Assignment on Current Economic Conditions

Symbiosis Institute of Business Management
MBA [Ex. Edu.] Batch 2012-2015
Semester IV
Group Members
Anurag Verma: Roll No: 35413
Amol Surwade: Roll No: 35407
Sushant Jog: Roll No: 35481
Business Analysis – IV
Assignment
Date of Submission: 10/04/2014

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MBA [Ex. Edu.] Batch 2012-2015, Semester – IV
Assignment: Business Analysis IV
Contents
1) What is the main issue with India today-growth or inflation? Why?.............................................3
2) Why is it believed that high growth is normally accompanied by high inflation?...........................4
3) What is stagflation? Why is India experiencing a stagflationary environment? .............................6
4) Will you use Nominal or Real GDP to measure the growth rate? Why?.........................................8
5) What is IIP? How does it help to understand growth levels in India? ............................................9
6) How is Inflation measured in India? What is the difference between CPI and WPI? ....................11
7) Why is it the case that WPI inflation is far lesser than CPI inflation in India?...............................13
8) Why did the RBI Governor not raise rates on 1st
April 2014 policy review even when the inflation
continues to be a concern?...............................................................................................................14
9) If inflation is so high and the growth rate low, why is it that FIIs continue to push funds into India
stocks? ............................................................................................................................................15
10) If you were the Finance Minister of the new Government, what would be the chief 3 policies
you would try to announce in the budget in June 2014?....................................................................16

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1) What is the main issue with India today-growth or inflation? Why?
Since 1991, the Indian economy has pursued free market liberalization, greater openness in
trade and increase investment in infrastructure. This helped the Indian economy to achieve a
rapid rate of economic growth and economic development. However, the economy still faces
various problems and challenges.
Fuelled by rising wages, property prices and food prices, inflation in India is an real and
increasing problem. Inflation is currently between 8-10%. This inflation has been a problem
despite periods of economic slowdown. For example in late 2013, Indian inflation reached 11%,
despite growth falling to 4.8%. This suggests that inflation is not just due to excess demand, but
is also related to cost push inflationary factors. For example, supply constraints in agriculture
have caused rising food prices. This causes inflation and is also a major factor reducing living
standards of the poor who are sensitive to food prices. The Reserve Bank of India have made
reducing inflation a top priority and have been willing to raise interest rates, but cost push
inflation is more difficult to solve and it may cause a fall in growth as they try to reduce
inflation.
Ahead of the 2014 elections, the issue of high inflation is uppermost in the minds of politicians,
policymakers and the people. Consumer prices in India have risen at an average annual pace of
10 per cent during the past five years, and Indian households are bracing for another 13 per
cent increase next year. To check inflation, the Reserve Bank of India has raised interest rates
and will review India’s monetary policy framework in line with recommendations by the Urjit
Patel Committee, which is expected to submit its report at the end of the year. It is also
essential to manage artificially induced national and international mechanisms. The central
bank and Ministry of Finance are working together to analyse and understand the reasons and
find ways to encourage investment and curb inflation.
2013/14 has seen a slowdown in the rate of economic growth to 4-5%. Real GDP per capita
growth is even lower. This is a cause for concern as India needs a high growth rate to see rising
living standards, lower unemployment and encouraging investment. India has fallen behind
China, which is a comparable developing economy

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2) Why is it believed that high growth is normally accompanied by high
inflation?
The relationship between inflation and growth remains a controversial one in both theory and
empirical findings. Originating in the Latin American context in the 1950s, the issue has
generated an enduring debate between structuralists and monetarists. The structuralists
believe that inflation is essential for economic growth, whereas the monetarists see inflation as
detrimental to economic progress.
It is argued that the developed countries do have very well developed financial markets and
less government interventions in goods markets. Such economies are mostly demand driven, in
which case stimulus to demand results in rising prices and a clear tradeoff is observed at low
level of inflation. On the other hand, the developing countries are more vulnerable to supply
shocks causing high variability in inflation and disturb the consumption, investment and
production
behavior. Further,
the government
interventions in
financial and goods
markets and
macroeconomic
rigidities such as
rigidities in labour
laws cause market
failure and
macroeconomic
instability.
Therefore, prices do
not give correct
signals about the
policies and the
course of actions of
the economic
agents.
In the short run, the
relationship
between growth
and inflation is
usually positive.
Policies that raise
output (for example, expansionary fiscal and monetary policies) also raise prices. Inflation is
undesirable because it adversely affects some sections of the population (especially the poor
and those whose earnings are not indexed to prices), distorts relative prices, leads to an

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appreciation of real exchange rates, erodes the value of the financial assets and creates
instability. The ultimate policy objective is a higher level of well-being for the population, but a
conflict arises in the means of achieving it—by higher growth or by lower inflation. There is a
trade-off involved and both cannot be achieved together.
A tightening of fiscal and monetary policies may achieve lower inflation but only at the cost of
growth. The government needs to find the right balance between contractionary and
expansionary policies to maximise the well-being of its people.
Macroeconomic stability and the necessary infrastructure are among the preconditions for
sustained growth. Among the ways inflation can affect growth, an important avenue is the
effect of inflation on investment. Low or moderate inflation is an indicator of macroeconomic
stability and creates an environment conducive for investment.
Countries with low or moderate rates of inflation have higher growth rates over the long-term
compared with countries with high inflation rates. However, low inflation does not constitute a
sufficient condition for growth. The Indian experience appears to support the above view. In
India inflation has generally been kept under control. There have been two episodes of high
inflation since 1980 but price rise has been controlled by various fiscal, monetary and
administrative measures.

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3) What is stagflation? Why is India experiencing a stagflationary
environment?
Stagflation is the term that describes a "perfect storm" of economic bad news: high
unemployment, slow economic growth and high inflation. The term was born out of the
prolonged economic slump of the 1970s, when the United States experienced spiking inflation
in the face of a shrinking economy, something economists had previously thought to be
impossible.
The word stagflation is a contraction of "stagnant" and "inflation." When the economy is
stagnant, it means that the gross domestic product (GDP) -- the standard measure of a nation's
total economic output -- is either growing at a very slow rate or shrinking. The natural result of
economic stagnation is increased unemployment. Businesses lay off employees to save money,
which in turn decreases the purchasing power of consumers, which means less consumer
spending and even slower economic growth.
Stagflation is not entirely new to the Indian economy, though. Such episodes did take place in
the early 1990s, the late 1970s and 1974-75, for instance. But the reasons, then, were mostly
‘external’ in the form of global oil shocks or balance of payments crises: The resulting currency
devaluations ended up disrupting domestic production activity as well as stoking cost-push
inflation. This time, the causes have been essentially ‘internal’, to do with government policy
failure and inaction. These created negative corporate sentiment to begin with, manifesting
itself through an investment slowdown from around the second half of 2013-14. By the time
the Government woke up to announce grand reforms sans any follow-up efforts at actual
implementation, investments had ground to a halt. With new jobs and incomes drying up, its
second-round effects are now being felt in consumption spending as well. The rupee’s
weakening, even if
attributed to ‘external’
factors, has only
superimposed itself on
a largely internal-
induced crisis.
Negative or very little
growth in industrial
output and near
double-digit retail
inflation, as revealed by
the Government’s latest
economic data, points
to a phenomenon of
stagnation coexisting
with high inflation — or,

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quite simply, ‘stagflation’. For policymakers, it represents a nightmarish situation where use of
conventional monetary tightening tools to fight inflation may only exacerbate an already
serious economic slowdown. On the other hand, lowering interest rates to stimulate the
economy could lead to households putting their money into land or gold, as against bank
deposits and other financial savings instruments offering only negative inflation-adjusted
returns. Interest rate cuts, moreover, are problematic when the country is simultaneously
running a huge current account deficit in its external transactions that has to be bridged
through capital inflows.
Today, the Indian economy is suffering from a fundamental absence of growth impulse, be it
from investment, consumption or exports. Together with the cost-push inflationary pressures
from a sliding rupee — not to speak of under-investments in infrastructure and farm sector
productivity, whose chickens are now coming home to roost — the end-result is stagflation.
This phase is unlikely to end without decisive action from the Government going beyond
making big-bang reform announcements. It is not lack of money but of confidence in the
Government’s ability — to clear the regulatory maze erected by its own departments or to
mediate between diverse stakeholders from landowners to workers — that is currently holding
back investments. Unless that confidence returns, which will happen only when businessmen
actually see things moving, there is little way out of the current mess.

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4) Will you use Nominal or Real GDP to measure the growth rate? Why?
Let’s understand first what GDP is and then will decide which one to choose for growth rate
GDP (Gross Domestic Product)
GDP is the total money value of all final goods and services produced in an economy during a
particular year by normal residents as well as non-residents in the domestic territory of a
country but exclude the incomes received from abroad.
GDP
=
Money value of all Goods and Services
+
Income earned locally by Foreigners
–
Income Received by Nationals abroad
In order to calculate the Money value we can choose prices which are based on the prevailing
ones or which are relative to a base year.
Nominal GDP uses the Current Prices for measuring the money value.
Real GDP measures the money value using the prices of a base year.
The growth rate cannot be measured on the basis of current prices because if today prices are
high and tomorrow they are down then it does not show the correct picture.
We vote for Real GDP measure for calculating the growth rate because here the prices are
based on some base year from which the relative performance is measured.

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5) What is IIP? How does it help to understand growth levels in India?
Index of Industrial Production (IIP)
IIP is a zoomed in view of major components of GDP i.e. it measures growth in the industrial
sector. It is also one of the essential short term indicators of the industrial activity in an
economy. It conveys whether the industrial output of a country has increased or decreased and
to what extent with respect to a fixed base reference.
The IIP numbers are calculated in 3 ways as described below:
1) Use Based – The industry is categorized broadly as Consumer Goods, Durable and Non-
Durable goods, Basic and Intermediate goods
2) Sector Wise – Industry is categorized sector wise such as Electricity, Mining, Manufacturing
etc.
3) Detailed Sector – Industry is categorized in to various details sectors.
IIP data is released every month in India. Office of Economic Advisor, Ministry of Commerce and
Industry released the first estimate of Index of Industrial Production officially with the base year
1937 covering 15 important industries. After many revisions, the base year currently stands at
2004-05. Over time, the items that are included in computing this index and their relative
weights have been changed many times.
To arrive at the IIP estimate, data is accumulated and sourced from as many as 15 agencies like
Central Statistical Organization, department of Industrial Policy and Promotion etc. As more
data is made available and responses are received from the manufacturing and other units, the
estimates are revised twice subsequently.
In computing the IIP, production data across 543 items that are grouped into 287 item groups is
taken into consideration and appropriate weights are assigned to reflect a representative index.
These are then broadly clubbed into 3 main categories - mining, electricity and manufacturing.
Mining and electricity are seen as the enablers of manufacturing - and as such, are very
important for growth in overall industrial activity - which in turn impacts overall GDP growth.
How is IIP index calculated : IIP index is calcualted with the Laspeyre's formula . The calculation
involves following steps:
(1) Identifying the weights of the various sectors on Product level , Product Group level and
Industry level. These weights will be identified on the basis of the total output in sales or gross
output value. The weights and the sectors are updated periodically to incorporate the changing
market scenario and the economic dynamics. Weights on the product level can be updated
annually while those of Industry level can be updated every 5 years.
(2) Once the weights are calculated the IIP number is calculated ,The index is a simple weighted
arithmetic mean of production relatives calculated by using Laspeyre’s formula
I=Σ(Wi*Ri)/ΣWi,
Where I is the Index, Ri is the production relative of the i-th item for the month in
question and Wi is the weight allotted to it based on Gross Output.

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The item-wise indices are vertically aggregated at 2-digit of industrial classification
based on weighted average, weights are proportionate to Gross Value Added.
How does IIP help to understand growth levels in India
A shrinking IIP is unfavorable to the overall GDP of a country while a rising IIP suggests that the
industrial activity is expanding and capacity addition is taking place in the economy.
The graph here shows annual growth rate of Indian IIP from 1995 to 2013. Those of us who
track stock markets over the years will notice a very sharp correlation between trends in IIP and
long term trends in the stock market
The period 1996-1997 saw a sharp deceleration in IIP growth, and we know this was quite a bad
phase for the stock markets. A sustained upward momentum in IIP growth rates is clearly
visible from 2003 onwards and this peaked at a massive 20% growth rate in some quarters in
2007. This also coincided with one of the biggest equity bull markets we have seen in recent
history. IIP skidded sharply thereafter in 2008 and bounced back in 2010, only to fall back
sharply in 2011. The stock market pretty much mirrored this movement. Since 2012, although
IIP growth rates are still very muted, we can see an upward trajectory in the direction of the
growth chart. This should perhaps give us some comfort that though growth in industrial
activity is still nowhere near what we saw in the 2005-2007 phase, at least the direction now
seems to be upward rather than downward.

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6) How is Inflation measured in India? What is the difference between
CPI and WPI?
For an economically diverse country like India, a single measure of inflation does not suffice so
it is measured by the Wholesale Price Index (WPI) and Consumer Price Index (CPI). At present,
India has four consumer price indices that account for four diverse groups, viz., agricultural
labourers, rural labourers and industrial workers and urban employees. Another term that was
also considered is GDP Deflator.
Wholesale Price Index (WPI)
A new series of WPI was launched in 2010 with 2004 as base year. The 100 point index is
subdivided into three different groups and it includes 676 items:
1) Primary Article Group, which include food and non-food agricultural products. It has
22% weightage and has 102 items in its kitty.
2) Fuel and Power Category; 19 items with 13% weightage
3) Manufactured products; 555 items with a weightage of 65%
India is one of the few countries where the WPI is considered as the headline inflation measure
by the central bank. This preference over the CPI is often explained in terms of three criteria –
national coverage, timeliness of release (now only limited to food products) and its availability
in a disaggregate format.
Consumer Price Index (CPI)
It is a measure of change in retail prices of goods and services consumed by defined population
group in a given area with reference to a base year. Presently the consumer price indices
compiled in India are:
1) CPI for Agricultural Labourers (CPI-AL): A person is treated as AL if he or she follows one
or more of the agricultural occupations in the capacity of the labourer on hire whether
paid in cash or kind. A variant of this is food indices for AL, which is separately available
along with CPI for AL
2) CPI for Rural Labourers (CPI-RL): A person is treated RL if he or she does manual work in
rural areas in agricultural and non-agricultural occupations in return for wages in cash or
kind.
3) CPI for Industrial Workers (CPI-IW): This covers Industrial workers employed in any one
of the seven sectors namely factories, mines, plantations, railways, public motor
transport undertakings, electricity generation, and distribution establishments as well as
ports and docks. The index covers only manual workers irrespective of their incomes.
4) CPI for Urban Non-Manual Workers (CPI-UNME): An urban non manual employee is
defined as one who derives 50 percent or more of his income from gainful employment
on non-manual work from urban non-agricultural sector.
Among the above indices, CPI-IW measures the cost of living for a fixed basket representing the
consumption behavior of one industrial worker and CPI-AL that of an agricultural worker. CPI-
UNME is mostly used for the purpose of regulating dearness allowance of some of the state

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government public and private employees. Central Board of Direct Taxes also uses the index for
advance tax liability of tax payers from capital gains. CPI-IW is the most well-known of these
indices as it is used for wage indexation in government and organized sector.
Here is the comparison summary between WPI and CPI
W.P.I C.P.I
Wholesale price index measures inflation at
each stage of production
Consumer price index measures inflation only
at final stage of production
Wholesale price index is the middle point of
the sum of all the goods bought by the traders
Consumer price index is the middle point of the
sum of all the goods bought by consumers
Wholesale Price Index (WPI), is based on the
price prevailing in the wholesale markets or
the price at which bulk transactions are made
The Consumer Price Index (CPI), is based on
the final prices of goods at the retail level.
There are only few countries that uses WPI to
calculate inflation rates
Many nations have already shifted to using
CPI.
There are 676 elementary items included in
WPI, some of which are insignificant &
outdated goods that are considered in WPI
CPI, on the other hand, have well-selected
variables.
Category Weights – Base Year is 2004-05
with Energy Products having 14.91% weights,
food 14.3% while services are not included.
Category Weights – Base Year is 20105 with
Energy Products having 9.49% weights, food
49.7% while services are included with 26.3%
weightage.
GDP Deflator
The GDP deflator is
another indicator of
inflation, which is often
considered to be
broader than the CPI
and the WPI.
In-order to calculate this
index, we uses two
more terms:
Nominal GDP which
uses the Current Prices
for measuring the
money value.
Real GDP measures the money value using the prices of a base year.
GDP Deflator = 100 * (Nominal GD / Real GDP)

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7) Why is it the case that WPI inflation is far lesser than CPI inflation in
India?
Last year, RBI governor gave this statement;
“To some extent, the divergence between WPI and CPI can be attributed to statistical
differences stemming from coverage, classification of items and the relative weights of their
constituents. However, there could be other reasons for this as well. For example, higher
transaction costs, taxes, etc. are reflected in the CPI but not in the WPI.”
WPI also referred as headline inflation, as the name suggests it measures the trend in
wholesale prices across various heads of primary articles, fuel & power and manufactured
products. The current series for WPI has a base year of 2004-05. The weightage given to
primary articles is close to 20%, while fuel and power has weightage of approximately 15%, rest
65% weightage has been assigned to manufactured products. Though this index broadly covers
the inflation across different segments of the economy, it is manufacturing based. Also being a
wholesale price index, an individual consumer may not be a direct and immediate beneficiary of
a fall in the inflation number.
Data collection issue still exists and the flow of data is not timely. The WPI doesn’t take the
price of services into consideration, which now accounts for 60% of the GDP (gross domestic
product). Also, it is too general and cannot be used for specific purposes. Basically WPI is not a
true reflection of inflation for a common man. However, in spite of having lacunae it is still used
for policymaking. For a common man, a fall in WPI does not warrant immediate celebration.
The trickle-down effect takes time to work.
The table shown below reflects the percentage of food products given in WPI and CPI
WPI CPI - New Series wef Feb 2012
Base Year 2004-05 2010
Elementary Items 676 200 (Weighted items)
Weightage of Food products 14.3 % 49.71 %
Weightage of Energy products 14.91 % 9.49 %
Weightage of Miscellaneous Items
Services not
included
26.31 %
Food price inflation accounts for much of the gap between the two indices at the moment. We
note that food represents half of the CPI basket (as opposed to 14% of the WPI, or 31% if you
include the less-volatile manufactured food items) and retail food prices are heavily
government influenced. That is the reason we have a lesser value of WPI inflation as compared
to CPI Inflation.

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8) Why did the RBI Governor not raise rates on 1st April 2014 policy
review even when the inflation continues to be a concern?
In the first bi-monthly monetary policy statement for 2014-15, the RBI Governor Raghuram
Rajan decided to pause and not disturb status quo. The repo rate and the rate at which RBI
lends money to banks remained at 8 per cent.
Here is the excerpt from the RBI Monetary Policy Statement 2014-15:
“Our policy stance is firmly focused on keeping the economy on a disinflationary glide path that
is intended to hit 8 per cent CPI inflation by January 2015 and 6 per cent by January 2016. At
the current juncture, it is appropriate to hold the policy rate, while allowing the rate increases
undertaken during September 2013 through January 2014 to work their way through the
economy. Furthermore, if inflation continues along the intended glide path, further policy
tightening in the near term is not anticipated at this juncture”
There are other several reasons for not raising the rates:
1. Retail inflation measured by the consumer price index (CPI) moderated for the third month
in succession in February 2014, driven lower by the sharp disinflation in food prices,
although prices of fruits, milk and products have started to firm up. Excluding food and fuel,
however, retail inflation remained sticky at around 8 per cent. This suggests that some
demand pressures are still at play.
2. There are risks to the central forecast of 8% CPI inflation by January 2015
3. Policy stance will be firmly focused on keeping the economy on a disinflationary glide path
that is intended to hit 8% CPI inflation by January 2015 and 6% by January 2016.
4. GDP growth is projected to pick up from a little below 5% in 2013-14 to a range of 5 to 6% in
2014-15 albeit with downside risks to the central estimate of 5.5%
5. Lead indicators do not point to any sustained revival in industry and services as yet, and the
outlook for the agricultural sector is contingent upon the timely arrival and spread of the
monsoon.

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9) If inflation is so high and the growth rate low, why is it that FIIs
continue to push funds into India stocks?
A late revival in economy in 2013 has investors and experts excited. The gross domestic product
(GDP), a measure of goods and services produced in the country, increased 4.8% in the July-
September quarter of 2013-14, as against 4.4% in the previous quarter. This was higher than
the estimates of most economists and equity analysts. Already, brokerage houses have revised
their 2013-14 GDP growth estimates from 4-4.5% to above 5%.
The sentiment has been helped by the government's aggressive approach to controlling the
current account deficit (CAD), a situation where imports exceed exports. The government has
been successful in restricting gold imports, and as a result CAD, which was 4.8% of GDP in 2012-
13, is likely to come down to 2.5-3% this financial year.
Fuelling hope further is the possibility of regime change at the Centre and the likely emergence
of the Bharatiya Janata Party as the ruling party after the 2014 general elections. Its prime
ministerial candidate, Narendra Modi, is being cheered by industrialists and market experts as
harbinger of change in the Centre's approach towards economic and industrial policies. The
results of the recent assembly elections in five states (in which the BJP got clear majority in
three and emerged as the single-largest party in one) has further established the public
sentiment in favour of the BJP. Equity markets cheered the victory with both the NSE Nifty and
the BSE Sensex gaining over 1.5% on December 9, the day after
the poll results were announced.
Of course, there is also no dearth of factors that can spoil the party. The fiscal deficit (a
situation where government expenses exceed revenues) continues to be a worry. The
government has set the target for
2013-14 at 4.8% of GDP, but most experts say it will not be met.
High inflation and interest rates continue to be a drag. The fear that the US Federal Reserve, or
Fed, will further scale down its liquidity-injection programme, triggering a sell-off by foreign
institutional investors, or FIIs, also looms large over both the rupee and stock markets. The
Fed has already said that it will scale back the programme, called quantitative easing, or QE, by
$10 billion to $70 billion a month from January.
Over the years, investment by FIIs in listed Indian equities has gone up substantially and
currently stands at about 40% of the overall free-float market capitalization. Therefore, a large-
scale sell-off of Indian equities by FIIs would hurt them more than any other investor group.
Given these positive trends and buoyant business expectations, Indian equities could provide
about 20% returns in 2014, taking the Sensex to 26,500 by December 2014. Despite the likely
delay in the investment cycle picking up, the expectation of it happening is likely to help
investment-theme stocks to outperform consumption-theme stocks in 2014.

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10) If you were the Finance Minister of the new Government, what
would be the chief 3 policies you would try to announce in the budget
in June 2014?
Today in India the average Indian citizen is excluded from the benefits of simple financial
services whether it is a bank account, insurance and pension. Post general Election, irrespective
of any government I would like to implement following 3 policies during Jun 2014 Budget.
1) Revive Investment in Slowing Economy
For an economy like India which has tremendous potential, FDI has had a positive impact.
FDI inflows supplement domestic capital, as well as technology and skills of existing
companies. It also helps to establish new companies. All of these contribute to economic
growth. I’ll definitely focus on this policy with high priority.
2) Actions on how the Fiscal deficit can come down to 3 percent of the gross domestic
product (GDP) over 36 months.
3) Educational Reforms
Although India has benefited from a high % of English speakers, there are still high levels of
illiteracy amongst the population. It is worse in rural areas and amongst women. Over 50%
of Indian women are illiterate. This limits economic development and a more skilled
workforce. If a dedicated focus is given to this reform then definitely economy can be
improved.

Assignment on Current Economic Conditions

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