Impact of Inflation and Interest Rates on Gdp, India Assignment

Impact of Inflation and Interest Rates on Gdp, India Assignment Words: 2137

In any economy the Gross Domestic Product at fixed prices, I. E. Real GAP, is the true indicator of its growth and prosperity and can be looked upon to forecast what the future of the economy will be to be able to take policy decisions in a scientific manner. This paper aims at examining various macro economic variables and use statistical methods to find the impact of these variables on each other. For this objective secondary data has been obtained about inflation rate (ICP), bank rate and real GAP of India during the years 2004 to 2013.

This data is on quarterly basis and hence contains over 30 observations. This data is obtained from the Bloomberg Terminal and the website www. Rib. Org. In and regression analysis is employed to obtain findings. Upon rigorous analysis it has been found out that Gross Domestic Product at fixed prices of India during the period under study is positively correlated with interest rate as well as with inflation rate trends for the said period. Keywords Real Gross Domestic Product or Gross Domestic Product at Constant Prices, Base Year, Inflation Rate or Consumer Price Index, Bank Rate and Interest Rate.

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Introduction The Indian economy comes on the 9th position in terms of GAP at market prices and n ten Yet n position In terms AT purchasing power parity our country Is also among the 620 major nations and also the BRICKS. But our economy faces many problems too that if not catered to today may result in the economy going in the shackles of stagnancy and even degradation in the credit ratings by the global rating agencies like Standard & Poor and the likes. The Indian economy has seen a paradigm shift in the millennium and those entire situations play a big role in the shape the economy is in today.

So let us try to map the state of the economy throughout the years 2000 till date. Owing to the IT industry boom worldwide and especially in India the GAP grew exceptionally well in the early sass’s. Another reason for it was the increasing number of cheap skilled labor force in the country and the ongoing trend of outsourcing. In 2004 the economy registered a growth rate of 8. 5 percent which was largely due to strong performance in agriculture and allied sector as well as the services industry.

Inflation for this period measured by the ICP for industrial workers declined significantly from the figures of the last few years to come at 3. 5 percent in March 2004 which started wowing an upward trend in the later part of the year due to increasing wholesale price inflation. In the next fiscal year 2005-06 the GAP at constant prices grew at 9 percent. The economy had shown growth above 8 percent in only five years, three of which were the last three years. According to experts these achievements were possible because of many factors.

These were momentum in industrial investment, modest inflation, growth in exports and imports, progress in fiscal consolidation and the launch of the National Rural Employment Guarantee Scheme (UNREST) for providing Job security to the employable youth. By this time the increasing growth was putting inflationary pressures on the economy and this was observed when the average inflation for the 52 weeks ending February 2007 was recorded at 5 per cent. Though the image of India as a high growth country was helping it in more than one ways by bringing more work in the IT sector and increased development on the industry front.

These factors contributed in bringing the growth rate at 9. 2 per cent in the fiscal 2006-07. There was a strong relation between the policy decisions taken during these periods and the economic performance in the form of high growth of GAP and also rising inflation. Though there was not much change in the stance of the monetary policy but there were significant fiscal policy measures that are worth mentioning. One such is the Fiscal Responsibility and Budget Management Act (FIRMA). Heavy initiatives were taken in the direction of fiscal consolidation under such regimes.

In 2008 the economies worldwide experienced arguably the worst economic meltdown leading to a three year long global recession. This incident was named ‘sub-prime crisis’ as it was basically induced by a huge quantum of sub-prime loans going bad in the US. The effects of the crisis were seen on almost all economies of the world however India had potentially some strengths that made it immune to the crisis to some extent. These were financially sound and well capitalized banking sector among others. However the inflation ever since has been high in the economy.

In 2008-09 growth significantly sled from its figures in the past few years coming down at 6. 7 percent. In the years that followed the policy makers were given a crucial task of bringing the economy back from the shackles of the global economic slowdown. The response was heavy fiscal expansion. This resulted in heavy expenditure on investment and reduction in levy of taxes. The Reserve Bank of India adopted an accommodative monetary policy in the later portion of 2008. This policy basically meaner financing the investment expenditure made by the government by issuing currency and by increasing the money supply in the country.

This decision helped to contain the sentiments of the general public and prevented India from the spill over effect of the global economic slowdown. At the same time the food inflation was rising and the ongoing measures could further fuel inflation so to avoid such situation the central ann. exited from the phase of this monetary accommodation by and restoring the statutory liquidity ratio (SSL) of scheduled commercial banks to its level that was there before the economic crisis. The recent slowdown of the Indian economy can be seen as a combination of the internal and external factors.

The stimulus the economy showed after 2008 led to the healthy growth in 2009-10 and 2010-11. But it should also be noted that because of the boost to consumption and the supply side constraints were leading to more and more inflation. And even after the central banks so many attempts to contain inflation it still continuously rose above the previous years’ numbers. And owing to the weight age given to food inflation in ICP the upward trend has made sure that ICP remains high. In the fiscal 2012-13 the growth of the economy slowed down to a mere 5 percent as compares to 6. 2 percent in the previous fiscal.

At this time the policy decisions have great implications on the future of the economy and thus the relation of the economy’s growth with variables like inflation rate and interest rates is very significant. The findings of this research are going to have huge ramifications on the policy decisions to be taken by the government. Literature Review For the preparation of this research paper several works of study of the similar nature were referred to. These papers were from different economies that facilitated by providing the understanding of how different macroeconomic variables may behave in different ways.

Abdul Aziza ; Merman Mohammad ABA Arabia (2013) collected data on variables like interest rate, inflation rate and GAP over a period of 10 years beginning from 2000 in Jordan. Their study showed that all these variables have a long term relationship among each other. Also, that both interest rate and inflation rate have an effect on real GAP. Evans Eagles ; Samuel Anti (2013) based their research on a similar theme however their research was based on data for 31 years ranging from 1980-2010 in Ghana obtained from Bank Of Ghana and other institutions.

The methodology used in this research paper was to apply multiple linear regressions to find and prove that there exists a positive relationship Detente Interest rate, Initiation rate Ana gross mostly product . I nee research was successful in pointing out that there is a positive relationship between all these rabbles and recommended that the government and the central bank employ policies that maintain a healthy level of these two variables for attaining a good level of economic growth.

Start Julian, Faro-E-Gamma Schema and Muhammad Assam (2013) conducted a similar research in Pakistan making three hypotheses that sought to establish a positive relation between interest rate and real GAP ; exchange rate and real GAP. And also a negative relation between inflation rate and real GAP. It kept the GAP as the dependent variable and the other three variables as independent. They apply regression analysis to establish that their hypothesis is true and correct. They eventually suggest that interest rate ceiling should be discontinued in order to boost the economy.

According to Parmesan V Salina and Sparkman. K (2008) too there are strong long term harmful effects on growth of a country. Based on data collected in India it uses co-integration and error correcting models to find out this relationship. They largely aim their study at providing suggestions to the government about how to use policy tools to keep the inflation under control. Raffia Hammed and Amen Mum (2011) take a slightly different approach as they don’t only keep under the purview of their research the benchmark interest rates but also other rates like the CAR and SSL, report rate etcetera.

They establish the impact of monetary policy decisions on the growth of the country. The data has been taken from Pakistan and the statistical tool used is regression analysis. This has taken the monetary function as the central one and seeks to achieve a positive relationship between money supply in an economic system. This meaner according to their research, in order to increase the growth of the economy the none supply should be increased however critics may say that monetary expansion may be inflationary in nature.

Andrea Bernard (2001) who in his paper compiles data from America for the period 1960-1999 provides an equilibrium model that is used as an initial region of possibility illustrating the impact of interest rates and inflation on the pace at which a country economy might grow. The model upon proper research shoes that inflation and GAP growth have a bearing on the bond yields and thus the interest rates prevalent in the economy. Thomas Alabama and John C. Williams (2001) sing data from the United States base their study on the hypothesis that natural rate of interest changes with time and is dependent on the rate of growth of output.

The authors use the kalmia filter test to prove their hypothesis and also illustrate that inaccurate measurement on the part of the policymakers can have a drastic effect on the overall stability of the macroeconomic state in a country. Timorous Malapropisms (2003) then establishes a relationship between long term bond yields and inflation. The study is made while keeping in reference real and nominal shocks and also shocks to term premix. The relationships found are both of a short term and a long term nature.

Survival Voyeur (2003) brings out the relation between the financial and real sectors of the Indian economy and uses the variables such as interest rates, inflation rate, exchange rate, stock return, and industrial productivity. I nee nature Ana results AT all tense emplace studies snows Tanat tender exists a correlation between macroeconomic variables and it also serves as a learning tool for our study as it explains the phenomena of a similar nature and the data is of quarterly periods in the Indian economy. Methodology

Source of Data: The Consumer Price Index has been considered for inflation and the Bank rate for interest rate has been considered. The data pertaining to both ICP and Bank Rate has been taken from Bloomberg. The data for GAP has been taken from the CAME database. Time period considered for data is from June,2004 to March,2013 (9 years or 36 quarters) Model To test the relationship between GAP and inflation and interest rate, we have used a simple multiple regression model wherein the variables are linear. We aimed to test the dependency of independent variables I. . Inflation rate and Interest over the pendent variable I. E. GAP of India. To get a continuous series of data, we took the log natural of all data streams. The model tested is as follows: GAP = + Pl Inflation Rate + џinterest + ex. where, go, Pl and PA are regression coefficients and ex. is the random error. Method of Analysis The data is sorted and presented in simple tables to be used for analysis. Line graphs and diagrams have been used to make the data more presentable. MS Excel has been used to analyses the data using various statistical tools.

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