Indicators of Macro Environment

Dr.Mrutyunjay Dash

Key Indicators

Gross Domestic Product– Nominal GDP: It is the value of the total goods and services produced

in an economy over a specified period of time (usually a year) at current market prices. In this calculation only the products for final consumption, capital goods are included.

– Real GDP: It is the physical quantity of goods and services produced. Real GDP is derived by applying GDP deflator to nominal GDP data.

– GDPdeflator: It is a price index number which can be applied to nominal GDP figure to remove the effect of changes in the price level. Thus it gives the real or physical quantity of goods and services produced in a particular year.

• However, GDP, whether measured in nominal or real terms, is the sum total of the output of the various sectors of an economy , computed on an annual basis

GDP Deflator: It is the numerical factor by which GDP value at current prices discounted so that the impact of increased prices in the valuation of GDP is removed and the real GDP figure is arrived at.GDP Rs 300bn -2002 ---Rs 390bn---2003The general price level rises -20%2002-Base yearPrice index in 2002-100 ----120---2003GDP Deflator 120/100=1.2Real or inflation –adjusted GDP value for 2003 390/1.2=325bnIn nominal terms GDP rises by 30%[300-390]But in real terms it is 8.3% [300-325]Real GDP=Nominal GDP/GDP DeflatorOr GDP Deflator =Nominal GDP/Real GDP

Consumer Price Index (CPI):It measures the cost of buying a standard basket of goods and services at different points of time.The standard basket is constituted to represent as closely as possible the consumption pattern of the population.It may include food and clothing, housing, entertainment, electricity, fuel, and other common items of consumption in day-to-day life.Weights are to be given to each item for calculating weighted average.How the weight is decided?Based on the proportion of the item in the total consumer expenditure on the basket.How to find out the proportion?Extensive household surveys are conducted.

Calculation of Inflation Rate based on CPIPdt.Group Share in Basket Price Index Weighted Index

Expenditure 2002 2003

Food 0.10 100 110 11

Clothing 0.05 100 100 05

Housing 0.25 100 120 30

Fuel 0.10 100 110 11

Transportation 0.20 100 115 23

Education 0.30 100 125 38

Total 100 118

Sectoral Shares:

The sectoral shares of GDP indicate the type and nature of an economy.

In agrarian economies the share of agriculture and allied sectors is the largest and the sector provides employment to the largest chunk of population.Economies with higher rates of growth are generally observed to be those in which the share of industry in national output is rising and that of agriculture is falling over time.

Industrialised country: contribution of service sector to national income normally happens to be the highest; more than 60%. Environment for firms in manufacturing or services is rated higher where these sectors account for a predominant share in national output.

• Agricultural Output: A dwindling agricultural sector can destabilise an economy with far reaching consequences for the economy.

Agriculture: Food for population [lapses-food insecurity/food imports]

Raw materials to industryEmployment to masses

Agricultural stagnation:In the face of rising population what would be the possible consequences?Inflation if how?Agriculture, Industry and service sectors interfaceIndustry: electricity, seeds, fertilisers, pesticides and insecticides, tractors, farm implements, etc as inputs . Service sector: credit, transport, insurance, training and marketing services.Technical interpretation: Thus in economies where there is found strong forward linkage of the agricultural sector,the level and rate of growth of agriculture is taken as a key indicator of the macro environment.

Agricultural stagnancy leads to inflation

Increase dependence on imports: A country with deplorable f. exchange reserves will impose tariff on import duty.

This leads to rising cost of input cost making it uncompetitive in both domestic and foreign markets.

Savings and Investment:For the purpose of estimating the domestic saving, the economy

has been divided into three broad institutional sectors.Public Sector: It comprises the public sector undertakings

Corporate Sector: The private corporate sector limits itself to ownership and management.

Household sector: The household sector is a residual sector embracing all economic units other than the units of public sector and

private corporate sector.Mobilisation of Saving: Low level of savings acts as a serious bottleneck

on the path of growth. In case, domestic saving is inadequateThen what is the way out?

It must be compensated by foreign saving. But foreign savings must have to be paid back with interest.

Thus it was argued that development does require sacrifice in the form of restraining consumption to force a higher rate of saving.

Domestic Saving

PUBLIC SECTOR PRIVATE SECTOR HOUSEHOLD SECTOR

Investment:Sustained high economic growth would require considerable improvement in investment. Given the country’s limited domestic resources, it is essential to enhance further the inflows of foreign direct investment. Enhancement of domestic investment would depend upon structural reduction in inflationary expectations and real interest rates, reduction in the fiscal deficit and so on.Rate of Inflation:•Creeping: 2-5%•Walking:5-10%•Running:10-20%•Galloping:20-50%•Hyper:>50%An inflation rate upto 5% is generally considered as a good sign of macroeconomic conditions and indicates stable and profitable conditions for business. It facilitates business planning and enables a firm to make reasonable projections about the future.

• However in macroeconomic dynamics inflation rate impacts the rate of exchange, rate of interest, exports and imports, money supply and credit and so on which affect the business environment.

• Money Supply: Money supply in an economy determines liquidity conditions in the market, interest rate structure and hence the cost of capital to the firms and the rate of inflation.

• Being a sensitive variable money supply should match the rate of growth of output for maintaining price stability in the economy. As when the MS is significantly lower than the growth of output then it badly affects economic growth. Why?. It creates liquidity shortage/increased market rate of interest/depressed demand/finally output.

• Similarly excess of MS begets inflationary Spiral in the economy.

• SLR and CRR:

• As per the stipulation of RBI banks are required to maintain a certain percentage of their deposits with RBI on which interest is also paid. While the banks have also to maintain a certain percentage of deposits in the form of cash and permitted assets and securities and investments. A fall in SLR or CRR makes more funds available.

• Foreign Trade: It not only affects national income but also is an indication of its openness and competitiveness in the world markets. Foreign trade as percentage of national income is used as a measure of a country’s openness or globalisation.

WHY?

• A country with low level of exports and imports indicates its inward orientation and poor international economic relations.

• The composition of trade also speaks of a country’s growth.

HOW?

If a country primarily exports food products & raw material for industry and imports principally improved and sophisticated items then it is said to be an underdeveloped economy. Various ratios have been formed to assess a country’s growth like:– Growth rate of exports and imports

– Exports as per percentage of foreign exchange reserves

– Imports as a percentage of foreign exchange reserves

Foreign Exchange Reserves:– Foreign exchange reserves act as important indicator of economic well-being of a

country for the following reasons.

•It determines the ability to pay for imports•It enables to meet external liabilities•It enables to raise fresh borrowings in international market.The adequacy of foreign exchange reserves: Why is it so important?

Not only to meet all such requirements but also to project a good image of the economy countries should maintain a comfortable level of reserves even by borrowing from abroad. This is probably the reason why a good level of reserves is often seen to co-exist with a high level of external indebtedness.In case of any eventualities of exchange depreciation the central bank should go for a sale of a part of its foreign currency in the market to stabilise its own currency.Therefore for a manger it is not the absolute level of reserves but factors like exchange rate fluctuations, external debt liabilities and the level of imports that really matter a lot.Implications: A dangerously low level of foreign exchange reserves of a country indicates an imminent and substantial devaluation of currency, a foreign exchange crisis and heavy restrictions on imports. All these signs indicate a negative macro environment for the economy as a whole.

Economic Infrastructure:• Quality infrastructure is necessary for economic efficiency. Insufficiency or

poor quality of infrastructure constraints business operations and raises operational costs.

– For example : Poor quality of roads and congested ports increase delivery time and wear and tear charges. Cargo clearance in Indian airport is 15 days where as in Japan it is only 48 hours.

Implications:– Inadequate infrastructural facilities act as a restrain on establishment of

multinational projects for factors such as power shortage, rationalisation of user charges, political risk, lack of resource commitments, long gestation periods and the like.

Social Indicators:– The test of Economic growth depends much on the extent to which it

brings about an improvement in the quality of life of the masses.• Components of Social Development:

– Education– Health care– Sanitation– Family welfare– Water supply– Social security– Nutrition– Social welfare– Poverty ratio; defined as the percentage of population living below the

poverty line

Strategy for Corporate Growth:• Competition based on cheap labour is increasingly

vulnerable.Comparative advantage can be better achieved by:Focusing on the global market opportunity

Competing through technology

And,as such competition will not make vulnerable to:

Competition from other low-wage countries

Products which higher labour contents

Can it be possible through higher productivity of labour forces only?

or

In terms of natural and capital resources.

This can be possible through

Quality features with cost advantage

Concentration on total cost, not just labour cost.

Prevailing Constraints for Growth:Internal constraints:

Lack of latest updated technologyPoor infrastructureAccess to foreign marketsPurchasing power of the domestic marketPolitical intervention in corporate decisionConstraints due to business laws and their administrationLack of customer focusPoor use of information technologyUnder-utilisation of manpower potentialConcerns that often affect business:Ecological and environmental degradation, as brought out in the Rio Summit.Fear of higher unemployment in the richer countries, due to cheaper imports.Fear of political leaders and administrators getting more corrupted.

Strategic Human Resource Management:Strategic HRM is characterised by a long-term focus.Each move in people management is made with an eye on the organisational goals. While this shift in the HRM approach seems to be catching on, let us refer to statistics relating to HRM in 115 units of the fortune 500 companies in the U.S.

Pertinent Questions:

How many of them practised strategic HRM?

Whether this approach improved organisational performance?

What was the role of the HRM managers in the new scenario?

The GM were asked to several questions related to HRM in his organisastion.

HRM managers are included in strategic planning

HRM in most of the cases lack proper attention as subjects like Product development, production and sales.

HRM policy decisions range from that of hiring, firing,rewards,compensation,promotion,etc which will

affect the organisational growth in the long-run.

Thus strategic HRM is a long-run focus.

• Inexpensive Labour a blessing or a curse?Cheap availability/undervaluation: Labour

Inexpensive labour/less incentive to impart for higher productivity through greater investment in technology and human resources.

Hard Reality: An Indian worker produces just about 5.5% as much as his American counterpart or just 75% as much as a Chinese worker.

Bench mark : west or Asian Tigers like Singapore or Malaysia

What went wrong?

Poor infrastructure

Unprofessional working conditions

And……….

Besides, Approach towards labour.

What is the basic flaw in our approach?

Are we globally competitive?

Position of Indian Managers in the world

Country Rank

New Zealand 1

Honkong 2

USA 3

Taiwan 9

UK 16

Turkey 27

India 43

China 48Global Competitive Report,2001

WEF’s Observations for India

The penetration rates of the latest technologies are still quite low by international standards, reflecting India’s low levels of per capita income and high incidence of poverty. Insufficient health services and education as well as a poorly developed infrastructure are limiting a more equitable distribution of the benefits of India’s high growth rates. Moreover, successive Indian governments have proven remarkably ineffective in reducing the public sector deficit, one of the highest in the world.

COUNTRY RANK

Switzerland 1

Finland 2

Sweden 3

Denmark 4

Singapore 5

USA 6

Germany 7

India 43

• Why it has so happened?• Is it due to poor TQM score?• Total Quality Management (TQM) is a comprehensive and structured

approach to organizational management that seeks to improve the quality of products and services through ongoing refinements in response to continuous feedback.

• TQM requirements may be defined separately for a particular organization or may be in adherence to established standards, such as the International Organization for Standardization's series.

• TQM processes are divided into four sequential categories:

• Plan• Do• Check• Act (the PDCA cycle).

Treating labour as cost rather than asset:• Implications:

Reduction of cost may be possible but what about productivity?

Literate and well educated workers could add much needed value significantly virtually anywhere.

Key issues:

Flexibility in utilising labour in varied options

Least importance to productivity aspect

Absence of exit policy/Disguised unemployment.

A slight change in our approach: Productivity Aspect

Higher Productivity/increased output/more margins

More margins/more fruitful investment/more meaningful employment and so on………..

ACT

CHECK

DO

PLAN

In the planning phase, people define the problem to be addressed, collect relevant data, and ascertain the problem's root cause;

In the doing phase, people develop and implement a solution, and decide upon a measurement to gauge its effectiveness

In the checking phase, people confirm the results through before-and-after data comparison

In the acting phase, people document their results, inform others about process changes, and make recommendations for the problem to be addressed in the next PDCA cycle.

Are we really conscious about TQM?

Richard Y Chang, eminent quality management expert opines” companies are viewing TQM as a hobby, a programme, an extra thing to do rather than integrating it”.

• Where do our managers really stand in the global market?

India Rank

• Availability of Managers 18

• Infotech 44

• TQM 42

• Global Managerial Experience 44World competitive Report,2001

BANKING & Its Operation

Commercial BankIt is an institution which accepts, for the purpose of lending or investment, deposits of money from the public repayable on demand or otherwise and in the course of its business creates money.Prof. Sayers Words:CBs are identified as institutions “whose debts- usually referred to as bank deposits-are commonly accepted in final settlement of other people’s debts.”Acceptance of depositsAdvancement of loansRepayment of deposits on demandCreation of money

Functions:

Acceptance of deposits Current account deposits

May be withdrawn at any timeDoes not involve any interest payment

Fixed deposits/Time depositsConstraint on withdrawalsMore returns

Savings Bank depositsMay be withdrawn but under certain conditionsRelatively lower rate of return

Advancement of loans Making ordinary loans: Undertaking/collateral security/an

account is created & total loan amount is credited to that account.

Overdraft: Privileges granted to the customers of a bank overdraw his account. [limit being fixed by the concerned bank]

Cash-credit: Cash credits are loans, granted against the borrower’s promissory notes guaranteed by two sureties at least and often supported by a pledge of securities or goods.

Discounting bills of exchange: Holder of a bill of exchange Commission is deducted Face value of bills of exchange At the time of maturity- bank receives final payment from the

party [initial; who submitted the bills of exchange]

Process of Discounting Bills of Exchange

Businessman A- Rs 60,000 [Delhi]

Goods purchased from B [Mumbai]

A Submitted the bill in his bank

After acceptance by the bank A sends to B

B deposits in his bank & his bank makes payment after deducting the appropriate commission

At the time of maturity bank [A’s bank receives final payment along with interest from A]

Can bank create credit?

Can the credit created by banks leads to multiple credit creation?

What is the mechanism of multiple credit creation?

What would happen to the liabilities of the various banks during the process of multiple credit creation?

Will it continue at the same rate or; every time will go on increasing at a diminishing rate?

Multiple Credit Creation:

Banks are not merely purveyors but also in an important sense, manufacturers of money." Comment [Sayers]

Net addition to the total supply of money-Credit Creation

Deposits

Passive Active

Passive Deposits: Acceptance of deposits.

These deposits do not make any net addition to the stock of money in the economy.

These deposits merely convert currency money into deposit money.

Do these primary or passive deposits carry any importance to the bank?

Yes, as these deposits provide funds out of which the bank makes loans and advances to its customers.

Derivative or Active deposits:

These deposits are created by the bank in a more active manner by opening a deposit account in the name of the person applies for advancement of loans.

Grant Amount-Rs 20,000 /collateral security

Opening the Account- Rs20,000

Every loan creates a deposit.

Initial Deposits-Rs 2000

CRR-10%

Rs 1800- Excess Reserves

Borrower A receives Rs 1800 as loan and issues a cheque to B who has an account in PNB.

PNB receives Rs 1800 as primary deposits CRR being 10%

Excess reserves would be Rs 1,620

In this way the process of multiple credit creation will continue; every time the liabilities of the various banks will go on increasing at a diminishing rate.

This process will continue until the entire excess reserves of Rs 1800 with the first bank have been distributed amongst the various banks in the economy.

The result will be that the total liability of all the banks would be 10 times the original amount of the primary deposit.

Credit Multiplier

Credit multiplier may be defined as the ratio between the ultimate amount of derivative deposits created and the original amount of excess reserves in the banking system.

Derivation of the Credit Multiplier:

CM= The volume of Derivative Deposits

Original Excess Reserves

= Rs 18,000/-

Rs1,800/-10

Interpretation:

Lower is the CRR higher will be the credit multiplier & Vice Versa

Thus CM is the reciprocal of the CRR.

Example:

CRR= 10%=10/100

Its reciprocal=1/10/100=10=CM

If CRR=20%

CM=1/20/100=5

“state in which the value of money is falling, i.e., the prices are rising.”: Crowther

“Inflation is a persistent and appreciable rise in the general level or average of prices.” : Ackley

However there is no generally accepted definition of inflation and different economist define it differently.

• Modern economists analyse inflation in a comprehensive and unified manner.

Inflation is always accompanied by a rise in the price level. It is a process of uninterrupted increase in prices.

Inflation is essentially a monetary phenomenon and is generally caused by excessive money supply.

Demand-Pull Inflation• Demand-pull inflation or excess demand

inflation occurs when aggregate demand for goods and services is greater than the available supply of these goods and services at the existing prices level.

• Thus, demand-pull inflation may be defined as a situation where the aggregate demand exceeds the economy’s ability to supply the goods and services at the current prices, so that the prices are pulled upward by the upward shift of demand function.

Demand-Pull Inflation:

Inflation is caused by an excess of demand or spending relative to the available supply of goods and services at existing prices.

Inflationary Gap: As an excess of anticipated expenditures over available output at base prices. This inflationary gap measures the extent of excess demand.

Total output: Rs 3000 crores/ available for consumption in exchange of money income.

If the economy injects Rs 5000 crores.

Tax paid Rs 800 crores

Net disposable income:Rs 420 crores

Then the inflationary gap woul be Rs 1200 crores.

How the inflationary gap can be bridged?

Increased Tax:

If 20%, then Net disposable income would be 4000.

[5000-20 % 5000]

Inflationary gap would be reduced by Rs 200 crores.

Increased Saving:

If 15% is saved then Net disposable income would be 4000-15% of 4000=Rs 3400

Inflationary gap would be further reduced to 3400-3000=400

Increased Supply:

Existing supply can be increased to bridge the gap.

Cost-Push Inflation

• The true source of inflation is the increase in cost of production

• The increase in cost of production is autonomous of the demand conditions

• The push forces operate through important cost components, such as, wages, profits or material costs, so that cost-push inflation may take the form of wage-push, profit-push or material-push inflation.

Reasons for Wage-Push Inflation

• In the modern times, the trade unions have become very strong and they succeed in securing higher wages for their members. This raises the cost of production and, to maximise their profits, the businessmen raise the prices of their products.• Wage rise may be induced by an excess

demand for labour, which may be the result of excess demand conditions in the commodity market.

• For wage-push inflation to ocuur, it is necessary that trade unions have substantial control over the supply of labour.

• In a country like India where the major portion of the labour force is not unionised, trade unions do not have much influence on wages.

Profit-Push Inflation

• Cost-push inflation also occurs when the monopoly power of the business enables them to raise prices to create their profits. Once started by a few powerful firms other small firms follow the suit and the over all consequence is inflation.

Material-Push Inflation

• Cost-push inflation is also caused by the increase in the prices of some key materials such as steel, basic chemicals, oil, etc. Since these materials are used directly or indirectly, in almost all the industries, the increase in their prices affect the whole of the economy and the prices everywhere tend to increase.

Monetary Policy

• Monetary policy is essentially a programme of action undertaken by the monetary authorities generally the central bank, to control and regulate the supply of money with the public and the flow of credit with a view to achieving predetermined macroeconomic goals. Shaw defines monetary policy as “any conscious action undertaken by the monetary authorities to change the quantity, availability or cost…. Of money”.

Instruments of Monetary Policy

Quantitative Measures of Monetary Control

Bank Rate

Open Market Operations

Cash Reserve Ratio

BANK RATE

• It is the rate of interest charged to a commercial bank which wants to borrow from the central bank.

• How a rise in bank rate is anti-inflationary?

Open Market Operation

• It refers to purchase and sale of govt. securities in the open market by the central bank on its own initiative. A central bank can also buy and sell not merely govt. securities but also other kinds of assets ,viz., bills,bonds,gold and foreign exchange.

Variable Reserve Ratio

• It is a method by which the central bank can alter the reserve requirements of commercial banks. The commercial banks are required by law to keep a minimum proportion of their deposits as cash with the central bank. This is called the statutory minimum reserve and any amount of cash kept by the banks in excess of this is known as excess reserves. The credit creating power of the banks rests on the excess reserves.

Qualitative or Selective Credit Controls

• Fixation of Margin Requirements• Consumer credit regulation

• By raising the minimum down payments• By lowering the maximum maturities or

repayment periods• By extending the coverage of durable goods

for the purpose of application of this regulation.

• Control Through Directives• Moral Suasion• Direct Controls

• Moral Suasion: Moral suasion as a form of selective credit control takes the shape of advice and direction by the central bank not to adopt unsound lending policies. The central bank can encourage banks to follow policies which are in the interest of the country. Moral suasion implies persuading the commercial banks to co-operate with the central bank in pursuing an appropriate credit policy.

Direct Action

• It refers to coercive actions taken by the central bank against commercial banks for follwing unsound credit policies.– It may charge penal rates of discount over

and above the normal bank rate.

Publicity

• It implies weekly statements of its assets and liabilities ,monthly reviews of credit and business conditions and comprehensive annual reports on its own operations, banking conditions published by the central bank. The central bank may employ this instrument of publicity in order to enable others to know its views so that it helps others to shape their policies in a proper way.

Fiscal Policy

Fiscal policy is defined as the government’s programme of taxation, expenditure and other financial operations to achieve certain national ends.

Taxation:

Revenue function

Regulatory function

Revenue function

• In pursuance of its revenue objective, the central government and also the state governments, used their taxing powers extensively and intensively. The govt. may stretch its tax net far wide like the Govt. of India imposed five new taxes such as estate duty, wealth tax, gift tax, expenditure tax, Professional tax, etc.

…………Continued

• Regulatory Function:

• Reduction of disparities in income and wealth

• Restriction of consumer demand with a view to containing inflation

• Shift of investment from non-essential to essential or priority sectors.

How the CPI is Calculated• Assume that there are only three goods (instead of goods and services in

over 200 categories in the actual calculation) included in the typical consumer's purchases and, in the base or the original year, the goods had prices of $10.00, $20.00, and $30.00. The typical consumer purchased ten of each good.

• In the current year, the goods' prices are $11, $24, and $33. Consumers now purchase 12, 8, and 11 of each good.

• The CPI for the current year would be the quantities purchased in the market basket in the base year (ten of each good) times their prices in the current year divided by the quantities purchased in the market basket in the base year times their prices in the base year.

• Thus [(10 x $11) + (10 x $24) + (10 x $33)] / [( 10 x $10) + (10 x $20) + (10 x $30)] = $680 / $600 = 1.133. That is, prices in the current year are 1.133 times the prices in the original year. Prices have increased on average by 13.3 percent. The quantities are the base year quantities in both the numerator and the denominator.

• By convention, the indexes are multiplied by 100 and reported as 113.3 instead of 1.133.

• The base year index simply divides the prices in the base year (times the quantities in the base year) by the prices in base year (times the quantities in the base year). The base-year index then is 1.00; or multiplied by 100 equals 100.

Causes of Inflation

• Over short periods of time, inflation can be caused by increases in costs or increases in spending. Inflation resulting from an increase in aggregate demand or total spending is called demand-pull inflation . Increases in demand , particularly if production in the economy is near the full-employment level of real GDP, pull up prices. It is not just rising spending. If spending is increasing more rapidly than the capacity to produce, there will be upward pressure on prices.

• Inflation can also be caused by increases in costs of major inputs used throughout the economy. This type of inflation is often described as cost-push inflation . Increases in costs push prices up. The most common recent examples are inflationary periods caused largely by increases in the price of oil. Or if employers and employees begin to expect inflation, costs and prices will begin to rise as a result.

• Over longer periods of time, that is, over periods of many months or years, inflation is caused by growth in the supply of money that is above and beyond the growth in the demand for money.

• Inflation, in the short run and when caused by changes in demand, has an inverse relationship with unemployment. If spending is rising faster than capacity to produce, unemployment is likely to be falling and demand-pull inflation increasing. If spending is rising more slowly than capacity to produce, unemployment will be rising and there will be little demand-pull inflation.

• That relationship disappears when inflation is primarily caused by increases in costs. Unemployment and inflation can then rise simultaneously.