From Socialist Rate of Growth to Bharatiya Rate of Growth, Working Paper No. 122, ICRIER, February 2004.
Propelling India from Socialist Stagnation to Global Power: Growth Process, Vol. I (Policy Reform, Vol. II), Academic Foundation, New Delhi, 2006.
Policy Regimes, Growth and Poverty in India: Lessons of Government Failure and Entrepreneurial Success!, Working Paper No. 170, ICRIER, October 2005.
“The Dynamics of Competition: Phasing of Domestic and External Liberalisation in India,” Working Paper No. 4/2006-PC, Planning Commission, April 2006.
02 August 2008
General: AV