BASIC ECONOMICS MODULE LAMP TRAINING 2011-12

WPI- The Wholesale Price Index or WPI is the price of a representative basket of wholesale goods. Some countries use the changes in this index to measure inflation in their economies, in particular India The Indian WPI figure is released weekly on every thursday and influences stock and fixed price markets. The Wholesale Price Index focuses on the price of goods traded between corporations, rather than goods bought by consumers. The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction. This helps in analyzing both macroeconomic and microeconomic conditions. Gross Domestic Product (GDP) - is the total amount of all goods and services produced in the country. This includes consumer spending, government spending and business inventories. Real GDP is a variant that takes out the impact of inflation, so that GDP can be compared over time. Real GDP is the basic measure of business activity and tracks the business cycle. Index of Industrial Production (IIP) -. The indicator measures the amount of output from the manufacturing, mining, electric and gas industries. It shows the health of the manufacturing sector of the country .

Balance of payments (BOP) - is the amount of foreign currency taken in minus the amount of domestic currency paid out; India usually has a balance of payments deficit.

Consumer Price Index (CPI) -is a measure of the price of a basket of goods and services; increases to this index indicate an increase in inflation.

FII (Foreign Institutional Investors)- An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds. The term is used most commonly in India to refer to outside companies investing in the financial markets of India. International institutional investors must register with the Securities and Exchange Board of India to participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies.

Trade deficit results when a country's imports exceed its exports. India usually has a trade deficit. Trade surplus results when a country's exports exceed its import. Current Account Deficit - Occurs when a country's total imports of goods, services and transfers is greater than the country's total export of goods, services and transfers. This situation makes a country a net debtor to the rest of the world. A substantial CAD is not necessarily a bad thing for certain countries. Developing counties may run a current account deficit in the short term to increase local productivity and exports in the future.

FDI- Foreign direct investment is that investment, which is made to serve the business interests of the investor in a company, which is in a different nation distinct from the investor's country of origin.

Fiscal Policy

Fiscal Policy refers to government actions (taxation and government spending) that may influence economic activity. These would include changing tax rates and increasing or decreasing government spending. Fiscal policy can be of two types: Expansionary fiscal policy (Government spending > tax collection): It is used in the situation of slowdown of economy to give a boost to the economy. Reflationary fiscal policies could therefore include: Cutting the lower, basic or higher rates of tax. Increasing the level of personal allowances. Increasing the level of government expenditure.

Contractionary fiscal policy (Tax collection> Government spending) Contractionary fiscal policy is a government policy of reducing spending and raising taxes. It is used in times of economic boom to slow down the economy. Deflationary fiscal policies could therefore include: Increasing the lower, basic or higher rates of tax Reducing the level of personal allowances Reducing the level of government expenditure

MONETARY POLICY

Monetary Policy refers to actions taken by the RBI to either increase or decrease the money supply in the economy. The RBI uses the following strategies to expand or contract funds in the banking system: Buying or selling government securities in the open market. Buying government securities increases the money supply by injecting cash into the economy and helps lead to lower interest rates; selling securities decreases the money supply by removing cash from the economy and helps to raise interest rates. Increasing or decreasing member bank reserve requirements. Higher reserve requirements tighten the money supply; lower reserve requirements loosen the money supply. Increasing or decreasing the discount rate to member banks who borrow reserves from the Fed. A higher discount rate tightens money supply; a lower discount rate loosens money supply. Changing the percentage of credit required to buy securities on margin.

CRR Rate Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks. Statutory Liquidity Ratio SLR (Statutory Liquidity Ratio) is the amount a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the expansion of bank credit. Repo rate Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive. Reverse Repo Rate Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates. It can cause the money to be drawn out of the banking system. Due to this fine tuning of RBI using its tools of CRR, Bank Rate, Repo Rate and Reverse Repo rate our banks adjust their lending or investment rates for common man.

What is Inflation? Inflation is defined as an increase in the price of bunch of Goods and services that projects the Indian economy. An increase in inflation figures occurs when there is an increase in the average level of prices in Goods and services. Inflation happens when there are less Goods and more buyers, this will result in increase in the price of Goods, since there is more demand and less supply of the goods. Relation between Inflation and Bank interest Rates Now a days, you might have heard lot of these terms and usage on inflation and the bank interest rates. Bank interest rate depends on many other factors, out of that the major one is inflation. Some of you might wonder how does increasing interest rate help containing inflation and how effective is it? The answer to the first question is that higher interest rates make borrowing money costlier, because now a borrower needs to pay a higher amount as interest in comparison to earlier. This discourages many borrowers, who now find it expensive to borrow money at such high rates and thus reduces the spending. In short, it reduces demand. How effective is the policy depends on whether inflation is caused due to supply constraints or excess demand. Supply constraints imply that the companies are not able to produce products at the same rate as the demand of those products. They are not able to produce sufficient quantity in time! Thus, in such a scenario, increasing interest rates is not of much help because its not solving the problem, which is of a supply constraint and not of excess demand. If the inflation is on the rise mostly due to an excessive demand (positive outlook for a particular sector like realty or stock market or the entire economy in general), increasing rates helps to a great extent. However, at no point, any one policy alone is sufficient to control inflation.

Currently in India inflation is caused partially due to supply side constraints and partially due to excess demand. However, supply side bottlenecks are affecting inflation much more than demand factors. For example, a bad crop negatively affected the supply of onions and thus led to a tremendous increase in the prices! Thirdly, due to high inflation and increased interest rates, stock markets have reacted negatively. Foreign institutional investors have withdrawn money from Indian stock markets due to high interest rates and inflation. Now you may wonder why? There are several reasons for the same. Lets take them one by one. One, inflation affects the raw material cost of companies. Cost of producing a good goes up due to an increase in inputs like labour, land, raw material, petrol, transportation, etc. Thus the profit margins of most companies reduce. To cover up for the reduced margin, companies hike prices of the goods they sell. Companies are not always able to pass on the increased cost of production onto the customer and have to thus bear a loss in profit share. This reduces the growth prospects of a company and thus its stock price reacts negatively. Another reason for the negative reaction in the stock markets is that FIIs have withdrawn money from Indian markets. Their perception of the Asian economy has gone negative due to high inflation in almost every country. Most of the economies are interlinked with heavy dependence on imports and exports. A lot of economies have crumbled and have thus shaken the confidence in the entire region. Everyone is very cautious. The two reasons combined have led to a negative reaction in the stock markets, due to which a lot of people have lost wealth, further aggravating the situation. Though the Indian economy has done fairly well in comparison to other world economies, inflation has taken a toll on its growth prospects.