GROWTH TRENDS AND GLOBAL COST INFLATION Arvind Virmani

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

INTRODUCTION Trends vs. Cycles: Tendencies Short Term Cyclical fluctuations (Project) => Trend Classify every uptrend as cyclical (‘overheating’) Long Term Trends Medium Term Performance: 2003 -04 to 2007 -08 Short Term: Inflation – Global cost push Role of Policy reform: Sustaining growth Raising productivity/ offsetting cost increases 02 August 2008 General: AV 2

Economic Growth Perspective Phase I: 1950 -1 to 1979 -80 Two sub-phases (50 to 65; 66 to 79) Phase II: 1980 -81 to 1993 -4 Start: Policy regime change End (a) Crises year(1990 -91). (b) Reform initiation 19912 (c) Adjustment/recovery (1992 -3 to 1993 -4) Phase III: 1994 -5 to ? 1994 -95: Statistical significant growth break Rising trend growth 02 August 2008 General: AV 3

Figure 1: Three Phases of Growth (Phase III Result of radical reform) 02 August 2008 General: AV 4

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

Growth acceleration: ( 2003 -4 to 2007 -8) In the next three figures: Cyclical movement around Rising trend HP filtered trend GDPmp: Avg. growth of 8. 9% Per Capita gdp growth has doubled To 7. 3% (from 3. 7% in 1980 -1991) Average income will double in ten years Avg. Private Consumption Gr rt: Almost doubled 02 August 2008 General: AV 6

Fig 2: Growth Acceleration-Gdp 02 August 2008 General: AV 7

Fig 3: Per Capita Income 02 August 2008 General: AV 8

Fig 4: Per Capita Consumption 7% Pc. Pfce Linear(Pc. Pfce) 6% 5% 4% Growth rate (%) 3% 2% 1% 02 August 2008 General: AV 2007 -8 2006 -7 2005 -6 2004 -5 2003 -4 2002 -3 2001 -2 2000 -1 1999 -00 1998 -9 1997 -8 1996 -7 1995 -6 1994 -5 1993 -4 1992 -3 0% 9

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

Fig 6: Investment Led 02 August 2008 General: AV 11

Fig 5: Investment Led Growth 02 August 2008 General: AV 12

CONTRIBUTION TO DEMAND 02 August 2008 General: AV 13

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

Investment: Total, Fixed & Private (ratio to GDP) 02 August 2008 General: AV 15

Supply Side: Savings rate also rose by 9. 8% (2003 -4 to 2007 -8) Avg. 33. 3% of GDP from 23. 6% in previous 5 yrs Private and Public Increment (4 yrs) 5. 1% & 3. 4% respectively Contributed(60: 40) Saving Rate: 36. 1% of GDP in 2007 -8 Maintenance of Investment and Saving Rate at 2007 -8 levels enough to give average growth 0 f around 9% Possible with deceleration in gr of profits, saving & investment to 9%. 02 August 2008 General: AV 16

FDI : Inward and outward 02 August 2008 General: AV 17

Sources of Growth 02 August 2008 General: AV 18

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

Drivers of Growth 02 August 2008 General: AV 20

Sector Drivers of Growth Acceleration in Value Added: Increase in growth rate Highest for Manufacturing and construction Followed by storage & agriculture. Investment Growth: Manufacturing 30. 5% per year Capital stock (end 2007 -8 over end 2002 -3). Construction(1. 92 times) Manufacturing (1. 75 times), rade, Hotels & Restaurants (1. 62 times). 02 August 2008 General: AV 21

Efficiency of Investment . 1992 -3 to 2005 -6 2006 -7 (act) (rev) (est) 11. 1 8. 6 9. 5 10. 5 8. 3 1. 5 1. 3 1. 0 2. 2 Manufacturing 2004 -5 2002 -3 ICOR 2003 -4 0. 5 0. 6 2003 -4 to Change 2007 -8 9. 2 -1. 9 1. 4 1. 2 -0. 4 0. 5 -1. 7 Construction Telecommunication 02 August 2008 General: AV 22

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

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

Global Cost Push? 02 August 2008 General: AV 25

Global Supply: Edible Oil(Palm) 02 August 2008 General: AV 26

Global Supply Shock: Iron Ore 02 August 2008 General: AV 27

Global Supply Shock: Oil Price 02 August 2008 General: AV 28

Rate of Growth: Iron Ore & Oil 02 August 2008 General: AV 29

Contribution to change in WPI 02 August 2008 General: AV 30

Acceleration in Inflation during 2008 H 1 over 2007 H 1: Contribution of different commodities WPI Inflation during H 1 2007 (i. e. from December 2006 end to June 2007 end) was 2. 7%. Inflation during H 1 2008 (i. e. from December 2007 end to June 2008 end) was 9. 9%(est). Of the 7. 2% increase in inflation this year, 2/3 rd was due to 3 sets of commodities: Edible oils (including) oils seeds and oil cakes) Iron and Steel (including iron ore) Mineral Oils and refinery products 02 August 2008 General: AV 31

Inflation in India (WPI) and USA(PPI) 02 August 2008 General: AV 32

Inflation: India-WPI Manf, UK-PPI Manf, USA PPI Ind 02 August 2008 General: AV 33

Inflation Convergence: US & India 19 th Junel 2008 Mumbai Isec: AV 34

CPI(unme) & Gdp Pvt Cons deflator 19 th Junel 2008 Mumbai Isec: AV 35

Monetary Policy and Inflation Cost Push and Monetary accommodation! Monetary Policy includes exchange rate policy Important only for its effect on objectives Monetary Policy Objectives Production/Growth & Inflation – emphasis varies Socio-Political Tolerance level of Inflation Primary Focus Today- Inflation & Expectations Capital flows main driver of RM gr. (prt. Q 4 2007 -8) M 3 gr. exceeded peaks of 92. 10 (98. 10) in 07. 10 M 3 ma gr. exceeded peaks of 95. 04 and 98. 04 in 07. 01 02 August 2008 General: AV 36

Monetary Accommodation? 02 August 2008 General: AV 37

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

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

Growth/Production objective: Policy and Institutional Reform March 2008 Forecast: 8% to 9% (8. 5 -/+ 0. 5) Oil shock and Production(IIP) data: Revised forecast: 7. 75% to 8. 75% (8. 25% -/+ 0. 5) Productivity enhancing reforms can help moderate cyclical downturn and inflation upturn. Motivation for revisiting/reviving pending reforms Energy Sector: Oil shock Investment Environment 02 August 2008 General: AV 40

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

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

Excess Capital Flows-over CAD (% of GDP) 02 August 2008 General: AV 43

Current Act and Goods & Services Deficit 02 August 2008 General: AV 44

Long Term: Sustaining Growth Reforms essential for sustaining 9% for two decades. Policy Reform Structural change: Labor market flexibility Competition: Decontrol, free entry Industry(sugar, fertilizer), mining(coal), infrastructure (electricity - open access), financial services. Education and Skills: Regulated (transparency, rating) entry (freer), controls (minimal) Urban Land policy (land use, supply, development, utilities) 02 August 2008 General: AV 45

Sustaining Growth: Institutional reform Public and Quasi-Public goods & services National Networks: Drinking Water, Waste (solid and liquid) Universal Primary education-outcome (not enrolment) Civic/Urban services Social service delivery: Empowerment Debit/credit (smart card): PC WP 2002 Multi-application smart card (UID): 2005, 2006, 2007 02 August 2008 General: AV 46

References Precursor: India’s Economic Growth: From Socialist Rate of Growth to Bharatiya Rate of Growth, Working Paper No. 122, ICRIER, February 2004. Two Phases (4 sub-phases), Third phase statistically insignificant. Heuristic Theory and Empirics! Policy Regimes, Growth and Poverty in India: Lessons of Government Failure and Entrepreneurial Success!, Working Paper No. 170, ICRIER, October 2005. The Dynamics of Competition: Phasing of Domestic and External Liberalisation in India, ” Working Paper No. 4/2006 -PC, Planning Commission, April 2006. Propelling India from Socialist Stagnation to Global Power: Growth Process, Vol. I (Policy Reform, Vol. II), Academic Foundation, New Delhi, 2006. “Maco-economic Management of Indian Economy: Capital Flows, Interest Rates and Inflation, Working paper No. 2/2007 -DEA, Ministry of Finance, November 2007. Economic Survey, 2007 -8, February 2008 02 August 2008 General: AV 47