MINISTRY OF FINANCE GOVERNMENT OF INDIA Reviewing Macro-economic Developments and Understanding Macro-Economic Policy Module 5 Contemporary Themes in India s Economic Development and the Economic Survey Arvind Subramanian Chief Economic Adviser 2017-06-14 Reviewing Macro Developments (Module 2) 1
Overview I. Why is it important to monitor the economy in real-time: ingredients of any macro-economic assessment through the lens of the last three Economic Surveys II. III. Framework for measuring these trends: domestic and external factors affecting the recent trends and future outlook for (A) Inflation (B) Output Current scenario as an illustration: Policy response: assessing the stance of fiscal and monetary policy 2
I. Ingredients of Any Macro- Economic Assessment 3
Ingredients of Any Macro-Economic Assessment Inflation (Go to Figure) Growth: Overall and sectoral (Go to Figure) Fiscal deficit (Go to figure) External Sector 1. Foreign exchange reserves 2. Capital flows 3. Exchange rates Financial Sector 1. Credit growth Implications for the appropriate stance of fiscal and monetary policy 4
May-09 Nov-09 May-10 Nov-10 May-11 Nov-11 May-12 Nov-12 May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 Current Account Deficit Should be Kept Below 3% of GDP; Foreign reserves should be at comfortable levels 0.0-0.5-1.0-1.5-2.0-2.5-3.0-3.5-4.0-4.5 Current Account deficit (percent of GDP) 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 H1 380 370 360 350 340 330 320 310 300 290 280 270 260 250 Foreign exchange reserves (USD Billion) Indicator Norms Current Status Import Cover 3 Months ~12 months Short term external debt cover ratio 1 1.8 Forex at the advent of financial -5.0 5
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 US$ billion FDI Desirable, Portfolio Investment Volatile 50 40 30 20 10 0-10 Net FDI Net Foreign Portfolio Investment -20 6
Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Rs/$ REER (Apr 2015 = 100) Bilateral Nominal or Nominal Effective or Real Effective Exchange Rates Nominal Exchange Rates: Rs/USD and NEER Real Effective Exchange Rate 69 80 107 68 67 66 65 64 63 62 61 60 Rs/$ (left) NEER 79 78 77 76 75 74 73 72 71 70 NEER (Apr 2015 = 100) 105 103 101 99 97 95 7
Circumstance-Specific Assessments Economic Survey 2014-15 In the 2014-15 Survey, we contrasted the prevailing macro-economic indicators with the 2013 near-crisis situation to bring out the achievement of macro-economic improvement. The 2013 near-crisis situation affected five emerging markets (Fragile Five) so a cross-country, across-time comparison was done. In 2014-15, since inflation had been a challenge, we highlighted what we felt was a possibly structural change in the determinants of inflation: namely rural wage inflation. 8
2010 2011 2012 2013 2014 2015 Improving Macroeconomic Stability: Comparing India with Fragile Five 25.0 20.0 15.0 The Survey relied on an overall macro-vulnerability index (MVI), combing: 10.0 5.0 0.0 1. Fiscal deficit 2. Current account deficit 3. Inflation. Brazil Indonesia South Africa Turkey India Russia Mean MVI 9
2010 2011 2012 2013 2014 2015 Improving Macroeconomic Stability: Comparing India with Fragile Five 6.0 5.0 4.0 3.0 2.0 1.0 0.0-1.0-2.0-3.0-4.0 Brazil India Russia Mean (A Rating) Indonesia China Mean (BBB) Rational investors take into account not just macroeconomic stability but also growth, which crucially determines rewards and returns. The Survey captured this using a rational Investor Ratings Index. 10
Fast Credit Growth and Past Crises Source: GFSR, IMF (April 2017) 11
Poor Standards: Assessing India s and China s Credit Ratings 210 China 11 210 India 11 AA- 190 170 10 9 AA- 190 170 Credit /GDP GDP growth(rhs) 10 9 A+ 150 130 Rating upgrade by S&P in December 2010 8 150 130 8 110 7 110 7 90 TSF*/GDP 6 GDP growth(rhs) 70 5 2010201120122013201420152016 BBB- BBB- 90 70 2010 2011 2012 2013 2014 2015 2016 *Total Social Financing (Source: IMF Article 4 Report for China) 12 6 5
May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 YoY Monthly percentage change Declining Rural Wage Growth: Inflation Momentum Declining Structurally 18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 Rural Wages 13
May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 YoY Monthly percentage change Headline CPI Inflation: A Structural Decline? 18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 Rural Wages and CPI Inflation Rural Wages Headline CPI 14
Circumstance-Specific Assessments Economic Survey 2015-16 and 2016-17 2015-16 Background development was turmoil in China. So, we asked whether there could be a financial crisis in China. Taxonomy of crises (Module 5) Debate on the fiscal deficit target (module 3 and 4) 2016-17 Demonetization was a key issue (Module 14) 15
II. Recent Economic Trends and Future Outlook 16
What is the Macro-Assessment Today? Government decided in the 2017-18 budget to reduce the fiscal deficit deficit from 3.5 % of GDP to 3.2 % of GDP RBI s Monetary Policy Committee (MPC) has very recently taken a decision to keep its monetary policy stance and key policy (repo) rate unchanged. Recent trends in inflation and medium-term outlook Recent trends in output growth and growth outlook 17
Real-time macro monitoring Economic policy is a bit like driving a car while only looking at the rearview mirror 17
II.A. Inflation 19
May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Year on year, percent change Falling headline CPI inflation, over-performing 2017 target for 8 months & well below medium-term target for 6 months 9.0 8.0 Headline CPI 7.0 6.0 5.0 RBI s end March 2017 target 4.0 RBI s medium term target 3.0 2.0 Core inflation excludes food and fuel. True core excludes prices of food, fuel, and petrol &diesel from transport & communication group. Go back 20
May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Year on year, percent change Steady Decline in True Core : Are Underlying Inflation Pressures Easing? 9.0 8.0 Headline CPI Core CPI True Core 7.0 6.0 5.0 RBI s end March 2017 target 4.0 RBI s medium term target 3.0 2.0 Core inflation excludes food and fuel. True core excludes prices of food, fuel, and petrol &diesel from transport & communication group. 21
Inflation Outlook: Is Over-Performance Likely to be Durable? External Factors 1. What is the possible impact of US Fed rate hike? 2. What is the possible impact of the exchange rate movement? (appreciation of 1% in the rupee reduces inflation by about 0.1 percentage point) 3. Are oil prices structurally low after the discovery of shale oil? 22
Spillover Effect of US Monetary Policy Fed Rate Hike Fed Rate Cut Capital outflows from India Capital inflows to India Depreciation of rupee Appreciation of rupee X and M domestic availability of goods X and M domestic availability of goods Inflation Inflation 23
Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Rs/USD$ Easing Imported Inflation: Appreciating Exchange Rate 69 68 67 66 65 64 63 62 24
A Structurally Altered Global Oil and Gas Industry? Newly discovered Shale oil is competitive at $45-50, and can expand/ contract supply quickly (accordion) This has neutered OPEC s price-setting power Effectively, Oil Prices are capped at the marginal cost of Shale. OPEC spare capacity (inverted) Brent USD Source: Roland Berger 25
A Structurally Altered Global Oil and Gas Industry? The new accordion 26
Inflation Outlook: Is Over-Performance Likely to be Durable: Domestic Factors What is the Outlook for the Monsoon and its Impact on Inflation? What is the net incidence of taxes post-gst? What is the impact of the 7 th Pay Commission Award? Will the output-gap narrow or expand? 27
Will the economy bounce-back quickly, exerting pressure on inflation or will the recovery be gradual? Price Demand Supply 28
II.B. The Real Sector 29
Sharply Decelerating Underlying Growth Since Early 2016-17 11.0 Quarterly GVA Growth (%) 9.5 8.0 6.5 5.0 3.5 Headline GVA Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 30
Sharply Decelerating Underlying Growth Since Early 2016-17 11.0 Quarterly GVA Growth (%) 9.5 8.0 6.5 5.0 3.5 Core GVA Headline GVA Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Go back Core GVA is obtained by subtracting agriculture and government services from aggregate GVA. 31
Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 YoY Quarterly Percentage Change Headline vs. Manufacturing GVA 14.00 12.00 10.00 8.00 6.00 4.00 2.00 Headline GVA Manu GVA 0.00 32
Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Percentage change (year on year) Sharp deceleration in new index of industrial production (IIP) growth since June 2016 10 9 IIP (3month MA) IIP 8 7 6 5 4 3 2 1 0 33
May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 Monthly Year on Year Percentage Change Aside: Month on Month Seasonally Adjusted Annualized Rate (SAAR) of Growth vs. Year on Year Growth 10 50 8 6 4 2 0-2 YoY (left) Monthly SAAR (right) 40 30 20 10 0-10 -20-30 -40 Month on Month Seasonally Adjusted Annualized Percentage Change 34
May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 Year on Year Percentage Change Aside: Monthly Year on Year Growth vs. Seasonally Adjusted Monthly Year on Year Growth (Adjusting for Diwali) 10 8 6 4 2 0-2 YoY SA YoY 35
FY11 FY12 FY13 FY14 FY15 FY16 FY17 Apr-17* YoY Growth (percent) A Sharp Decline in Credit Growth to Industry, but Less Dramatic Than the Headline Number Suggests 15.0 10.0 5.0 - -5.0-10.0 Credit to Industry *Note: Credit to industry figures for April are not yet available. It is derived by imputing the share of industry in total credit witnessed in the previous month. 36
YoY Quarterly Growth Weak and Declining Investment (I) 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0-1.0-2.0-3.0 Gross Fixed Capital Formation Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2015-16 (1RE) 2016-17 (PE) 37
Looking forward: Is the Current Slowdown Temporary or Not? We will assess 1. Exports(X), 2. Consumption (C) 3. Investment (I) 4. Government Spending (G) 5. Taxes(T) 38
Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 YoY quarterly percent change REER (Apr 2015 = 100) Exports (X): Rising World GDP Growth Will Lift Exports but Appreciating Rupee Will Undermine Some of It 4.00 3.80 3.60 World GDP Growth 107 105 Real Effective Exchange Rate 3.40 3.20 103 3.00 101 2.80 2.60 99 2.40 2.20 97 2.00 95 39
Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 YoY Quarterly Growth Consumption (C): Will there be a sharp bounce-back After Demonetization? 25 23 21 19 17 15 13 11 9 7 5 Growth in Personal Loans 40
III. What Should be the Stance of Fiscal and Monetary Policy? 41
Government Spending (G): Mild but Steady Fiscal Contraction in 2017-18 at the Central, State, and Public Sector Levels 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Fiscal Deficit of General Government (Excluding CPSE and UDAY) 4.9 4.5 4.1 3.9 3.5 3.2 2.0 2.2 2.5 2.5 2.7 2.6 2012-13 2013-14 2014-15 2015-16 2016-17 State Center RE 2017-18 BE Data for 2015-16 to 2017-18 is for 16 States (accounting for 80-82% of GDP) for which budgets have been presented. 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Borrowings of General Government (Including CPSE, Excluding UDAY) 0.7 0.5 0.5 0.9 1.1 4.9 4.5 4.1 3.9 3.5 2.0 2.2 2.5 2.5 2.7 2.6 2012-13 2013-14 2014-15 2015-16 2016-17 State Center CPSE RE CPSE Central Public Sector Enterprises. 1.0 3.2 2017-18 BE Go back 42
Per cent of GDP Government Spending (G): Public Sector Investment is Falling Despite Weak Private Investment 7.0 6.0 6.0 6.6 6.3 5.0 4.0 2.3 2.7 2.3 3.0 1.9 2.1 2.2 2.0 1.0 0.0 1.9 1.9 1.8 2015-16 2016-17 RE 2017-18 BE Center State CPSE 43
May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 Monetary Policy: Is the Real Policy (Repo) Rate at the Appropriate Level Given Substantially Lower Inflation and Weakening Activity? 5 4 Real Repo 3 2 1 RBI s Real Neutral Rate (1.25%) 0-1 Real repo rate is obtained by subtracting inflation from the nominal repo rate. 44
Conclusions Yours not mine! 45
Recommended Readings 1. Second Bi-monthly Monetary Policy Statement, 2017-18 Resolution of the Monetary Policy Committee (MPC), Reserve Bank of India(June 7, 2017) (https://rbi.org.in/scripts/bs_pressreleasedisplay.aspx?prid=40 685) 2. Chapter 1, Economic Survey 2014-15 to 2016-17. (http://indiabudget.nic.in/survey.asp) 46
Appendix: The GDP Measurement Debate 47
GDP-New Series: Major Changes Moving closer to international practices as recommended by System of National Accounts 2008. In manufacturing sector, moving from an establishment to an enterprise approach, with use of Ministry of Corporate Affairs data (MCA 21). Sales tax used as a measure of growth in trade index instead of a physical proxy which tracked volume of tradable goods (Gross Trading Index) 48
2005-06 2006-07 2007-08 2008-09 2009-2010 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Patterns of Real GDP Since 2011-12: New Series Shows a Large Increase in Crisis Year (2013-14) 11 10 9 GDP mp (2004-05 base) GDP mp (2011-12 base) 8 7 6 5 4 3 5.5 4.7 6.4 5.0 49
Quarterly YoY Growth Divergence Between IIP Manufacturing (Old Series) and GVA Manufacturing Growth Striking 14 12 GVA manufacturing 10 8 6 4 2 0-2 IIP manufacturing (old) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013-14 2014-15 2015-16 2016-17 50
Quarterly YoY Growth Divergence Between IIP Manufacturing and GVA Manufacturing Growth has Decreased Under the New Series 14 12 GVA manufacturing 10 8 6 IIP manufacturing (new) 4 2 0-2 IIP manufacturing (old) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013-14 2014-15 2015-16 2016-17 51
Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 WPI-CPI divergence creates measurement problems 12 10 8 6 4 2 0-2 -4-6 -8 CPI(%) WPI (2011-12 series) (%) 52
1. In Manufacturing, Reduction in Input Prices (WPI) Relative to Output Prices, Under Current Methodology, Could Overstates Real GDP Growth Quantity_Output Quantity_Input Price_Output Price_Input Time 1 10 7.8 20 10 Time 2 10 7.8 20 5 Nominal Values Real Values Time period 1 Time period 2 (Single Deflation) Gross Value of output 200 200 Gross Value of input 78 39 Gross Value Added 122 161 Gross Value of output 200 200 Gross Value of input 78 39 Gross Value Added 122 161 Real Growth in Time period 2 (in per cent) Single Deflation (current methodology) Volume extrapolation GVO 0.0 GVI -50.0 GVA 32.0 0.0 53
2. In Some Services Sectors (20% of Total GVA), Real GVA Growth Measured by Deflating Nominal Growth by Overall WPI Rather than CPI-services Deflator or Some Other Services- Related Deflator Divergence between Inflation Indices 2013-14 2014-15 2015-16 2016-17 WPI-New Series and CPI 1.3 3.3 7.4 2.7 WPI -Old Series and CPI 0.5 2.6 6.2 0.8 54