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India amidst the Global Crisis

Contrary to popular belief, there were palpable signs of the Indian economy losing steam long before the outbreak of the global crisis. But there is little doubt that the global meltdown has seriously aggravated the problem and made the task of reversing the domestic downturn much more difficult. For an adequate appreciation of the country's ongoing economic slide, this paper considers the domestic as well as the external factors at work both before and during the crisis.

THE CRISIS AND INDIA

India amidst the Global Crisis

Mihir Rakshit

Contrary to popular belief, there were palpable signs of the Indian economy losing steam long before the outbreak of the global crisis. But there is little doubt that the global meltdown has seriously aggravated the problem and made the task of reversing the domestic downturn much more difficult. For an adequate appreciation of the country’s ongoing economic slide, this paper considers the domestic as well as the external factors at work both before and during the crisis.

This is a revised version of a lecture delivered at the University of Calcutta on 7 March 2009.

Mihir Rakshit (proj_monfin@hotmail.com) was a professor at Presidency College and Indian Statistical Institute, both in Kolkata, and is currently Director, Monetary Research Project, ICRA.

“It’s always best on these occasions to do what the mob do”.

“But suppose there are two mobs?”, suggested Mr Snodgrass.

“Shout with the largest”, replied Mr Pickwick.

– Dickens, Pickwick Papers

1 Introduction

T
he purpose of the present paper is to examine the operation of domestic and external factors behind the ongoing deceleration of the Indian economy. There is a widespread perception that India along with other emerging market economies (EMEs) has been the victim of relentless globalisation in general and the excesses of financial institutions in advanced countries in particular. The world economic crisis, let us recall, first surfaced in the US sub-prime mortgage market in August 2007, soon spread to markets for other securities in both the US and elsewhere, and in the process caused, within a few months, a huge financial meltdown, a string of bankruptcies and a sharp economic slowdown in practically all industrialised countries.1 For more than a year since the outbreak of the crisis, it appeared that the emerging Asian economies, especially the larger ones like China and India, would not only remain relatively insulated from the crisis, but also play a major role in moderating the global downturn and paving the way for a worldwide recovery in a year or so. However, with a marked deterioration in the condition of both advanced and emerging economies since September 2008, what came to be called the “decoupling hypothesis” has proved seriously wrong and a bottoming out of the global downturn is nowhere in sight as of now.

Blaming an “out-group” villain2 or purely external events for one’s woes is universal among human beings, but not generally well-founded. The present instance is no exception. Though international economic conditions have no doubt been affecting the Indian economy adversely, there were palpable signs of the economy losing steam long before the outbreak of the global crisis. Nor has the role of policy omissions and commissions during the course of the crisis been minor in aggravating domestic economic difficulties. For an adequate appreciation of the country’s ongoing economic slide, it is thus useful to consider the domestic as well as the external factors at work both before and during the crisis.

2 Pre-Crisis Developments

India’s gross domestic product (GDP) growth, it needs to be emphasised, had started decelerating in the first quarter of 2007-08 (Table 1A, p 95), nearly six months before the outbreak of the US financial turbulence and considerably ahead of the surge of recessionary tendencies in all developed countries from August-September 2008. That the beginning of the deceleration of the

march 28, 2009 vol xliv no 13

Indian economy predates the global meltdown is also attested to by the sharply downward trend since March 2007 of the year-onyear (y-o-y) rise in the index of industrial production (IIP), the bellwether of the country’s economic performance (Table 2, p 98). Indeed, the slowdown in industries during 2007-08 was much more pronounced than that in GDP growth; while the latter registered a 0.5 percentage fall (to 9.2% ) from the earlier year, the decline in industrial GDP amounted to as much as 3.1 percentage points.

Table 1A: Y-o-Y Growth Rate of India's GDP and Its Components (2000-01 to 2008-09)

For diagnostic purposes, it is worth noting that the economic slowdown occurred despite a significant increase in agricultural (GDP) growth, from 3.8% in 2006-07 to 5.1% in 2007-08. In sharp contrast, the growth in the secondary and the tertiary sectors declined from 10.6% and 11.2% in 2006-07 to 7.5% and 11.1%, respectively in 2007-08. Since agricultural output is primarily supply determined, and production in industries and services is demanddriven in the short run,3 the deceleration, it is clear, was due to

At Constant Prices 2000-01 2001-02 2002-03 2003-04
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
GDP at market prices 4.0 5.2 3.8 8.4
5.2 6.6 3.8 1.1 3.8 4.4 6.3 6.1 5.1 5.3 2.0 3.1 4.9 8.1 11.2 8.9
Agriculture, forestry and fishing -0.2 6.3 -7.2 10.0
0.4 5.6 -0.7 -4.4 3.0 5.9 7.0 8.8 -1.3 -5.2 -12.1 -8.2 0.0 7.5 19.2 10.7
Industry@ 6.4 2.4 6.8 6.0
7.7 6.5 7.2 4.3 1.5 2.1 2.6 3.2 5.4 7.3 7.2 7.2 5.1 5.4 5.9 7.5
Services 5.7 6.9 7.5 8.8
6.4 7.1 6.3 3.5 6.4 6.2 8.1 6.6 7.7 8.3 7.1 7.1 7.6 10.7 9.7 7.5
Gross Investment* -3.5 -2.9 17.0 19.9
-1.3 -3.3 -4.3 -9.3 0.6 0.4 5.7 8.3 8.2 13.2 12.1 10.5 9.3 14.0 10.2 16.7
of which, Public -3.0 3.0 -7.0 8.3
Admin department and
departmental enterprises -31.1 39.9 2.6 -4.2
Non-department enterprises
and quasi government bodies 24.5 -16.9 -15.7 22.1
Private -5.4 7.8 15.6 13.6
of which, Corporate -28.3 8.6 12.9 24.3
Households 10.5 2.1 21.3 9.6
Gross investment net of import of
capital goods -3.8 -4.0 15.1 19.5
Pvt final consumption exp 3.2 6.2 2.7 5.8
1.8 3.6 3.4 4.0 8.1 6.4 5.8 4.5 1.2 2.9 2.6 4.0 5.7 6.9 5.9 4.9
Government final 0.9 2.3 -0.4 2.6
consumption exp -7.5 -2.0 -3.1 9.3 5.8 1.9 14.1 -6.4 -4.2 1.7 -1.2 1.1 8.3 18.7 1.4 -10.3
Export of goods and services$ 18.2 5.7 21.8 5.8
19.0 16.0 22.8 15.2 18.0 3.4 -2.2 3.1 16.8 26.4 24.8 21.2 -4.1 0.0 8.9 17.6
Export of goods and services# 18.0 1.5 17.8 10.8
18.7 16.4 22.6 14.8 13.4 -0.9 -5.3 0.6 13.5 21.8 20.4 15.9 -0.6 5.2 13.9 22.7
ELEM# 23.9 1.1 17.2 10.4
Export of goods# 23.4 -0.4 17.4 12.8
25.6 18.4 24.5 25.2 2.6 -2.2 -3.3 1.5 16.6 21.6 18.1 13.9 1.4 2.1 21.9 24.3
ELEM of goods only# 34.2 1.3 16.6 10.5
Export of services# 5.7 6.4 18.4 18.4
1.3 11.1 18.7 -5.5 47.9 2.9 -10.2 -2.0 6.1 21.8 26.1 20.8 1.2 18.9 12.9 38.4
Import of goods and services$ 3.5 3.4 10.4 16.8
9.5 7.8 4.9 -6.0 12.2 5.7 -3.3 -0.1 -0.8 5.1 14.5 23.0 20.9 15.6 15.2 15.9
Import of goods and services# 8.2 1.5 17.7 12.7
14.3 13.1 9.5 -2.0 9.5 2.8 -4.9 -1.0 6.7 12.1 22.3 30.2 15.7 12.4 11.3 11.7
ILEM# 11.3 1.1 17.1 12.6
Import of goods# 6.4 -1.6 12.0 13.8
13.2 18.5 7.4 -9.3 6.1 -5.8 -4.3 -1.7 -0.9 10.4 18.8 19.8 21.2 6.8 12.9 14.9
Import of services# 27.6 -4.1 21.1 -10.4
30.0 0.8 31.9 49.4 3.7 24.0 -23.9 -13.8 18.9 0.6 15.3 48.8 -20.1 14.2 -10.2 -20.0
Remittances# 5.7 22.3 3.8 20.6
13.1 -12.6 29.7 -6.9 68.1 17.7 -20.9 39.1 -30.1 27.2 25.8 10.4 12.4 41.0 35.7 -2.6
memo items:
REER** 100.5 99.1 100.7 100.1 102.1 101.0 100.3 100.0 98.7 98.4 98.5 97.1 98.3 100.9 99.9 99.2
NEER** 93.5 92.0 91.6 91.4 92.7 91.4 90.6 91.6 90.5 88.9 89.3 87.8 86.7 88.8 87.2 85.9
Remittances (in $ million) 3,192 2,656 4,142 3,116 5,227 3,119 3,271 4,239 3,604 4,009 4,242 4,983 4,396 6,140 6,313 5,313
of which Official 51 48 54 99 97 72 56 233 53 52 169 177 73 80 187 214
Private 3,141 2,608 4,088 3,017 5,130 3,047 3,215 4,006 3,551 3,957 4,073 4,806 4,323 6,060 6,126 5,099
(Contd)
Economic & Political Weekly march 28, 2009 vol xliv no 13 95
EPW
Table 1A: Y-o-Y Growth Rate of India's GDP and Its Components (2000-01 to 2008-09) (Continued)
At Constant Prices 2004-05 2005-06 2006-07 2007-08 (QE) 2008-09(AE)
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
GDP at market prices 8.3 9.2 9.7 9.2 7.1
8.3 8.6 6.1 10.3 8.9 8.3 9.0 10.6 8.0 10.9 9.5 10.3 9.3 8.8 8.5 8.6 7.8 8.0 5.1
Agriculture, forestry and fishing 0.0 5.9 3.8 5.1 2.6
3.6 0.7 -5.1 2.6 4.0 4.6 8.2 6.0 3.3 3.6 3.4 4.8 3.8 3.7 3.2 3.0 2.9 3.3 2.1
Industry@ 8.5 8.0 10.6 7.5 4.2
7.7 9.2 9.2 8.0 9.8 6.6 7.2 8.6 10.0 10.7 10.3 11.4 10.6 8.3 8.4 5.8 4.3 5.0 0.2
Services 9.9 11.0 11.2 11.1 9.2
10.3 8.3 9.3 11.5 10.4 10.5 11.0 12.0 11.6 11.5 11.1 10.6 10.6 10.4 10.3 11.2 10.2 10.0 9.1
Gross investment* 19.5 19.4 10.9 16.9 9.7
22.2 20.5 23.5 23.1 17.7 18.3 20.5 19.8 16.1 12.9 14.9 13.7 15.3 16.6 15.0 10.7 6.5 12.8 9.0
of which, Public 14.7 21.5 12.0 27.6
Admin department and
departmental enterprises 21.5 24.8
Non-department enterprises and
quasi government bodies 8.8 -0.2
Private 29.9 20.4 14.8 5.9
of which, Corporate 71.1 36.1 20.4 16.8
Households 1.2 3.3 8.9 7.5
Gross investment net of import
of capital goods 19.1 16.8 9.3 19.0
Pvt final consumption exp 5.2 8.7 7.1 6.5 6.8
3.3 7.9 4.6 5.2 10.1 8.9 7.9 7.9 5.5 9.6 6.6 6.8 7.7 5.7 7.2 8.3 8.0 6.9 4.6
Government final 2.6 5.4 6.2 7.0 16.8
consumption exp 8.3 -10.4 -0.8 12.9 -0.8 13.2 17.5 -4.4 43.7 -12.1 -2.3 4.1 0.5 13.3 5.0 16.7 4.9 5.7 22.3
Export of goods and services$ 28.1 14.8 18.9 7.5 20.8
29.0 21.5 28.0 31.9 16.8 18.4 14.4 11.3 24.6 28.1 14.9 11.4 14.5 -2.0 15.8 12.1 21.4 14.4 6.2
Export of goods and services# 32.3 20.2 21.8 4.6 21.5
34.8 24.1 31.5 37.2 21.7 24.6 19.4 17.0 28.5 32.0 17.4 13.2 0.6 -3.1 14.7 9.6 22.2 18.6 6.0
ELEM# 33.4 22.9 25.6 5.1
Export of goods# 19.0 17.2 17.8 5.4
22.0 18.2 10.4 25.0 24.9 21.0 18.5 8.5 22.8 28.8 13.3 9.2 3.1 -0.2 16.2 3.4 14.9 24.6
ELEM of goods only# 20.3 20.3 24.4 8.6
Export of services# 48.9 26.8 27.4 -1.8
55.9 32.4 64.5 44.5 16.1 33.2 21.7 34.6 38.4 36.4 23.1 18.3 0.1 -5.7 4.8 -5.6 9.7 36.6
Import of goods and services$ 16.0 45.6 24.5 8.6 27.9
-5.2 17.4 32.7 17.9 74.5 39.6 35.8 40.8 25.6 35.2 20.4 18.5 6.4 2.6 10.7 7.9 21.7 20.5 18.4
Import of goods and services# 33.7 24.9 21.2 7.5 31.4
10.6 33.8 52.2 36.9 48.8 20.3 16.0 21.1 23.1 32.2 16.9 14.4 3.0 2.0 10.3 6.1 25.7 24.6 21.7
ILEM# 35.1 27.9 24.4 8.2
Import of goods# 37.6 25.2 17.9 10.6
12.3 44.7 44.7 46.7 53.5 22.9 13.5 19.4 22.2 27.9 16.0 7.2 3.4 1.0 20.7 18.2 25.3 46.0
Import of services# 54.0 17.8 24.0 -3.7
36.2 25.5 138.6 40.7 23.1 3.1 21.2 23.0 13.9 40.1 10.0 34.9 1.7 -4.8 -5.8 -4.0 7.1 18.1
Remittances# -13.3 12.9 10.0 24.1
27.5 -34.6 -40.0 9.3 -10.6 6.8 52.9 14.2 15.8 9.0 8.3 7.7 -6.6 45.4 24.0 36.1 43.9 51.0
memo items:
REER** 100.3 99.6 99.6 100.8 102.1 104.3 101.5 101.5 97.1 96.5 99.8 100.6 104.8 105.7 105.2 103.4 99.0 97.7
NEER** 88.9 86.3 86.3 87.8 90.1 91.1 88.6 89.6 86.1 84.2 86.2 87.1 93.8 94.6 94.7 92.5 90.0 87.0
Remittances (in $ Million) 6,133 4,274 4,073 6,305 5,906 4,993 6,438 7,350 6,873 5,385 7,447 8,463 7,518 9,265 10,866 13,368 11,511 14,232
of which Official -7 96 34 137 17 2 53 122 -21 14 190 44 -13 47 74 131 33 -53
Private 6,140 4,178 4,039 6,168 5,889 4,991 6,385 7,228 6,894 5,371 7,257 8,419 7,531 9,218 10,792 13,237 11,478 14,285

(i) AE: Advanced Estimate; QE: Quick Estimate. (ii) ELEM: Export (of goods and services) less export-related imports; ILEM: Import (of goods and services) less export-related imports.

(iii) REER: Real effective exchange rate; NEER: Nominal effective exchange rate. For both the indices weights are based on 36-country trade and the base year is 1993-94. @ Excluding construction, which is included in the service sector. * Quarterly figures for gross investment (not adjusted for errors and omissions) comprises gross fixed capital formation and changes in stocks while annual figures for gross investment (adjusted for errors and omissions) additionally includes valuables. ** Rise in either of REER and NEER indicates appreciation of rupee. $ Based on CSO figures of real exports of goods and services, estimated by using export price indices as the deflator. # Growth based on real exports and imports of goods and services and remittances estimated by using GDP deflator. Source: Central Statistical Organisation, GOI, National Accounts Statistics, 2008 and various press releases; RBI's web site.

demand-side factors operating in the markets for non-agricultural For analysing variations in demand it is customary in macroproducts. One of the factors governing the demand for these prod-economic analysis to focus on the relatively autonomous compoucts is agricultural income; but since its impact was positive during nents of demand which do not depend significantly on current 2007-08, the effects of other demand-side factors must have been levels of production or income.4 Following this principle, as a sufficiently adverse to outweigh the salubrious impact of a bumper first approximation investment, government expenditure and harvest. Let us examine the most important of these factors. exports are treated as autonomous, while imports and household

march 28, 2009 vol xliv no 13

Table 1B: Shares (%) of Different Components of India's GDP (2000-01 to 2008-09)
At Current Prices 2000-01 2001-02 2002-03 2003-04
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Agriculture, forestry 23.4 23.2 20.9 21.0
and fishing 24.7 19.6 27.4 21.3 23.4 19.3 27.5 22.0 22.4 17.6 23.9 19.4 21.2 17.2 25.4 19.5
Industry@ 20.4 19.6 20.5 20.1
20.5 21.8 19.2 20.2 20.0 21.0 18.3 19.3 20.3 21.7 19.6 20.4 20.1 21.0 18.8 20.5
Services 56.3 57.2 58.6 59.0
54.8 58.6 53.4 58.4 56.6 59.8 54.2 58.7 57.3 60.7 56.5 60.2 58.7 61.8 55.8 60.0
Gross investment* 24.3 22.8 25.2 28.2
24.0 24.9 22.1 23.1 24.1 24.5 21.1 23.7 24.4 25.8 23.8 24.8 25.5 27.5 23.8 42.2
of which, Public 6.9 6.9 6.1 6.3
(Admin department and
departmental enterprises) 2.4 3.2 3.2 2.9
(Non-departmental enterprises
and Quasi government bodies) 4.5 3.6 2.9 3.5
Private 16.6 16.7 18.6 19.5
of which, corporate 5.2 5.4 5.7 6.6
Households 11.4 11.3 12.9 13.0
Pvt final consumption exp 63.7 64.4 63.2 61.7
64.1 62.3 66.9 61.4 65.4 63.3 64.0 61.6 63.3 61.4 66.9 61.1 63.8 60.9 63.4 92.2
Government final 12.6 12.4 11.9 11.3
consumption exp 10.0 12.2 10.4 17.4 10.0 11.9 10.8 15.8 9.2 11.5 11.0 15.3 9.6 12.7 10.0 19.8
Export of goods and services 13.2 12.8 14.5 14.8
12.2 12.8 12.9 13.8 13.3 13.3 10.9 13.1 14.3 15.4 13.5 14.8 13.6 15.0 13.9 26.0
ELEM 11.5 11.0 12.5 12.7
Import of goods and services 14.2 13.6 15.5 16.1
14.2 15.6 13.5 13.6 15.0 15.4 11.5 12.7 15.2 16.4 14.4 16.0 16.8 17.0 14.5 25.7
ILEM 12.4 11.9 13.4 14.0
Remittances 2.9 3.3 3.3 3.7
2.9 2.5 3.4 2.6 4.6 2.8 2.6 3.4 3.1 3.4 3.1 3.6 3.3 4.5 3.8 3.2
At Current Prices 2004-05 2005-06 2006-07 2007-08 (QE) 2008-09 (AE)
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
Agriculture, forestry 19.2 18.8 18.4 18.1 17.6
and fishing 19.9 15.9 22.5 18.2 18.7 15.4 22.6 18.0 18.1 14.8 22.0 17.9 17.6 14.5 21.1 16.8 16.8 13.7 21.0
Industry@ 20.8 20.7 20.9 20.8 20.2
20.6 22.0 19.9 20.8 21.1 21.7 19.6 20.6 21.1 21.9 19.7 20.9 21.5 21.7 19.8 20.9 20.8 21.3 18.8
Services 60.0 60.5 60.8 61.1 62.2
59.5 62.2 57.6 61.0 60.2 62.9 57.9 61.3 60.7 63.3 58.3 61.2 60.9 63.7 59.1 62.3 62.4 64.9 60.2
Gross investment* 32.2 35.5 35.9 39.1 40.1
29.7 31.5 28.8 31.4 32.8 34.8 31.9 34.1 34.9 35.3 33.5 35.6 36.6 38.2 35.7 35.9 36.4 39.9 37.7
of which, public 6.9 7.6 7.8 9.1
(Admin dept.and
departmental enterprises) 3.3 3.7
(Non-departmental enterprises and
quasi government bodies) 3.6 3.9
Private 23.4 25.8 27.0 28.5
of which, corporate 10.5 13.3 14.6 15.9
Households 12.9 12.5 12.5 12.6
Pvt final consumption exp 58.4 57.4 55.8 55.0 55.1
59.3 58.5 60.8 55.3 58.7 58.0 59.6 53.8 57.2 57.2 57.7 51.6 56.1 57.0 57.9 51.5 56.7 56.4 58.5
Government final 10.7 10.4 10.3 10.1 11.1
consumption exp 9.6 10.5 9.4 13.1 8.7 11.0 10.2 11.5 11.9 9.0 9.3 11.0 10.9 9.5 9.1 11.9 10.6 9.0 10.7
Export of goods and services 18.1 19.9 22.1 21.2 24.0
16.9 17.1 17.2 20.7 18.9 19.7 18.8 21.9 22.5 23.5 20.2 22.5 20.7 20.9 21.4 22.7 23.4 22.9 21.5
ELEM 15.6 17.6 20.1 19.4
Import of goods and services 19.9 22.7 25.1 24.7 30.3
17.1 21.0 20.7 20.4 23.4 23.3 22.1 22.3 26.7 27.7 23.6 23.2 25.1 26.0 24.0 22.6 29.3 30.0 27.7
ILEM 17.4 20.4 23.2 23.0
Remittances 3.0 3.1 3.1 3.5
3.9 2.7 2.2 3.2 3.2 2.7 3.0 3.3 3.4 2.6 3.0 3.2 2.9 3.5 3.4 4.0 3.9 4.9
  • (i) AE: Advanced Estimate; QE: Quick Estimate.
  • (ii) ELEM: Export (of goods and services) less export-related imports; ILEM: Import (of goods and services) less export-related imports. @ Excluding construction, which is included in the service sector. * Quarterly figures for gross investment (not adjusted for errors and omissions) comprises gross fixed capital formation and changes in stocks while annual figures for gross investment (adjusted for errors and omissions) additionally includes valuables. Source: Central Statistical Organisation, GoI, National Accounts Statistics, 2008 and various press releases; RBI's web site.
  • Economic & Political Weekly

    EPW
    march 28, 2009 vol xliv no 13

    consumption are considered endog-Table 2: Macroeconomic Indicators of the Indian Economy (Figures are Y-o-Y growth rates except for exchange rates and capital inflows)

    2005-06

    enous.5 In the Indian context, this

    Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

    standard classification of the compo-

    Real GDP at market prices 9.3

    nents of autonomous demand re

    8.9 8.3 9.0 10.6

    quires modification in two respects. IIP 8.2

    8.1 10.8 12.2 4.7 7.6 7.2 9.8 6.0 5.7 8.5 8.8 8.9

    First, it is instructive to differentiate

    of which capital goods 15.8

    between public and private invest

    14.6 13.4 13.5 14.9 12.9 22.8 24.3 11.5 12.9 27.0 10.7 11.9

    ment since (a) their variations, being

    Net import of capital goods 64.1

    governed by separate sets of consid-

    CPI (IW) 4.2erations, often differ quite consider- 5.0 3.7 3.3 4.1 3.4 3.6 4.2 5.3 5.6 4.7 4.9 4.9

    ably; and (b) unlike in developed WPI 4.4

    5.9 5.5 4.3 4.3 3.7 4.1 4.7 4.2 4.4 4.1 4.0 3.9

    countries, public sector capital forma-

    Exchange rate* 43.7 43.5 43.6 43.5 43.6 43.9 44.8 45.8 45.8 44.4 44.3 44.5

    tion, despite its loss of pre-eminence

    NEER** 89.0 90.0 91.2 92.1 91.0 90.4 89.4 88.3 88.1 89.4 89.9 89.5

    compared with the pre-reform era,

    REER** 100.6 102.1 103.7 105.0 104.0 103.9 102.5 101.4 100.6 101.5 101.7 101.3 still remains fairly significant. Second, In million $

    in the Indian economy, remittances Export of goods 36.1 33.8 30.1 28.8 43.3 22.2 32.3 2.9 25.5 11.9 12.5 13.8

    from non-resident Indians (NRIs) are Import of goods 62.2 63.9 35.4 46.2 56.9 36.9 32.2 21.0 18.5 17.1 11.4 15.7 Trade balance -172.0 -149.1 -47.6 -95.7 -94.9 -77.5 -32.0 -77.5 -1.7 -32.4 -7.3 -24.3

    a non-negligible source of private

    FDI inflows 268 654 264 324 399 282 412 746 342 482 127 1,240

    consumption6 and to that extent have

    FII inflows -338 -318 1,209 1,784 1,062 1,022 -1,054 420 1,831 603 1,660 1,450

    to be treated as an autonomous factor

    of which, Equity -150 -261 1,226 1,824 1,161 1,066 -841 903 2,047 805 1,693 1,509

    driving domestic demand. (Note

    Debt -188 -56 -16 -40 -99 -43 -213 -483 -216 -202 -34 -58

    however that in this case the autono-

    In Rs crore Exports, imports and trade balance are in real term@

    mous component of aggregate de-Export of goods 30.2 23.5 19.7 17.0 29.6 11.9 24.4 0.2 25.2 9.1 9.7 11.4

    mand is not the remittance itself, but Import of goods 55.2 51.4 24.6 32.8 41.9 25.3 24.3 17.8 18.2 14.2 8.6 13.2 Trade balance -160.3 -130.0 -35.8 -77.8 -41.0 -62.5 -24.2 -72.8 -1.5 -29.1 -4.7 -21.6

    the consumption resulting from it.)

    FDI inflows 1,172 2,845 1,151 1,411 1,740 1,238 1,846 3,414 1,567 2,141 563 5,518

    A simple way of broadly assessing

    FII inflows -1,476 -1,386 5,258 7,760 4,621 4,458 -4,627 1,874 8,361 2,756 7,436 6,430

    the quantitative significance of the

    of which, Equity -654 -1,140 5,329 7,934 5,051 4,647 -3,694 4,039 9,335 3,678 7,588 6,689

    autonomous components of demand

    Debt -821 -246 -70 -174 -430 -188 -934 -2,165 -974 -922 -152 -258

    in driving variations in domestic out-2006-07 put is to consider their growth rates Real GDP at market prices 9.7

    8.0 10.9 9.5 10.3

    along with respective weights in the

    IIP 11.6

    total amount of autonomous expendi

    9.9 11.7 9.7 13.2 10.3 12.0 4.5 15.8 13.4 11.6 11.0 14.8

    ture. The higher the growth rate and

    of which capital goods 18.2the larger the weight of some com- 19.6 21.4 21.6 18.3 16.6 9.5 6.5 29.4 26.2 16.3 18.0 18.1

    ponent, the greater will be its impact Net import of capital goods 19.2

    on the proportional increase in GDP. CPI (IW) 6.8

    5.1 6.3 7.6 6.7 6.3 6.8 7.3 6.3 6.9 6.7 7.6 6.7

    In terms of this perspective, let us

    WPI 5.4

    see what the major sources of the

    3.9 4.8 5.1 4.8 5.1 5.4 5.5 5.5 5.7 6.4 6.4 6.6

    growth slowdown were in the pre-

    Exchange rate* 44.9 45.4 46.1 46.5 46.5 46.1 45.5 44.9 44.6 44.3 44.2 44.0 crisis period.7 NEER** 87.7 85.4 85.1 84.2 83.6 84.7 86.2 86.5 85.9 87.1 87.2 87.1

    One of the major sources of decel-REER** 98.2 96.4 96.6 95.8 95.6 98.0 100.0 100.4 99.1 100.7 100.6 100.5 In million $

    eration of the Indian economy pre-

    Export of goods 11.8 25.9 31.8 40.6 24.5 26.9 13.7 34.3 14.9 19.0 16.3 11.3

    ceding the crisis, as Tables 1A and 1B

    Import of goods 10.6 8.1 19.0 26.4 15.6 30.5 40.7 35.5 20.9 6.7 22.6 19.7

    suggest, was the declining trend in

    Trade balance -7.9 18.8 6.9 0.2 2.5 -37.4 -112.2 -37.5 -38.4 23.5 -46.0 -55.2

    capital formation, especially in the

    FDI inflows 661 538 523 1,127 619 916 1,698 1,151 5,130 1,921 698 603 private sector. After its prolonged FII inflows 174 -1,473 193 285 1,173 1,318 1,879 2,213 -599 -370 1,834 82

    slump from the mid-1990s to 2001-02, of which, Equity 118 -1,630 106 252 1,000 1,166 1,736 2,037 -797 113 1,620 -244

    investment recovered in 2002-03 and Debt 56 157 88 33 173 152 142 176 198 -482 214 325

    clocked an average growth of nearly In Rs crore Exports, imports and trade balance are in real term@ Export of goods 8.9 24.5 32.0 42.1 25.8 26.2 9.3 24.8 6.5 12.5 9.7 4.3

    19% over the four-year period 2002-06

    Import of goods 7.6 6.9 19.1 27.7 16.8 29.8 35.3 25.9 12.0 0.9 15.7 12.2

    (Table 1A). Private investment, account-

    Trade balance -5.0 19.7 6.8 -0.9 -23.2 -36.7 -103.9 -27.7 -28.2 27.6 -37.8 -45.6

    ing for 75-80% of aggregate capital

    FDI inflows 2,979 2,444 2,410 5,239 2,880 4,231 7,723 5,164 22,902 8,520 3,083 2,652

    formation, grew at an average rate of

    FII inflows 770 -6,647 875 1,297 5,448 6,133 8,670 10,187 -2,766 -1,682 8,195 361

    nearly 20% (compared with the 9.4%

    of which, Equity 522 -7,354 480 1,145 4,643 5,425 8,013 9,380 -3,667 492 7,240 -1,082 growth recorded by public invest-Debt 249 707 396 152 805 709 657 806 901 -2,174 956 1,443

    ment) and constituted the principal (Contd)

    march 28, 2009 vol xliv no 13

    Table 2: Macroeconomic Indicators of the Indian Economy (Continued) driver of the country’s GDP growth8
    Apr May Jun Jul Aug 2007-08Sep Oct Nov Dec Jan Feb Mar during this period. However, since 2005-06, there has been a marked de-
    Real GDP at market prices 9.3 8.8 9.2 8.5 8.6 celeration in aggregate investment;
    IIP 8.5 its average growth during 2006-09
    11.3 10.6 8.9 8.3 10.9 7.0 12.2 4.9 8.0 6.2 9.5 5.5 has fallen by about 8 percentage

    of which, Capital goods 18.0points (to 12.5%) from that in the pre

    10.9 22.4 23.1 12.3 30.8 20.9 20.9 24.2 17.6 2.6 10.7 20.3

    ceding period. No less significant, the

    Net import of capital goods 6.1

    sharply downward trend in private

    CPI (IW) 6.4

    investment started in 2005-06 itself.

    6.7 6.6 5.7 6.5 7.3 6.4 5.5 5.5 5.5 5.5 5.5 7.9

    WPI 4.8 In this respect there is an interesting
    6.3 5.5 4.5 4.7 4.1 3.5 3.1 3.3 3.8 4.5 5.3 7.5 parallel between the current slow-
    Exchange rate* 42.1 40.8 40.8 40.4 40.8 40.3 39.5 39.4 39.4 39.4 39.7 40.4 down and the deceleration of the In-
    NEER** 91.8 94.7 95.0 94.8 94.4 94.7 95.3 94.3 94.7 94.3 93.1 90.0 dian economy in 1996-97; in the ear-
    REER** 102.6 106.0 105.9 106.0 105.3 105.9 106.1 104.6 104.9 104.9 103.5 101.9 lier instance too the onset of decelera-
    In million $ Export of goods Import of goods Trade balance 27.5 41.8 -72.8 21.6 35.0 -66.5 14.1 38.3 -107.5 18.2 26.1 -46.6 18.2 33.6 -73.7 16.1 1.1 25.3 48.8 30.3 26.3 32.5 5.5 -36.4 20.9 24.3 -32.6 34.9 64.0 -175.4 43.6 47.1 -57.1 18.6 35.9 -88.3 tion was preceded by a sharp slowdown in private investment (Rakshit 2004). Be that as it may, the impor-
    FDI inflows 1,643 2,120 1,238 705 831 713 2,027 1,864 1,558 1,767 5,670 4,438 tant point to note in this connection is
    FII inflows 1,752 1,265 269 5,545 -1,772 4,609 5,684 -1,567 2,204 -2,747 1,049 -250 that the quantitative significance of
    of which Equity 1,516 942 401 5,855 -1,922 3,957 5,067 -1,450 1,383 -3,232 430 -32 the downturn in private capital for-
    Debt 236 323 -132 -310 150 652 617 -116 821 485 619 -218 mation in pulling down GDP growth
    In Rs crore Exports, imports and trade balance are in real term@ well ahead of the global financial tur-
    Export of goods 14.5 4.6 -3.2 -1.5 -0.6 -2.7 23.8 9.8 2.3 14.8 23.8 4.1 moil is undoubted.9 First, in 2006-07,
    Import of goods 27.4 16.2 17.3 5.1 12.3 -15.3 5.2 11.6 5.2 39.6 26.8 19.4 private investment constituted more
    Trade balance -55.3 -43.2 -76.0 -22.2 -46.0 37.4 21.3 -14.9 -12.2 -134.3 -35.4 -65.3 than one-fourth of GDP and nearly
    FDI inflows FII inflows of which Equity Debt 6,925 7,722 6,679 1,042 8,653 5,320 3,960 1,360 5,052 1,102 1,643 -541 2,857 22,609 23,872 -1,263 3,395 2,869 7,981 -7,162 18,788 23,090 -7,771 16,133 20,591 608 2,656 2,500 2008-09 7,360 -6,319 -5,850 -469 6,134 6,960 22,547 8,891 -11,082 4,230 5,579 -13,036 1,733 3,312 1,954 2,497 17,912 -1,010 -130 -880 40% of total autonomous expenditure.10 Second, between 2006-07 and 2007-08, the fall in the growth of private investment was as much as
    Real GDP at market prices 7.8 8.0 7.1# 8.9 percentage points. The implication is that ceteris paribus the growth
    IIP 6.2 4.4 5.4 7.4 1.4 4.8 -0.4 2.4 -2.0 debilitating impact of private invest
    of which, Capital goods 12.4 4.3 7.8 17.9 0.9 18.6 3.1 -2.3 4.2 ment amounted to a huge 3.36 per-
    CPI (IW) 7.8 7.8 7.7 8.3 9.0 9.8 10.5 10.5 9.7 centage points in 2007-08. Though
    WPI 8.0 8.9 11.8 12.4 12.8 12.3 11.0 8.6 6.4 5.2 this impact was more than out-
    Exchange rate* 40.0 42.1 42.8 42.8 42.9 45.7 48.8 49.0 48.7 48.9 49.3 weighed by the 17.6 percentage point
    NEER** 93.3 89.0 87.7 87.0 88.6 85.4 83.2 84.3 jump in public investment, the esti-
    REER**In million $ 101.7 97.6 97.6 97.3 99.6 96.1 92.5 92.5 mated 7.2 percentage point fall in
    Export of goods Import of goods 45.7 39.7 27.6 38.7 38.4 32.3 35.7 57.2 26.9 51.9 10.4 43.3 -12.1 10.6 -9.9 6.1 -1.1 8.9 -15.9 -18.2 -13.7 -18.2 aggregate investment in the current year (2008-09) is almost certainly
    Trade balance -30.0 -57.8 -22.7 -102.6 -96.5 -133.4 -61.2 -33.1 -30.8 22.6 30.0 due to the continuation of the down-
    FDI inflows 3749 3932 2392 2247 2328 2562 1497 1083 ward trend in private investment
    FII inflows -155 -1283 -2751 442 12 -1258 -4265 401 589 -853 from 2005-06.
    of which, Equity 267 -1242 -2503 -455 -300 -2052 -3805 -644 434 -1052 Curiously enough, the most impor-

    Debt -422 -40 -248 897 312 794 -461 1045 155 199 tant demand-reducing factor operat- In Rs crore Exports, imports and trade balance are in real term@ ing in the pre-crisis period was the

    Export of goods 29.0 22.9 35.5 34.1 24.4 16.2 0.9 4.4 13.7 -2.7 -0.2

    sharp slowdown in exports. Accord-

    Import of goods 23.7 33.6 29.6 55.3 49.0 50.9 26.9 22.9 25.1 -5.4 -5.4

    ing to Central Statistical Organisation

    Trade balance -15.1 -51.9 -20.2 -100.2 -92.6 -145.8 -85.0 -54.2 -50.4 10.5 19.1

    (CSO) data, 2007-0811 saw export

    FDI inflows 137,701 16,595 10,258 9,626 10,011 11,688 7,304 5,304

    growth plummeting to 7.5% from

    FII inflows -627 -5174 -11,095 1,782 46 -5,074 -17,205 1,617 2,377 -3,443

    18.9% registered in the earlier year

    of which, Equity 1075 -5012 -10,096 -1,837 -1,212 -8,278 -15,347 -2,598 1,750 -4,245

    (Table 1A). Even this constitutes an

    Debt -1702 -163 -999 3,619 1,258 3,204 -1,858 4,215 627 802

    underestimation of the decline in ex-

    Figures of export, import and trade balance for February 2009 are taken from Business Standard, 5 March 2009.

    * Per US $. ** Base: 1993-94=100. Weights are based on 36-country trade. Rise in either of REER and NEER indicates appreciation of Rupee.

    ternal stimulus to the domestic econ

    # Advanced Estimate. @ Growth based on real exports and imports of goods and trade balance estimated by using GDP deflator. Source: Central Statistical Organisation’s web site; Reserve Bank of India’s web site; SEBI’s web site. omy. The CSO estimates of export

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    march 28, 2009 vol xliv no 13

    growth are obtained by deflating nominal export earnings by the export price index. This yields the percentage change in the volume of export. However, for estimation of the demand generation impact of exports (a la the foreign trade multiplier analysis) what is relevant is the command of export earnings over domestic consumption and investment. Hence, the need for using theGDP deflator rather than the export price index.12 Again, to the extent some exports directly involve use of imported items (for example uncut diamonds or gold in the export of gems and jewellery), it is export earnings less the value of the items that denote the autonomous component of domestic demand arising from trade.13 In the context of these observations it is easy to see how important export slowdown was in causing the decline in GDP growth in general and industrial growth in particular during 2007-08. Exports (of goods and services) less export-related imports (ELEM) were a little over 20% of GDP in 2006-07, but their share in total autonomous expenditure was nearly 30%. This together with the fact that between 2006-07 and 2007-08 there was a

    15.8 percentage fall in ELEM attests to the enormous significance of exports in engineering the GDP deceleration.

    The decelerating trends of industrial and GDP growth started, let us remember, from April 2007 and the first quarter of 2007-08, respectively. Though quarterly data for ELEM are not available, our estimates of export growth (gross of export-related imports) indicate how closely this turning point corresponds to the behaviour of export earnings. Export growth started decelerating from the third quarter of 2006-07, plummeted from 13.2% to 0.6% in the first quarter of 2007-08, and declined further to minus 3.1% per cent in the second quarter of 2007-08.14 It is thus clear that the two most important factors behind the deceleration of GDP in general and industrial production in particular15 were in operation well before the onset of the global crisis.

    The slowdown in GDP growth in the pre-crisis period, it needs to be noted, was significantly less than what the precipitous fall in the growth of private investment and exports would suggest. The reason lay partly in a step-up in public expenditure. Between 2006-07 and 2007-08, the growth of public investment and government consumption went up by 15.6 and 0.8 percentage points, respectively. Given their shares in autonomous expenditure at 11.4% and 15.1% respectively, the accelerated increase in public expenditure helped greatly in preventing a sharper slide in GDP growth.16 The more important mitigating factor was perhaps the 1.3 percentage point rise in the growth of agricultural GDP. Apart from its direct contribution to overall GDP growth, the increase in farmers’ income also helped in raising the demand for industrial goods and services and triggering off a multiplier process in the non-agricultural sector.

    The foregoing analysis brings to the fore a significant difference between the growth-debilitating and growth-enhancing factors operating before the crisis. While the former are related to structural features of the economy or behaviourial characteristics of private agents (domestic or foreign), the latter are either primarily policy instruments or (as in the case of agricultural performance) largely random, at least in the short and medium run. It is for this reason that in the absence of vigorous and sustained expansionary policy measures, the downward drift of the Indian economy, we believe, would have continued, albeit at a slower pace, even without the global meltdown. The pre-crisis trend in household consumption also lends support to our surmise.

    In recent years there appears to have occurred a significant change in the propensity to consume, which has an important bearing on GDP growth. Since the first quarter of 2005-06, there has been a marked deceleration in household consumption that cannot be accounted for by the behaviour of GDP. Between 2005-06 and 2006-07, growth of private consumption declined by as much as 1.6 percentage points even though there was a 0.5 percentage point rise in GDP growth. Nor is it easy to explain why the slowdown in consumption growth was larger than that in GDP in 2007-08. The point to appreciate in this context is that since private consumption accounts for around 60% of domestic income, the downward trend in the consumption ratio is of major macroeconomic significance when GDP growth is demand-driven. The ratio had shown a relentlessly downward trend since 2001-02, registering a huge 9.4 percentage fall over the period 2002-07.17 One reason behind the slowdown of consumption in relation to aggregate income was the decline in personal disposable income as a ratio of GDP. But note that as per estimates from CSO data (GOI 2008), between 2002-03 and 2006-07 the ratio of private disposable income to GDP came down from 84.3% to 77.6%, and that of private consumption to disposable income from 75.0% to 71.9%. This points to the operation of other factors in curbing household expenditure. The most important of these was perhaps the worsening distribution of income between those engaged in the sunrise sectors and the vast and growing majority of the populace working in unorganised enterprises. The other factor, relatively transient, was the rise in prices of articles entering the consumption basket of rural and urban workers. Since April 2006 there was a significant rise in consumer price index (CPI-IW and CPI-RL) inflation18 due mostly to an increase in food and other commodity prices, and this tended to have a restraining impact on consumption demand for non-agricultural goods and services. However, the role of commodity price inflation in the performance of the Indian macroeconomy acquired much greater significance after the onset of the global crisis.19

    3 Global Crisis: Domestic Consequences

    Though the decelerating phase of the Indian economy started way ahead of the US mortgage market meltdown, there can be little doubt that the global crisis has seriously aggravated the problem and made the task of reversing the domestic downturn much more difficult. Before examining how international economic developments might have affected the domestic economy since the outbreak of the crisis, it is useful to take stock of some of the striking features of the Indian macroeconomy during this period, especially of the sources and components of aggregate demand. First, the slowdown in GDP and industrial growth, which as already noted had started from the first quarter of 2007-08, became much more pronounced from the fourth quarter of 2007-08 and the first quarter of 2008-09, respectively, that is, more than three to six months after the eruption of the sub-prime crisis (Table 1A). The proximate source of this was the sharper slowdown in both private consumption and aggregate investment20

    march 28, 2009 vol xliv no 13

    from early January 2008. Second, over March-August 2008, export as well as import growth was significantly higher than in the precrisis period – something which cannot but be viewed as counterintuitive in the context of the global economic woes. It was only from September 2008 that the crisis seems to have finally taken its toll of the country’s trade flows. This combination of the sharper slowdown of demand driven primarily by domestic factors along with an acceleration of exports and imports21 constitutes a veritable conundrum of the Indian economy during this period. Third and no less paradoxical, from June-August 2007-08, non-resident Indian (NRI) remittances zoomed, averaging a y-o-y growth of more than 38% between the second quarters of 2007-08 and 2008-09, and thereby belying the predictions of most pundits regarding the adverse impact of the world crisis on the inflow of such funds. Finally, with a much sharper deceleration of investment and private consumption and a steep downturn of export growth from the third quarter of 2008-09, the economy seems to have entered a new phase and been sucked into the maelstrom of the global crisis.

    Financial Contagion

    For a year or so after its outbreak, the crisis raged mostly in the financial sectors of developed countries, causing mounting losses, a string of bankruptcies,22 and a severe log-jam in the flow of credit, especially in the inter-bank money market. Given their relatively small exposure to US asset-backed securities (ABSs) and structured derivative products like collateralised debt obligations (CDOs), Indian banks have not been seriously rocked by the global financial turmoil. However, apart from the heightened uncertainty and darkening prospects making domestic banks extremely wary of extending loans, there have been other routes through which the crisis has cast its long shadow on Indian financial markets and hence on the real sector of the economy.

    With increasing relaxation of capital account transactions and the close integration of the domestic economy with international financial markets, the first significant impact of the global crisis was on the country’s capital inflows, especially external commercial borrowings (ECBs) and foreign institutional investment (FII).23 Almost immediately after the crisis surfaced (net) ECBs and FII registered a steep fall between October and November 2007, from $3.6 billion and $5.7 billion to $2.2 billion and minus $1.6 billion, respectively. Since then the downward trend of the two components of capital inflows has remained unabated. The most important reason behind drying up of ECBs was the huge financial meltdown and the associated credit crunch, with a widening spread between the yield on private bonds and that on government securities. The sharp fall in FII flows to EMEs, including India, even though their economic prospects seemed better than that of the US, was due in large part to the need for repairing the balance sheets of developed-country financial firms in the context of the mind-boggling operational and mark-to-market losses being suffered by them. As is to be expected, the reversal of capital flows has led to a steady fall in the value of the rupee despite substantial running down of foreign currency assets by the Reserve Bank of India (RBI); between October 2007 and November 2008, both the nominal effective exchange rate (NEER) and

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    the real effective exchange rate (REER) went down significantly,24 the former by 11.6% and the latter by 12.8%. As we shall elaborate later, this fallout of the global financial meltdown was positive for the Indian economy inasmuch as it led to an improvement in the trade balance.

    Other consequences of the financial upheaval were not so salubrious. To the extent domestic producers relied upon ECBs for funding their projects partly or wholly, drying up of this source of long-term credit may have played a role in the significant dip in investment growth since the outbreak of the crisis. However, the importance of this factor for domestic demand can easily be exaggerated. When external borrowings are used entirely for buying machinery and equipment from abroad, the associated investment does not raise domestic income or employment. In general most investment projects use both domestic and external (real) resources so that the investment reducing impact of a fall in ECBs, even when the borrowings were meant to be used fully for raising productive capacity, would generally be a fraction of their decline.

    FII outflows might also have had a negative impact on domestic investment. Given the relative thinness of the Indian share market, the sharp fall in FIIs followed by their withdrawal contributed, albeit with some lag, to the bursting of the India’s stock market bubble. Curiously enough, though IIP growth had started declining since March 2007, the share market boom continued until early 2008; between March and December 2007, the Bombay Stock Exchange (BSE) index, fuelled in part by substantial FII inflows, went up from 12,858 to 19,827. The bullish sentiments prevailed for a short while even after the downward drift in FII began in November 2007.25 However, a whopping $3.2 billion FII (equity) outflow in January 2008 triggered a relentless bear run, making the BSE plunge by 52% (to 9,350) between December 2007 and January 2009. For the Indian economy, it is true, there appears to be no direct, casual link between capital formation and either FII or share prices. But remembering that many companies have cancelled their proposed equity issues in the face of plunging share prices, the bearish trend is likely to have had a dampening effect on the private propensity to invest. This is not to deny that in the context of the (pre-crisis) bull run despite the industrial slowdown, domestic factors might in all probability have been more important in the bursting of the bubble and development of pronounced bearish tendencies.

    Finally, despite the resilience of Indian banks, the global financial meltdown has had some adverse consequences for creditfinanced economic activities. Widespread banking troubles created a serious credit crunch for traders. Instances of banks delaying or not honouring guarantees extended to traders became more frequent. Domestic exporters were also finding it increasingly difficult to secure credit. Since it is the advanced country banks that have been in the eye of the financial storm from the very beginning of the crisis, the credit crunch tended to have a greater impact on Indian exports than imports. The difficulty of importing components or raw materials directly required for producing exportables also has had a negative impact on domestic demand. Again, with the globalisation of the supply chain in the production process, a disruption anywhere in the cross-border flow of intermediate inputs tends to create a disproportionately large effect on output and employment in both the domestic and the international economy.

    The problem of accessing credit was not confined to traders alone. Though Indian banks remained relatively unscathed, they became increasingly choosy in extending loans, especially to buyers of real estates and consumers durables – the two categories of economic agents who had so far played an important role in sustaining domestic demand. One reason for the banks turning more cautious was no doubt the heightened volatility of global financial markets in general and the plight of the once mighty transnational banks in particular. But the caution was also warranted by the rise in non-performing assets (NPAs), the resulting erosion of banking capital and the far-from-rosy prospects of the domestic economy. Irrespective of the reasons behind the reversal of bank behaviour, its significance for domestic demand, via operation of the (negative) financial accelerator,26 could be profound.

    Global Inflation

    For a little over a year after the outbreak of the financial crisis, the world economy experienced, between September 2007 and October 2008, a pronounced stagflationary phase, with growth slowdown on the one hand and rising inflation on the other (Rakshit 2009b). For Organisation for Economic Cooperation and Development (OECD) countries the y-o-y consumer price index (CPI) inflation, starting from a lowly 1.9% in August 2007 exhibited an uninterrupted increase to peak at 4.9% in July 2008 and remained at an elevated level over the next two months (at 4.7% and 4.5%, respectively). The trend of producer price index-manufactured goods (PPI-M) inflation during this phase was similar but more pronounced, rising as it did from 1.9% in August 2007 to 9.9% in July 2008 and then moderating somewhat to 9.4% and 8.9%, respectively in the next couple of months (Table 3). The global inflation was driven mostly by commodity prices,27 especially prices of energy and agricultural goods.28 So far as the Indian economy is concerned, since prices of practically all

    Table 3: Movements of Different Price Indices in India and in the World (2005-06 to 2008-09, Figures are Y-o-Y growth rate)

    2005-06 2006-07

    Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

    India CPI (IW) 5.0 3.7 3.3 4.1 3.4 3.6 4.2 5.3 5.6 4.7 4.9 4.9 5.1 6.3 7.6 6.7 6.3 6.8 7.3 6.3 6.9 6.7 7.6 6.7

    CPI (RL) 3.0 3.0 2.7 3.8 3.2 3.2 3.2 4.6 4.9 4.7 4.7 5.3 5.2 6.4 7.2 5.9 6.2 7.0 8.1 8.0 8.3 8.9 9.5 9.2

    WPI 5.9 5.5 4.3 4.3 3.7 4.1 4.7 4.2 4.4 4.1 4.0 3.9 3.9 4.8 5.1 4.8 5.1 5.4 5.5 5.5 5.7 6.4 6.4 6.6

    WPI-Food 3.7 2.6 2.9 5.3 3.5 4.2 4.6 5.9 6.9 7.2 6.0 5.3 4.7 6.5 8.3 4.4 5.3 9.0 8.7 7.5 8.8 9.5 10.3 10.3

    WPI-Fuel group# 11.2 10.9 10.5 10.7 8.8 11.0 11.0 7.4 7.8 7.9 8.5 8.9 8.2 9.2 8.9 7.4 8.1 5.6 5.1 4.6 3.7 3.6 1.8 1.4

    WPI-Minerals oils 17.4 16.8 13.2 15.7 12.0 15.9 17.2 10.7 11.5 12.4 12.3 13.1 11.9 13.6 16.3 13.4 14.7 7.5 5.4 4.6 3.2 3.4 1.7 1.0

    World Oil price ($ per barrel)* 44.6 23.7 48.0 44.3 44.6 42.7 17.4 20.3 37.2 39.9 28.5 15.8 31.4 42.4 26.1 26.8 12.4 -2.6 -5.6 1.8 4.4 -16.7 -3.8 -3.7

    Commodity price** -1.6 6.5 12.3 66.6 20.2 12.2 22.7 35.3 25.4 31.4 30.3 29.7 33.0 35.1 30.2 23.5 19.5 23.4

    Food price** -7.4 3.5 8.1 60.8 11.6 1.8 5.9 8.0 3.5 7.4 7.9 10.4 15.8 23.3 21.0 17.3 15.5 17.0

    OECD PPI-Manufactured products 4.3 3.3 3.6 3.9 3.9 4.5 4.3 3.3 3.9 4.0 3.6 3.3 3.9 4.8 5.1 4.9 4.7 2.9 1.8 2.9 3.0 2.3 2.8 3.1

    CPI 2.7 2.3 2.2 2.5 2.7 3.2 2.9 2.5 2.5 2.9 2.7 2.5 2.7 3.1 3.2 3.1 3.0 2.1 1.8 2.1 2.4 2.1 2.3 2.5

    CPI-Food 2.1 1.8 1.1 1.2 1.2 1.4 0.8 0.7 1.2 2.0 1.8 1.3 1.1 1.3 1.9 2.2 2.9 3.2 3.1 2.9 2.6 2.5 3.0 3.4

    memo item:

    India's real GDP 8.9 8.3 9.0 10.6 8.0 10.9 9.5

    2007-08 2008-09

    India CPI (IW) 6.7 6.6 5.7 6.5 7.3 6.4 5.5 5.5 5.5 5.5 5.5 7.9 7.8 7.8 7.7 8.3 9.0 9.8 10.5 10.5 9.7 10.4

    CPI (RL) 9.1 7.9 7.5 8.0 8.5 7.6 6.7 5.9 5.6 5.9 6.1 7.6 8.6 8.8 8.8 9.4 10.3 11.0 11.1 11.1 11.1 11.4

    WPI 6.3 5.5 4.5 4.7 4.1 3.5 3.1 3.3 3.8 4.5 5.3 7.5 8.0 8.9 11.8 12.4 12.8 12.3 11.0 8.6 6.4 5.2

    WPI-Food 10.2 8.8 5.3 9.7 8.5 5.0 3.0 2.6 2.4 2.1 3.4 5.9 5.5 5.7 5.9 6.0 6.9 7.7 9.9 10.0 10.1 11.0

    WPI-Fuel group# 1.1 0.6 -0.8 -1.5 -1.9 -2.5 -1.6 0.1 2.9 3.8 4.8 6.8 7.0 7.7 16.3 17.2 17.2 16.6 12.9 6.5 -0.1 -1.7

    WPI-Minerals oils 0.6 -0.3 -2.7 -3.9 -4.5 -3.4 0.0 1.2 5.0 5.7 7.0 9.4 9.7 11.0 25.6 27.2 27.2 26.1 17.6 8.8 -1.6 -3.7

    World

    Oil price

    ($ per barrel)* -8.2 -10.5 -4.9 -0.3 -0.9 25.1 46.4 59.4 47.9 70.3 60.9 74.3 76.0 97.6 98.5 79.9 61.1 30.0 -11.1 -39.3 -55.3 -55.1

    Commodity Price** 21.1 13.3 20.3 15.7 15.8 21.3 19.9 15.7 15.6 23.1 32.7 38.1 29.3 26.3 27.9 27.9 18.7 7.0 -14.4 -23.3 -30.5 -29.1

    Food Price** 15.8 15.7 25.7 23.1 29.7 41.9 35.3 30.8 38.1 45.3 57.0 66.7 63.0 58.7 56.7 55.0 39.4 19.3 -1.4 -9.8 -18.3 -15.8

    OECD

    PPI-Manufactured

    products 2.9 2.8 2.4 2.5 1.9 3.1 3.9 5.0 4.7 5.6 5.8 6.3 6.5 7.7 8.8 9.9 9.4 8.9 6.6 2.8

    CPI 2.4 2.4 2.3 2.1 1.9 2.3 2.9 3.4 3.4 3.5 3.5 3.6 3.5 3.9 4.5 4.9 4.7 4.5 3.7 2.3 1.5

    CPI-Food 3.8 3.6 3.6 3.5 3.4 3.6 4.3 4.8 5.0 5.2 5.1 5.2 5.7 6.1 6.5 7.2 7.2 6.8 6.5 6.2 6.0

    memo item:

    India's Real GDP 9.3 8.8 8.5 8.6 7.8 8.0 5.1

    * West Texas Intermediate. ** The Economist Commodity Price and Food Price Index (in $ terms). # Fuel, power, light and lubricants. Source: Central Statistical Organisation's (CSO) web site; OECD's web site; Economist's website; web site of Federal Reserve Bank of St Louis.

    march 28, 2009 vol xliv no 13

    petroleum products are administered and trade in agricultural goods is far from free, transmission of global inflation to domestic prices occurred with a time lag, from November rather than September 2007. However, with the wholesale price index (WPI) inflation rising from 3.1% in October 2007 to 12.8% in August 2008, and staying in double-digit figures during the succeeding two months, the price pressure in India was significantly greater than that in advanced countries. This is particularly so for CPI inflation which turned double digit in August 2008 and did not show any sign of deceleration even by January 2009.29

    Though the worldwide commodity price-led inflation did not owe its origin to the global financial crisis,30 it reinforced the decelerating tendencies in the Indian economy31 in a number of ways. First, since the demand for food and fuel are income as well as price inelastic, the sharp rise in their prices relatively to those of other goods led to a fall in demand for industrial products and services and strengthened the recessionary forces already at work in the domestic economy.

    Again, the surge in prices of crude oil in the international market affected the country’s trade balance and hence the scale of domestic economic activity both directly and through the multiplier mechanism. However, since the global financial meltdown and recessionary tendencies have also affected domestic output and employment through exports and imports, it is useful to consider simultaneously the transmission of the main external impulses via the trade balance.32

    External Impulse and Foreign Trade

    The significance of the impact on external trade for the domestic economy arises on three counts. First, with the spectacular increase in both merchandise and services exports lasting for more than a decade,33 massive investment has been undertaken in export-oriented sectors, including special economic zones (SEZs). A sharp drop in export growth thus not only effects an economic slowdown through the textbook-type multiplier process, but is also likely to cause debt default, bankruptcies, and severe cutbacks in investments in the pipeline with all their adverse implications encompassing both the financial and the real sectors. Second, given the share of exports at around 22% of GDP, the quantitative impact of a slowdown in exports on domestic demand is far from negligible. Third, crude oil, perhaps the most crucial intermediate input required for sustaining the production process, is the single-most important item of India’s merchandise import, accounting for around one-third of the total. Changes in international oil prices, it is thus no wonder, have major consequences for the Indian economy, remembering that demand for petroleum products34 is relatively price inelastic in the short run.

    In a demand-constrained economy, a rough and ready measure of the growth-debilitating effect of external factors operating through the trade route is the current account deficit,35 reflecting the net leakage of domestic demand to the rest of the world. Judged by this index, the adverse impact of global developments transmitted through trade is fairly clear; since the fourth quarter of 2006-07 the current account deficit has continued to widen and was as high as 4.3% of GDP in the second quarter of 2008-09.36 However, the deficit is the outcome of all factors, both domestic and external.

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    march 28, 2009 vol xliv no 13

    Hence arises the need to examine the various ways in which global developments since the onset of the US sub-prime turmoil have affected India’s exports and imports of goods and services.

    First, the slowdown in global GDP growth has constituted by far the most important factor constraining the country’s exports. Indeed, the extent of deceleration of world income does not fully reflect the seriousness of the problem faced by exporters. The OECD countries account for around 42% of India’s merchandise exports and practically the entire export of services, especially the high-growth ones. With services accounting for 37% of export earnings (including earnings from invisibles) in recent years, the precipitous fall in GDP growth and emergence of strong recessionary tendencies in advanced countries have constituted a major contractionary factor for the Indian economy.37 This is not to deny the importance of exports to developing countries whose share in merchandise exports jumped from 30.9% in 2001-02 to 42.3% in 2007-08. The important point to note in this connection is that, since the world income elasticity of demand for India’s exports appears to be quite high, the negative impact of a global economic meltdown on the country’s export earnings would tend to be correspondingly large.

    Second, the surge in international oil price inflation led to an increase in India’s crude import bill from $5.6 billion in July 2007 to $10.96 billion in August 2008, with the share of oil in total imports rising from 30.5% to 36.6% over this period. The quantitative significance of this doubling of oil imports may be appreciated from the fact that at its height the incremental (monthly) drain from domestic demand on account of oil imports was about 6% of the country’s income and hence constituted a significant source of GDP deceleration during this period. (By the same logic the declining trend in the oil import bill should ceteris paribus be growth enhancing.)

    Third, the global financial crisis, as already noted, affected exports and imports through a drying up of the supply of trade credit. Its net impact on India’s trade balance was perhaps favourable (though the overall effect of the crisis on aggregate demand, operating through the domestic banking system, was undoubtedly negative).

    We have noted earlier a much more important route through which the financial turmoil had a positive fallout for the country’s export earnings. Mounting difficulties faced by the US and other advanced country financial firms have led to large-scale withdrawal of foreign funds, especially FIIs, from the Indian (and other EME) capital market(s). The resulting depreciation of the rupee has helped in limiting the GDP slowdown in two ways. First, in the initial phase of the crisis, when the global meltdown was mostly in the financial and not so much in the real sector, currency depreciation provided a significant boost to the country’s foreign exchange earnings. Thus between October 2007 and August 2008 the NEER and the REER indices declined from 93.3 and 106.1 to 88.6 and 99.6, respectively. During the same period, India’s earnings from merchandise exports in terms of dollars registered a whopping 33.3% (y-o-y) growth (Table 2). It is only since then that the recessionary forces have become dominant everywhere and export growth plummeted and turned negative from October 2008 onwards.

    Depreciation, it is worth noting, also helped in raising the purchasing power of export earnings over domestic consumption and investment. This is so even allowing for the pass through of higher prices of foreign goods (due to depreciation) to domestic prices.38 The quantitative significance of this factor in moderating the slowdown may be appreciated from the fact that during the third quarter of 2008-09 the decline in export growth in terms of dollars was 7.7%, but both under the CSO measure and in terms of command over domestic output there was an increase in export growth of about 6.3%.39 For the five-month period, October 2008-February 2009, when export proceeds valued in dollars showed an uninterrupted negative growth averaging 10.5%, the (direct) contribution of merchandise export growth to domestic demand growth was, in fact, positive and amounted to 3.2%. Hence arises the importance of focusing on the value of exports (or imports) in terms of domestic products for purposes of assessing the effects of exchange rate movements on domestic demand.

    Nor can one overemphasise in this context the need to distinguish among the sources of depreciation. When the depreciation is due primarily to the capital outflow, as happened during the earlier phase of the crisis, it would tend to produce a favourable impact on export and domestic demand. However, if it is the rising trade deficit due to declining world income that lies at the root of depreciation, it only moderates, but cannot reverse the contractionary forces transmitted through trade to the domestic sector. With the decline in export earnings due to the global economic downturn playing an increasingly greater role in driving down the value of the rupee, it is no wonder that since September 2008 there has been a significant fall in foreign exchange earnings from merchandise exports. Over January-February 2009, real exports40 registered an absolute decline, amounting to nearly 3%, even though there was a near 20% (y-o-y) depreciation of the rupee against the dollar during these two months. Indeed, since the demand for services exports are more (OECD-) income elastic, in recent months the (domestic) growth debilitating impact of the crisis operating through trade is much greater than that suggested by the decline in merchandise exports.41

    Let us see how the foregoing analysis helps in explaining the post-crisis features of the Indian macroeconomy noted at the beginning of the present section. There is little doubt that from the last quarter of 2008 both the financial stress and contractionary forces have become significantly stronger in the developed as well as the developing countries. This coming on top of the sharply eroding confidence of domestic economic agents has accelerated the downturn in all components of private demand – household consumption, exports and private investment. No wonder then that, from this quarter onwards there has occurred a qualitative change in the country’s macroeconomic performance.

    We have already explained at length the economic forces at work behind the improvement in export earnings till September 2008 even while there was a slide in world GDP growth. The reason, we have noted, lay in the depreciation of the rupee due to outflow of foreign funds and the sharp fall in capital inflow by way of ECBs. A significant jump in inward remittances in this period also contributed towards the rupee’s weakening and hence larger exports (Table 1A).

    But how to account for the rise in remittances in the midst of the global gloom? The answer seems to be that the gloom as yet was not truly global. Thanks to booming petroleum prices, oil exporting countries were doing very well. Given the importance of the Middle East nations as sources of NRI incomes and as markets for Indian goods and services, the oil bonanza seems to have been an important factor behind the rise in remittances as also in exports.

    Finally for the more pronounced decline in the domestic components of aggregate demand in the earlier phase. The drying up of external sources of borrowing, the sharply rising costs of production of investment goods (due to the jump in prices of minerals and metals), the bursting of the stock market bubble, and the domestic credit crunch, especially in respect of loans for housing and consumer durables – all these acted as major impediments to domestic demand. However, no less important was the role of government policies or their absence.

    4 Policy Omissions and Commissions

    One may identify two types of policy failures that contributed towards the per-crisis slowdown and magnified the negative impact of the global downturn. The first is structural, the second relates to macro-management.

    The deceleration of GDP and industrial output significantly ahead of the global financial storm was, as we have seen, driven by the slowdown in private investment and exports; for both the government’s structural policies were largely to blame. This is not to suggest that all these policies were counter-productive. Indeed, despite tardy execution in some instances, programmes like the Golden Quadrilateral and other highway projects, ruralcum-urban reconstruction, and the employment guarantee scheme have provided both a demand- and supply-side boost to the economy. The initiative for roping in the private sector, through what is called the public-private partnership (PPP), for closing the country’s huge infrastructural gap is also well intentioned. However, the sharp downturn in private sector capital formation since 2004-05 attests to a serious deficiency in this policy of stimulating private investment, especially in sectors with large positive externalities.

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    MANAGER

    march 28, 2009 vol xliv no 13

    Table 4: RBI's Policy Instruments (2006-09)
    Effective since Reverse Repo Rate Repo Rate Cash Reserve Ratio WPI Inflation CPI (IW)
    Inflation
    1 2 3 4 5 6
    24-Jan-06 5.50 (+0.25) 6.50(+0.25) 5 4.2 5.3
    09-Jun-06 5.75 (+0.25) 6.75(+0.25) 5 4.7 5.1
    25-Jul-06 6.00 (+0.25) 7.00(+0.25) 5 4.7 6.3
    31-Oct-06 6 7.25(+0.25) 5 5.3 6.8
    23-Dec-06 6 7.25 5.25 (+0.25) 5.3 7.3
    06-Jan-07 6 7.25 5.50 (+0.25) 5.5 6.3
    31-Jan-07 6 7.50(+0.25) 5.5 6.0 6.9
    17-Feb-07 6 7.5 5.75 (+0.25) 6.7 6.9
    03-Mar-07 6 7.5 6.00 (+0.25) 5.1 6.7
    31-Mar-07 6 7.75(+0.25) 6 6.5 7.6
    14-Apr-07 6 7.75 6.25 (+0.25) 5.7 7.6
    28-Apr-07 6 7.75 6.50 (+0.25) 6.1 7.6
    04-Aug-07 6 7.75 7.00 (+0.50) 4.4 5.7
    10-Nov-07 6 7.75 7.50 (+0.50) 3.0 6.4
    26-Apr-08 6 7.75 7.75 (+0.25) 7.3 5.5
    10-May-08 6 7.75 8.00 (+0.25) 7.6 7.9
    24-May-08 6 7.75 8.25 (+0.25) 7.8 7.9
    12-Jun-08 6 8 (+0.25) 8.25 8.2 7.8
    25-Jun-08 6 8.5 (+0.25) 8.25 11.0 7.8
    05-Jul-08 6 8.5 8.5 (+0.25) 11.6 7.8
    19-Jul-08 6 8.5 8.75 (+0.25) 11.9 7.8
    30-Jul-08 6 9 (+0.50) 8.75 11.9 7.8
    30-Aug-08 6 9 9 (+0.25) 12.4 8.3
    11-Oct-08 6 9 6.50 (-2.50) 11.8 9.0
    20-Oct-08 6 8 (-1.00) 6.5 11.4 9.0
    25-Oct-08 6 8 6 (-0.50) 11.1 9.0
    03-Nov-08 6 7.5 (-0.50) 6.00 10.7 9.8
    08-Nov-08 6 7.5 5.5 (-0.50) 10.7 9.8
    08-Dec-08 5 (-1.00) 6.5 (-1.0) 5.50 8.4 10.5
    03-Jan-09 4 (-1.00) 5.5 (-1.00) 5 (-0.50)* 6.4 10.5
    04-Mar-09 3.5 (-0.50) 5 (-0.50) 5.00 3.4 10.4

    * with effect from 17 January 2009. IW: Industrial Workers. Source: RBI's web site.

    The basic weakness of the government policy relating to PPP, as we have elaborated elsewhere (Rakshit 2006), lies in reliance on private funding of infrastructural investment projects through provision of viability/upfront grants. Given the large and widespread external benefits which private entrepreneurs cannot internalise, indivisibility-cum-durability of these projects, uncertainty concerning demand conditions over the lifetime of the assets created, and the high risk aversion of private lenders and enterprises, it is easy to see why only a fraction of the projected private investment in highways and other infrastructures has actually materialised. No wonder, after the phase of cherry picking projects with assured, high returns was over, the growth in private investment has registered a steep fall. Nor has provision of large explicit or implicit subsidies to SEZs or other specific sectors been of help in improving the overall investment prospects and preventing the fall in aggregate private sector capital formation.

    The reason behind the slowdown in export growth in the p re-crisis period also seems to be largely policy related. Defying all economic logic (Rakshit 2006), the government went in for l arge-scale liberalisation of FIIs. This, apart from inflating the stock market bubble, led to a significant strengthening of the

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    march 28, 2009 vol xliv no 13

    rupee and posed a serious hurdle to the country’s export growth. Indeed, the counter-productive nature of the government policy concerning FIIs may be appreciated from the fact that the RBI had to intervene massively to prevent the value of the rupee from going through the roof and adopt the Market Stabilisation Scheme (MSS) even though it added significantly to the government’s debt burden (Rakshit 2006).

    In the context of the ongoing crisis much more important than the structural policy deficiency has been the failure of macro management. Even in February 2008, nearly six months after the outbreak of the global crisis, the union and the state governments in their budgets for 2008-09 proposed to reduce revenue deficit by 0.4 and fiscal deficit by 0.7 percentage points. The proposals were in observance of the time schedule set under the Fiscal Responsibility and Budget Management Act (FRBMA) and reflected the then entrenched orthodoxy regarding the superiority of monetary and fiscal policies for controlling cycles. For its part, the RBI proved extremely hawkish and went in for a series of dear money measures over a prolonged period. As documented in Table 4, from January 2007 to as late as 10 October 2008, the RBI’s policy was persistently contractionary; over this period, the repo rate and the cash reserve ratio (CRR) were raised to 9.0% from 7.5% and 5.5% respectively. The RBI’s policy during this phase was similar to that of many central banks (including the European Central Bank) and in conformity with the Taylor rule, even though the rule is counter-productive when inflation is commodity price induced and there is a large output gap (Rakshit 2009b).

    It was only when most of the world’s major central banks, including the US Federal Reserve, the European Central Bank and the Bank of England, had simultaneously effected a 0.5 percentage point cut in their policy rates that the RBI reversed its policy stance, cutting the CRR by 250 basis points to 6.5% on 11 October 2008 and the repo rate by 100 basis points to 8% on 20 October 2008. The government also finally relented, and following the examples of China, the US, the UK and other countries announced its first fiscal stimulus package on 7 December 2008. However, since timing is of essence for the effectiveness of counter-cyclical measures, not only for individuals but also policymakers, observance of the Pickwickian principle, though tempting, may not

    o ften be good for the society or the economy.

    Notes

    1 See Rakshit (2008) for a discussion of the origins of the subprime crisis and its rapid contagion. 2 A behaviour christened scapegoat theory in social psychology.

    3 The relevant macro-theoretic framework for countries like India is a structuralist model which incorporates the dualistic features prevalent among different types of markets in developing economies. See Bose (1989), Taylor (1983) and Rakshit (1982, 1989 and 2009a) in this connection.

    4 As distinguished from endogenous components which are governed by income. It may be noted that while analysing the sources of demand for non-agricultural goods, agricultural output may be considered as autonomous or an exogenous factor.

    5 Since our purpose is to identify factors driving the demand for non-agricultural goods and services, we need to consider non-agricultural components of investment, export and so on – something we have not been able to do in view of non-availability of sector-wise data for the relevant components of final demand and the input-output matrix for the reference years. However, this is unlikely to seriously distort our results, remembering that the overwhelming part of both the aggregate and the incremental components of investment, government expenditure and exports consists of non-farm products.

    6 And investment in some cases. 7 Some caveats appear to be in order at this stage.

    First, the presumption is the overwhelming part of GDP is demand determined. Strictly speaking, the procedure suggested in the text yields the

    sources of non-agricultural GDP growth. Second, we have not quantified in the text the component of private consumption out of agricultural income, remembering that for the non-agricultural sector, this component is largely autonomous (Rakshit 1982). Third, were the components identical in respect of their demand-generation impact, c eteris paribus the GDP growth would tend to a pproximate the weighted average of the growth rates of the autonomous components. However, since apart from structural factors (for example, changes in the system of taxation, transfer, and so on) or random shocks, effects of the auto nomous components tend to differ, our procedure gives only a rough-and-ready idea of their relative importance in effecting GDP growth during a period.

    8 Both directly and through the operation of the multiplier effect.

    9 Note that the sharp rise in public sector capital formation in 2005-06 as also in 2007-08 prevented the growth in investment from falling in the two years. However, with the steep and relentless decline in growth of private investment, from 29.9% in 2004-05 to 5.9% in 2007-08 (Table 1A), the onset of the downturn in the most important component of aggregate demand significantly ahead of the global crisis is unmistakable.

    10 Excluding the demand out of agricultural income.

    11 Note that though the global financial turmoil started in the third quarter of 2007-08, world GDP growth did not fall significantly during the financial year. In fact, in the calendar year it increased by 10 basis

    points to 5.2% (IMF 2008, 2009).

    12 To illustrate, suppose prices of a country’s export go up, but the amount exported remains the same. If the increase in domestic prices of consumption and investment goods is less than that in export prices, there would be an increase in the country’s GDP both directly and through additional consumption demand arising therefrom.

    13 The reason, the perceptive reader must have realised, is that in the case of such exports the leakage due to their related imports occurs in the very first round of the additional income generated (through exports). Hence the foreign trade multiplier operates on exports less export-related imports (Tables 1A and 1B).

    14 Curiously enough, the growth jumped to 14.7% in the third quarter of 2007-08 (Table 1A), just when the global financial crisis had broken out – something we shall try to make sense of in the next section.

    15 Note that investment and export constitute major sources of demand for industrial goods.

    16 Indeed, except for 2006-07, when there was a dip in the growth of public investment, both public consumption and investment have displayed a consistently rising trend since 2002-03.

    17 In a full employment economy, this would be a growth promoting factor.

    18 IW: industrial workers; RL: rural labourers.

    19 In view of the fact that there was no significant change in remittances, we have ignored their demand generation role during the pre-crisis period.

    20 Quarterly data for private and public investment separately are not available.

    21 Throughout the period, let us recall, there was a major slide in GDP growth, which would normally tend to reduce imports.

    22 Only large-scale rescue operations by governments in the US and Europe prevented a decimation if not total collapse of the financial sector in these countries.

    23 Unsurprisingly, the global crisis has had no significant impact on the inflow of foreign direct investment (FDI). The resilience of FDI was also conspicuous during the east Asian and Latin American crises.

    24 During this period the RBI holding of forex r eserves declined from $275 billion to $248 billion. However, since a fair part of forex reserves is held in euro, the extent of the RBI sale was much larger than what the figures suggest (remembering that the euro appreciated substantially against the US dollar in this period).

    25 There was however some recovery of FII inflows in December 2007.

    26 This refers to the cumulative increase in bank credit, as its expansion raises both income and asset prices, reduces NPAs, raises bank profits and capital, and thereby augments banks’ capacity (and willingness) to lend. See Bernanke et al 1999.

    27 And their pass through.

    28 While the increase in world agricultural prices was due primarily to poor harvests and trade-restrictive measures adopted by exporting nations, the sources of the oil price inflation may be traced to the high energy-intensive growth (despite the slowdown) of China and many other EMEs; large subsidies on petro-products by both exporting and importing nations; negligible growth in productive capacity; and emergence of speculative tendencies during the later part of the stagflationary phase. For an analysis of factors operating during this phase see Rakshit 2009b.

    29 In its relentlessly upward movement for more than a year, CPI-RL inflation turned double digit in August 2008 and went on to clock 11.4% in January 2009. The rise in CPI-IW inflation was only slightly less, it peaked at 10.5% in October-November 2008 and remained at 9.7% in Decem

    ber 2008.

    30 See note 28.

    31 As well as the world economy (Rakshit 2009b).

    32 Though we have already noted how slowdown of ECBs and outflow of FII tended to produce a favourable trade balance through depreciation of the rupee.

    33 The much faster growth of India’s exports compared with that of world exports is attested to by the fact that between 1994 and 2006 India’s share in world merchandise exports went up from 0.58% to 1.0%; the increase in the share of services exports during the period was much larger, from 0.58% to 2.7% (WTO’s web site).

    34 Hamilton (2008) estimates the short-term elasticity of the demand for crude oil to be about minus

    0.125. 35 This would not be true in a full employment economy where a current account deficit, permitting the country to invest more than its saving, tends

    to be growth promoting.

    36 As per the CSO data available as of now.

    37 Note that between 2006-07 and 2007-08, while

    merchandise export growth declined from 24.3% to 2.2%, the fall in growth of services exports was much sharper, from 34.5% to minus 4.9%.

    38 Remembering that, given the weights of various goods in price indices, the incremental inflation resulting from (say) a per cent depreciation would be significantly less than 1%.

    39 The use of the CSO export price deflator yields an estimate of 6.25%; that of the GDP deflator 6.33%.

    40 Measured in terms of domestically produced goods and services.

    41 Monthly data for exports and imports of services are not available. Hence the surmise.

    References

    Bernanke, B S, M Gertler, and S Gilchrist (1999): “The Financial Accelerator in a Quantitative Business Cycle Framework” in J B Taylor and M Woodford (ed.), Handbook of Macroeconomics, Vol 1C, North-Holland.

    Bose, A (1989): “Short Period Equilibrium in a Less Developed Economy” in M Rakshit (ed.), Studies in the Macroeconomics of Developing Countries (New Delhi: Oxford University Press).

    Government of India (2008): Central Statistical O rganisation (CSO), National Accounts Statistics, (http://www.mospi.gov.in/mospi_cso_rept_ pubn.htm).

    Hamilton, J D (2008): “Understanding Crude Oil P rices”, NBER Working Paper No 14492 (Cambridge, Massachusetts: NBER).

    IMF (2008): World Economic Outlook: Update, 6 N ovember.

    – (2009): World Economic Outlook: Update, 28 J anuary. Rakshit, M (1982): The Labour Surplus Economy

    (Delhi: Macmillan and New Jersey: Humanities Press).

  • ed. (1989): Studies in the Macroeconomics of Developing Countries (New Delhi: Oxford University Press).
  • (2004): “Some Macroeconomics of India’s Reform Experience” in K Basu (ed.), India’s Emerging Economy: Performance and Prospects in the 1990s and Beyond (Cambridge, Massachusetts: MIT Press), reprinted in Rakshit 2009a.
  • (2006): “On Liberalising Foreign Institutional Investments”, Economic & Political Weekly, 41 (11), 991-98. Reprinted in M Rakshit (2009), Money and Finance in the Indian Economy (New Delhi: Oxford University Press).
  • (2008): “The Subprime Crisis: A Primer”, Money and Finance, 3 (3), 75-124.
  • (2009a). “Understanding the Indian Macroeconomy” in Macroeconomics of Post-Reform India (New Delhi: Oxford University Press).
  • (2009b): “Global Economic Crisis: Stagflationary Phase”, Money and Finance, forthcoming.
  • Taylor, L (1983): Structuralist Macroeconomics (New York: Basic Books).

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