Assignment

Macroeconomics
Section 3
Group 7

Nipun Sahrawat FT153037
Minna Thomas FT153020
Ranjith Raman FT153009
Apoorv Mohan FT153058
Souvik Dey FT153079
Vishal Gupta FT153098













Challenges of Macro Economic Policy making in since 2006-2007

The events since 2007 have provided a significant challenge to the orthodox settlement on monetary
and fiscal policy. A policy framework based on a broad inflation targeting regime (including targets
for output and employment) appeared to be very successful in reducing the volatility of inflation and
output. With fiscal policy operating to help smooth the business cycle somewhat with automatic
stabilisers. However, following the financial storm, the zero interest rate floor was found to act as a
significant constraint on interest rate policy and subsequently many cracks in the financial
architecture appeared, and led to the use of alternative or complementary instruments of policy.
There has also been an extensive debate on the extent that we may need to develop further
instruments of monetary policy to complement financial regulation and possibly deal with structural
questions such as global imbalances.
The ongoing financial crisis has asked some very hard questions of modern macroeconomics, an
important aspect of which has been to develop models that allow us to understand macroeconomic
fluctuations using decision rules derived from microeconomic principles. The resulting prescriptions
for monetary policy pay much more attention to the calculation of optimal feedback rules under
uncertainty, learning and various forms of price and wage rigidity. A new Science of Monetary Policy
making has replaced the Art of Central Banking and a generation of economists and policy-makers
now consider the monetary policy problem from within the narrow confines of short term interest
rate targeting. Some new thinking is now required.
The Indian economy recorded robust annual growth of 9 percent plus up until 2008 and this high
growth phase was also accompanied by consolidation of key macroeconomic indicators. However,
this process suffered a setback with the onset of the financial crisis of 2008. Growth rebounded
initially in response to large monetary and fiscal stimuli but has slowed down significantly
subsequently; moreover, a substantial widening of the current account and fiscal deficits occurred
from 2008-09, along with inflation climbing to an elevated level.
With the observed decline in domestic saving and investment rates, there are concerns that Indias
potential growth rate has now fallen significantly. Furthermore, given the large twin deficits, a
balance of payments crisis maybe looming. Especially in view of the declaration of tapering by the US
Federal Reserve from the accommodative monetary policy and the concomitant volatility in the
global and domestic financial markets.
These concerns have receded somewhat now along with the significant correction in the current
account deficit (CAD) that has taken place since the second quarter of 2013-14. There is also a view
that the high growth phase of 2004-09 was a debt-led cyclical boom, supported by unprecedented
capital inflows, coinciding with an exceptional growth phase in the world economy.



After the financial crisis in 2008-09, Indias real GDP growth rebounded sharply during 2009-11, but
this rebound was short-lived and growth decelerated significantly in the following three years (see
table below). This deceleration in growth was accompanied by a number of disconcerting
macroeconomic developments since 2008-09 viz.
(i) The noteworthy fiscal consolidation process witnessed during 2003-08 suffered a
setback and, despite some renewed correction, the fiscal deficit in 2013-14 was still
well-above that of the pre-crisis year.
(ii) The CAD, which was relatively moderate and averaged less than 1 percent of GDP during
1992-2008, widened significantly to just fewer than 5 percent in 2012-13 (but has since
more than halved to 2.3 percent in the first three quarters of 2013-14 in response to
policy actions).
(iii) The headline inflation, especially consumer inflation, has remained persistently high in
the post-crisis period.
(iv) The private corporate investment has declined significantly.
Key Macroeconomic Indicators: 2006-14
Year
Real
GDP
Growth
(factor
cost)
Real
GDP
Growth
(market
prices)
GFD/GDP
(Centre) CAB/GDP
Non-oil
CAB/GDP
WPI
Inflation
CPI
Inflation
REER
Index *
Real
Policy
Rate **
2006-07 9.6 9.3 3.3 -1 3 6.6 6.7 101 3.1
2007-08 9.3 9.8 2.5 -1.3 2.9 4.7 6.2 108.6 2.2
2008-09 6.7 3.9 6 -2.3 3.1 8.1 9.1 97.8 0.9
2009-10 8.6 8.5 6.5 -2.8 1.5 3.8 12.2 95.3 1.5
2010-11 8.9 10.3 4.8 -2.7 1.1 9.6 10.5 103.5 2
2011-12 6.7 6.6 5.7 -4.2 1.1 8.9 8.4 100.7 1
2012-13 4.5 4.7 4.9 -4.7 1.1 7.4 10.4 96.3 0.9
2013-14 4.9 4.6 4.6 -2.3 *** NA NA NA NA
Note:
*: 36-currency real effective exchange rate index (2004-5=100).
**: Nominal effective policy rate less 12-month moving average of non-manufactured products WPI
inflation.
**: April-December.
Source: Reserve Bank of India; Central Statistical Organization.

DOMESTIC MACROECONOMIC POLICIES AND GROWTH SLOWDOWN
Part of the growth slowdown in the Indian context during 2011-14 vis--Vis the immediate post-crisis
years (2008-09 and 2009-10) could be attributed to the withdrawal of the large monetary and fiscal
stimulus that was administered immediately after the crisis. Following the collapse of Lehman
Brothers in October 2008 and the intensification of the Financial Crisis, there were large capital
outflows from India reflecting sales by foreign institutional investors in the domestic stock market.
There was, however, no direct impact of the Lehman collapse on the Indian banking system due to
its limited exposure to toxic assets, in turn reflecting the prudent regulatory framework in India with
regard to banks. Indian financial markets also worked normally in the aftermath of the Lehman
collapse, albeit with elevated volatility. Notwithstanding these relatively positive domestic
developments, there was a sharp slowdown in the domestic economy in the second half of 2008-09;
there was a perception that the global developments would have a serious sustained adverse impact
on the real economy, given the relatively high degree of openness of the Indian economy by that
time.
Here, it is relevant to note that the Reserve Bank of India was in a tightening mode as late as
July/August 2008 in response to the then prevailing domestic macroeconomic conditions.
Nonetheless, given the sharp downturn in the global economy and the perceptions of these
developments having a serious knock-on effect on the domestic economy, India, like many other
EMEs, took both monetary and fiscal measures. In response to these stimulus measures, the Indian
economy was among the first to recover from the Financial Crisis , with growth during 2009-11 being
almost the same as during the pre-Financial Crisis high growth phase (2003-08), but this turned out
to be temporary for a variety of reasons discussed later.
On the whole some direct challenges are:
1.) Sustainable growth
2.) Inclusive growth
3.) Demographic dividend
4.) Inflation
5.) Rapid urbanization
6.) Land reforms
As we can see below, growth has been slowing:

Weak Investment is driving current slowdown:


Inflation reigns high; recent slowing only from base effects:

Large fiscal deficits, slow pace of consolidation

Monetary responses to check inflation:
1) Liquidity adjustment facility (LAF) key element in the operating framework of monetary
policy
2) Single policy rate - Repo - signals stance; operates within corridor set by Bank rate and
reverse repo rate (1%)
3) Objectives: Growth with price stability.
4) Operating targets: overnight call money rate (weighted average);
5) Operating objective: contain this rate around the repo rate within the corridor.
6) Other instruments to manage persistent liquidity: outright open market operations (OMO),
cash reserve ratio (CRR) and market stabilisation scheme (MSS)

RBI Weekly Statistical Release Report
RBI releases a weekly statistical release called Weekly Statistical Supplement (WSS). WSS comprises
of 22 tables each detailing rich data on RBIs monetary operations and emerging trends in banking
and financial markets. Where Federal Reserve has made it mandatory to release its balance sheet
details every week only post the 2007 crisis; RBI has been releasing its balance sheet and other
important monetary data on a weekly basis via this WSS release.
What is interesting to note is many tables in WSS are inter-linked picking data from other tables but
labelled differently. Reading and analysing WSS hence becomes a difficult and complex task. As WSS
points to some important developments in the economy particularly monetary trends,
understanding the flow of money is important.
WSS has two main sets of data released at different dates:
RBIs monetary operations data: This includes RBIs balance sheet, forex reserves and
reserve money. This is released with a weekly lag. Thus WSS of 30-Dec-13 will show figures
of 23-Dec-13.
Banking and Financial Market data: This includes data on commercial bank deposits and
credit, money supply etc. This is released with a fortnightly lag e.g. WSS of 30-Dec-13 will
show figures of 16-Dec-13.
There is other kind of data as well which is just for reporting purposes. It includes financial market
data like BSE/NSE closing, Certificates of Deposit, Commercial Paper etc. which are reported as per
data availability. Like CD data is released with a lag of almost 2 months, CP data with one month etc.
The other financial market data related to secondary markets like BSE/NSE closing, G-Sec turnover
etc. are reported with a week lag.
The challenge with WSS is to understand the meaning of the various items in RBIs monetary
operations data and Banking data. RBI releases its Annual Balance Sheet every year for the year
ending on 30 June. The Annual Balance sheet explains the terms of RBIs balance sheet with more
clarity and details. Hence, we chose a date which matches data presented in WSS and RBIs balance
sheet.
There are three main tables on RBIs monetary operations in WSS:
Table 1 : Reserve Bank of India - Liabilities and Assets
Table 2: Foreign Exchange Reserves
Table 8: Reserve Money: Components and Sources





TABLE 1

TABLE 2
2. Foreign Exchange Reserves
Item As on June 27, 2014 Variation over
Week End-March
2014
Year
` Bn. US$ MN. `
Bn.
US$
MN.
` Bn. US$
MN.
` Bn. US$
MN.
1 2 3 4 5 6 7 8
1 Total Reserves 18,954.9 3,15,778.7 2.2 856.6 671.1 11,555.5 2,035.1 31,133.8
1.1 Foreign Currency
Assets
17,356.4 2,88,812.6 1.5 850.9 747.3 12,453.3 2,116.4 33,534.4
1.2 Gold 1,227.3 20,790.4

68.9 776.4 62.7 2,045.6
1.3 SDRs 268.1 4,459.8 0.5 4.0 0.2 3.8 8.9 118.0
1.4 Reserve Position in
the IMF 103.1 1,715.9 0.2 1.7 7.1 117.6 27.5 473.0




TABLE 3
5. Ratios and Rates
(Per cent)
Item/Week Ended
2013 2014
Jun. 28 May 30 Jun. 6 Jun. 13 Jun. 20 Jun. 27
1 2 3 4 5 6
Ratios

Cash Reserve Ratio 4.00 4.00 4.00 4.00 4.00 4.00
Statutory Liquidity Ratio 23.00 23.00 23.00 23.00 22.50 22.50
Cash-Deposit Ratio 5.26 4.84
..
4.95
.. ..
Credit-Deposit Ratio 76.37 76.52
..
77.08
.. ..
Incremental Credit-Deposit Ratio 45.50 32.81
..
49.11
.. ..
Investment-Deposit Ratio 30.14 29.05
..
29.05
.. ..
Incremental Investment-Deposit
Ratio
38.48 40.70
..
42.14
.. ..
Rates

Policy Repo Rate 7.25 8.00 8.00 8.00 8.00 8.00
Reverse Repo Rate 6.25 7.00 7.00 7.00 7.00 7.00
Marginal Standing Facility (MSF)
Rate
8.25 9.00 9.00 9.00 9.00 9.00
Bank Rate 8.25 9.00 9.00 9.00 9.00 9.00
Base Rate 9.70/10.25 10.00/10.25 10.00/10.25 10.00/10.25 10.00/10.25 10.00/10.25
Term Deposit Rate >1 Year 7.50/9.00 8.00/9.05 8.00/9.05 8.00/9.05 8.00/9.05 8.00/9.05
Savings Deposit Rate 4.00 4.00 4.00 4.00 4.00 4.00
Call Money Rate (Weighted
Average)
7.19 7.78 7.90 8.00 8.18 8.11
91-Day Treasury Bill (Primary)
Yield
7.48 8.65 8.52 8.56 8.56 8.56
182-Day Treasury Bill (Primary)
Yield .. ..
8.60
..
8.66
..
364-Day Treasury Bill (Primary)
Yield
7.50 8.70
..
8.60
..
8.70
10-Year Government Securities
Yield
7.44 8.67 8.52 8.59 8.70 8.72
RBI Reference Rate and Forward
Premia

INR-US$ Spot Rate (` Per
Foreign Currency) 59.70 59.03 59.20 59.48 60.28 60.10
INR-Euro Spot Rate (` Per
Foreign Currency)
77.98 80.34 80.83 80.71 82.12 81.88
Forward Premia of US$ 1-month 6.63 8.13 8.41 8.57 8.56 8.69
3-month 6.23 8.54 8.65 8.68 8.76 8.79
6-month 5.90 8.54 8.82 8.61 8.66 8.92

Below are the highlights of the RBI monetary policy of India 2014-15:

Short-term lending (Repo) rate unchanged at 8%
Cash reserve ratio (CRR) unchanged at 4%
SLR cut by 50 bps to 22.5% to unlock banking funds
Expect economic growth for 2014-15 to be between 5-6%
Further policy tightening will not be warranted if inflation continues to decline
Reiterates CPI inflation target of 8% by January 2015, 6% by 2016
Decisive election results should help bring in gradual recovery of growth
Farm sector outlook clouded by forecast of delay in monsoon
Export credit refinance facility cut to 32% from 50%
FPIs allowed in currency derivative market
Indians as well as non-residents can carry up to Rs 25,000 while leaving country
Hikes eligibility limit for forex remittances to USD 1, 25,000, from USD 75,000 at present.

Analysis of the Current Macroeconomic Monetary Trends:

1. Output:

Growth in the Indian economy had been shifting down from 9.6 per cent in Q4 of 2010-11. It
troughed around 4.4 per cent for three quarters from Q3 of 2012-13 to Q1 of 2013-14. Since then
there are signs of growth bottoming out with marginal improvement recorded during Q2 and Q3 of
2013-14 to 4.8 and 4.7 per cent respectively.
However, this improvement has been feeble and clear signs of recovery are yet to emerge, even as
the economy seems to be gearing for a modest recovery during 2014-15. Decline in financial savings,
sluggish growth in fixed capital formation over successive quarters, persistently high inflation and
low business confidence contributed to the decline in potential growth, particularly in the absence
of adequate structural policy measures to lower inflation on a durable basis through improved
supply responses and to facilitate implementation of large investment projects.
Agriculture sector witnessed record production Industrial growth stagnating- The Index of Industrial
Production (IIP) showed no increase during April-January 2013-14, compared with 1.0 per cent
growth in the corresponding period of the previous year. This stagnation in growth over two years
reflects subdued investment and consumption demand.
Employment scenario showing signs of gradual recuperation The IT-BPO sector contributed to this
improvement along with other sectors such as textiles, telecom, pharmaceuticals as well as
travel/tourism

2. Aggregate Demand:

In contrast to the pick-up in GDP growth at factor cost, the GDP growth at market prices during Q3
of 2013-14 moderated, reflecting lower mobilization of net indirect taxes. Component-wise, both
private and government final consumption expenditure continued to decelerate while fixed
investment contracted in Q3. The weighted contribution of net exports to overall growth continued
to remain the highest amongst all the components of GDPs expenditure side.

3. Inflation:

CPI inflation declined to 8.1 per cent in February 2014 (a 25-month low) from 11.2 percent in
November 2013, mainly due to declining vegetable prices during this three-month period
Apart from vegetables, CPI inflation in cereals and products posted a significant decline at 9.9 per
cent in February 2014 from 12 per cent in November 2013. However, the pace of decline may come
off as vegetable prices appear to have run their course of seasonal correction.
4. External Factor:

External sector risks have been decidedly lowered, allowing monetary policy to focus on its core job
of lowering inflation and supporting growth subject to disinflation.

Imports continued to contract for the ninth successive month, with a sixth straight month of double
digit decline. The decline in imports was primarily due to sharp moderation in gold imports since July
2013.

Overall, Indias trade deficit at US$ 128 billion during April-February 2013-14 was about 29 per cent
lower than that of US$ 180 billion during April-February 2012-13.

5. Monetary and Liquidity Conditions:

The Reserve Bank in its Third Quarter Review of Monetary Policy on January 28, 2014, hiked the repo
rate by 25 bps to 8 per cent on account of upside risks to inflation, to anchor inflation expectation.

6. Macro-Economic Outlook:

Various surveys conducted around January 2014 had indicated that business confidence improved
significantly for Q4 of 2013-14. The Reserve Banks 65th round of Industrial Outlook Survey
conducted during February-March 2014 reaffirmed that in terms of assessment, the Business
Expectations Index improved in Q4 of 2013-14 as compared to the previous quarter. However, based
on expectations, it moderated marginally for Q1 of 2014-15.
Conclusion:
Prospects of a pick-up in real GDP growth in the second half of 2013-14, have been dampened by
negative growth in industrial production over two consecutive months, sluggishness in services
sector activity and the weakening in private consumption and investment demand. Notwithstanding
the improved export performance and buoyant outlook for agricultural production, GDP growth for
2013-14 could be somewhat lower than the central estimate of 5 per cent projected at the time of
the Second Quarter Review.