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.