global economy and its effects in developing economy final

8/3/2019 Global Economy and Its Effects in Developing Economy Final

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Executive summary:

Economic growth being the impressive word for all the countries in the year 2002-2007, but the

economy of the year 2007-2009 showed the slowdown, which was the real concern for all the

countries.

The developed and the developing countries both faced the problem of the economic slowdown

in the year 2007-2009. Both the economies had a time where it was very difficult to maintain the

their growth rate, some of the countries even had a negative growth during that time, due to

which governments of different countries took the fiscal policies to control the situation. Along

with the fiscal policy which was not sufficient to control the situation, the Federal or the Reserve

Banks took the monetary policies to control the situation. To an extent they had a control over

the inflation but on the other hand they had a great threat from the increasing unemployment of

the countries.

Though, the Central along with the RBI had a control on the inflation of the countries but alsothe countries faced a great imbalance in the demand and supply aggregates.

These problems were mainly due to differences in the export and the import of the countries due

to which they had a great deficit in the balance of payment (account of the export and the import

of the country is done). The value of money fell to an extent where some of the countries found it

difficult to survive. The investment of the developed countries decreased, the investment

decreased due to the risk of their return.

The process of the slowdown followed a trend such as:-

Fall outflows and equity market crash Massive slowdown in ECB, Trade credit and Banking flows. FOREX market crisis, fall in rupee and reserve Money market squeeze. Collapse of the import and the export market. Credit market dries up.

World Growth Rate and Growth Rate of India

The world economy is deeply mired in the most severe financial and economic crisis since theSecond World War. With its increasing impact, both in scope and depth worldwide, the crisis

poses a significant threat to the worlds economic and social development,

World Gross Product (WPG) is expected to fall by 2.6 percent in 2009.compared with the

positive growth of 2.1 percent in 2008 and an average annual growth rate 4 percent prior to the

crisis 2004-2007, whereas Indias GDP growth rate declined to 5.8 percent (year-on-year) in the


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second half of 2008-09 from 7.8 percent in the first half and the growth improved to 6.1 percent

in the first quarter of 2009-10.

There are great fluctuations in the GDP of the world as a whole and in India. As the countries

were facing a hike in the demand, they could not meet with the supply so there was a hike in the

price as well. The government intervened by rising the Bank rates, REPO rates and the CRR due

to which the flow of money in the market reduced to a great extent thus the investment in theeconomy was very less due to which the unemployment rate increased and became a great

challenge for the government.

UNEMPLOYMENT AND ITS EFFECTS

A rapid rise in the unemployment has been witnessed since 2008 and is expected to worsen in

the year 2009-2010. Initially it was projected that there would be a rise in unemployment to a

denomination of 50 million over the next two years but as the situation goes from bad to worse

the number would almost certainly double and going by the historical trend it would taketheeconomy approximately four to five years to revive itself to normalcy. There was a general up

rise in the long term unemployment which was indicted by large scale migrants, and migration

from urban areas to rural areas. However, due to the adaption of expansionary fiscal policy

government, public investment increased and thus there was an increase in employment as

compared to the rest of the world.


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AD= C+G+I+(X-M)

As the Expansionary fiscal policy was being implemented by Government, it increased the

public investing further. This resulted in an increase in demand which indeed resulted in increase

in employment. Paradoxically, there was a rise in unemployment in the other developing

countries.

INFLATION AND ITS MEASURES

In India, we follow the trend of measuring the Inflation by making use of Wholesale Price Index.

It is cumbersome to use the CPI in measuring the inflation in India. Being a vast economy, the

industry is very much disorganized thereby taking a lot of time to keep track of all the industries.

The Economic Survey 2008-09 notes that 157 out of 181 countries in the IMF statistics use

consumer price index (CPI) for tracking inflation. India does not have an aggregate CPI butcomputes sectional CPIs for four different consumer categories (agricultural labor (AL), rural

labor (RL), industrial workers (IW) and urban non-manual employees (UNE).

The inflation has been very throughout the process of the economic growth. When the

government has the motive of the high economic growth they invest more in the economy. Due

to the flow of the money is high in the economy, the purchasing power of the economy increases,

thus the consumption in the economy increase which can be met by increasing the supply as well

which is not possible in a short period of time due to which the prices of the goods and services

rises.

Comparing the inflation rates of the developed and the developing country

The inflation in the emerging country is more than that of the advanced countries is due to fact

that in advanced countries the technology is more advanced than the emerging countries. Thus

they can easily meet with the increasing demand of the country, thereby keeping the inflation in

control.


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Now, considering the inflation in India, we can find that India is undergoing a high rate of

inflation. The high rate of inflation in India is mainly due to large population of the country.

India is mainly facing a high rate of inflation in the food sector.

Food Inflation

Inflation is concentrated in food items and what we have is food inflation and not a general

inflation. For products like personal care and effects and other miscellaneous items, the rates of

inflation have touched 12 per cent and 20 per cent respectively in June 2009. It also happens due

to bad monsoon.

The graph shows inflation in India:


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THE WPI AND THE CPI CONCEPT

India follows the WPI (Wholesale Price index) method, due to the huge distribution of the states

and the non-uniformity of the production prices in the country where as the most of the countries

follows the CPI (Consumer Price Index).

The wholesale price index measures the market prices of the product which is marked by the

wholesalers whereas the consumer price index measures the prices of the product at which the

consumers are charged.


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EFFECT ON THE MANUFACTURING SECTOR

Pre-recession manufacturing sector was having creeping growth, after recession it became

negative growth of -0.3 percent. It happened due to global financial crisis and also due to rise in

fuel prices, employee costs and commodity costs, which in turn increases overall input cost for

manufacturing sector. The sector had started showing growth of 7.4 percent in July 2009 and

10.2 per cent in August. It happened due to loose monetary policy and loose fiscal policy.

All details are given in table below:

Corporate Performance: Manufacturing Sector (Average Annual

Growth in Per Cent)

1997-02 2002-08

Net Sales 11.4 17.9

Income from financial

transactions

1.9 32.6

Other income 9.1 20.5

Total expenses 11.5 17.3

Raw materials, spares, etc. 11.2 22.1

Power and fuel 8.1 11.5

Employee compensation 10.2 11.8

Depreciation 14.8 10.2

Profit after tax -1.4 41.6

EFFECT ON INVENTORY

Manufacturing companies built their inventories during the boom period 2002-08, with a stiffincrease in rate of 18%. After recession, inventory levels declined by 14 per cent in 2008-09, due

to decrease in demand and production.


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FISCAL DEFICIT AND DEBT CONTROL

The fiscal deficit (centre and states combined) came down to 4.2 per cent of GDP in 2007-08

(well below the permitted 6 percent), the primary deficit (fiscal deficit net of interest payments)

turned into a surplus of 1.3 percent of GDP. The total public debt as a proportion of GDP also

came down from the peak of 81.4 per cent in 2003-04 to 75.1 per cent in 2007-08. The situation

changed drastically in 2008-09. The fiscal deficit shot up to 8.9 percent of GDP (10.7 per centincluding off-budget bonds against 5 percent in 2007-08) and the primary surplus turned into a

deficit of 3.5 per cent of GDP. The public debt, however, declined marginally to 74.7 percent of

GDP.

Budget estimates for 2009-10 indicate a further worsening in the current year with the fiscal

deficit rising upto 10.2 per cent of GDP, primary deficit to 4.5 per cent and debt ratio

deteriorating to 76.6 per cent. This has raised afresh the issue of Indias fiscal stability and debt

sustainability.

EFFECT OF THE AGRICULTURAL GDP GROWTH

The poor monsoon on agricultural growth and GDP for the year 2009-10 has considerably

suffered The last time the country experienced a severe monsoon failure was in 2002-03. During


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that year, agricultural output declined by 7 per cent bringing down the GDP growth rate by about

2 per cent.

We estimate the following regression model for agricultural growth (AGRIGR):

AGRIGR = + *RF t + *SA t +*L3AGRIGR t + e t

Where the three variables are:

(1)The deviations of rainfall from normal (RF)(2)The net sown area (SA), and(3)The last three-year moving average of agricultural growth (L3AGRIGR).

EFFECT OF NON-AGRICULTURAL GDP GROWTH

India is using Principal Component Index (PCI) for the non-agricultural GDP forecast. India has

kept the set of leading indicators unchanged. They are (i) production of machinery and

equipment, (ii) non-food credit,(iii) railway freight traffic; (iv) cement sales, (v) net sales of the

corporate sector, (vi) fuel and metal prices, (vii) real rate of interest, (viii) BSE Sensex and (ix)

exports.

The advantage of PCI is that it performs the required scaling of data and assign weights todifferent indicators. The PCI method assigns weights to each component leading indicator by an

iteration process based on its contribution to total variation in the composite index.

The three fiscal packages have moderated the intensity of the impact of the crisis on Indias GDP

growth. This can be shown in below figure.


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BALANCE OF PAYMENTS

Indias BOP has suffered immensely due to global crisis. The current account deficit shot up to

2.6 per cent of GDP in 2008-09 from 1.5 per cent of GDP in 2007-08. And this is the highest

level of current account deficit for India since 1990-91. The impact on the capital account was

more pronounced as the capital account surplus dropped from a record high of 9.2 per cent of

GDP in 2007-08 to ameager 0.8 per cent of GDP in 2008-09. And this is the lowest level of

capital account Surplus for India since 1981-82. The year ended with a decline in reserves of

US$20.1 billion (Inclusive of valuation changes) against a record rise in reserves of US$ 92.2

billion for 2007-08.

Exports continue to drop but imports are falling faster mainly due to lower oil prices. Therefore,

the trade deficit up to August 2009 is lower compared to the same period last year. However,

surplus on the invisibles account has declined in the first quarter from last year as software

exports have declined by 12 per cent although private remittances have grown by 10 percent. The

most striking aspect is the reversal of capital outflows of last year. While foreign direct

investment, external commercial borrowings and bank capital flows (other than NRI deposits)

remain lower or negative so far, huge inflows are taking place this year under portfolioinvestment and, to some extent, under NRI deposits. This is very much the result of the policy

stance in OECD economies, characterized by aggressive monetary easing and near zero policy

rates.


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MONETARY POLICIES AND FISCAL POLICIES

RBI reacted aggressively by bringing down the CRR from 9 per cent to 5 per cent. It also

reduced the Statutory Liquidity Ratio by 1 per cent, Repo rate from 9 per cent to 4.75 per cent

and Reverse repo rate from 6 per cent to 3.75 per cent resulting in increasing money supply in

the economy .RBI also opened windows for bank to lend to mutual funds, Non-banking financial

companies and many housing finance company, The central bank also opened refinancing

facilities for the banks. The actual potential release of primary liquidity by central bank is as

massive as about Rs 5617 billion.

The central Government announced three fiscal stimulus packages which included reduction in

excise duty by 4 per cent point to boost the import.In order to increase the Export, the central

Government reduced the central excise duties and service tax by 2 per cent points. Also, in order

to increase the GDP growth in India Expansionary fiscal policy, it was undertaken by spending

Rs 200 billion in scheme such as Mahatma Gandhi National Rural Employment Guarantee Act,SwarnyaJayanti Gram SwarojgarYojana( SGSY).

Result of the Fiscal Policy: The growth in GDP dropped to 5.8 per cent during the second half of

2008-09 from 7.8 per cent in the first half of the year.Growth improved slightly to 6.1 per cent in

the first quarter of 2009-10.Industry especially the manufacturing sector was the most severely

affected by the crisis. Industrial growth plunged to 1.9 per cent in the second half of the year

2008-2009 from 6.1 per cent. While the service sector has been resilient up to the third quarter of

the year 2008-2009 but later showed signs of weakness with its growth declining to 8.6 per cent

in the last quarter of 2008-09.The lower GDP decline in the private consumption growth to just

2.5 per cent in the second half of 2008-09.The government consumption growth, on the other

hand rose steeply by 35.9 per cent in the second half of the year 2008-2009 from just 0.9 per cent

in the first half of the year. This growth in government consumption played a major role in

reducing the impact of dropping growth and other components of aggregate demand preventing a

large fall in GDP growth

CHANGES IN THE POLICY:

Governments worldwide have made available massive public funding (almost 30% of the WGP

i.e. $18 trillion) to remedy the financial crisis. Many countries also adopted fiscal stimulus plansof about $2.6 trillion (about 4% of the WGP).

A combined effort by the governments is required in the following areas:

1. Further co-operative action is required to restore the financial health of banks, especiallyin developed countries. The fiscal stimulus would be of no use if any further action is not

taken.


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2. There should be proper coordination between the governments undertaking the fiscalmeasures. Failure to coordinate will limit the multiplier effect. Further, as the major

developed countries are undertaking most of the stimulus, it does not ensure adequate

rebalancing of the global economy. If there is proper coordination between the

governments, the stimulus efforts would be larger and also additional resources would be

available for developing countries. In a coordinated policy scenario, the world economy

would recover to an annual growth rate of 4-5% with developing economies growing at

almost 7% per year.

3. Fundamental reforms are needed to overcome the flaws, which caused the crisis in thefirst place, and to guard against future crises. Such reforms should deal with weaknesses

in the international financial system. Balance of payments of many countries is rapidly

deteriorating because of the crisis. Wherever needed, standstill agreements and temporary

moratoriums on existing debt-payment obligations should be part of the package. A new

global reserve system which no longer relies on national or regional currencies as the

major reserve currency should be created.4. A new framework in line with the early 21 st century realities needs to be created. The

changing economic weights in the world economy need to be more clearly reflected.

Global responses till date have lacked the participation of the developing countries. It is

essential to create a body that can provide coordination and set the world on a sustainable

development path.

CONCLUSION

The Monetary and the Fiscal Policy is not enough for the countrys development. As from the

above analysis we can project that the monetary policy becomes effective only after the three

quarters by the time inflation reaches its peak and then it becomes very difficult to control.

The fiscal stimulus has helped in substituting for lost private demand to some extent and

prevented a steeper fall in GDP growth. Post-recession effects are still there. Real Demand for

the industrial sector is still not picking up. The monsoon failure has created uncertainty as to

whether demand growth will be sustained.

The non-agricultural sector may have a better growth than the agricultural sector. The advance in

the agricultural sector is very necessary so that country should be self-sufficient to meet thesudden increase in the aggregate demand. The agricultural sector of India should stress upon how

to store the food grains so that it can meet the demand, which can be the best way to solve the

high inflation rate.

Concrete action will be needed in four major areas to make up for the estimated decline in global

aggregate demand and to increase the overall WGP.


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1) Further decisive and cooperative action is needed to restore the financial health of banks,

especially in developed countries.

2) The fiscal stimulus measures should be better coordinated and aligned with global sustainable

development objectives.

3) Fundamental reforms of the international financial system are needed to overcome the

systemic flaws which caused this crisis in the first place and in order to guard against future

crises.

4) New framework for global economic governance in line with early twenty-first century

realities needs to be created.

global economy and its effects in developing economy final

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