EPS Magazine Pragati

7/29/2019 EPS Magazine Pragati

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VOLUME I No.1 FEB 2013


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Editorial Board Coordinators

Debtanu Dutta Batch 2012-14 Akash Deep Batch 2011-13

Biswa Prateem Das Batch 2012-14 Siddhartha Roy Batch 2011-13

Manjunatha D Belgere Batch 2012-14 Sukriti Jain Batch 2011-13(Designing)

Swati Gupta Batch 2011-13

Contact us [email protected]


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Indian Institute of Management, Kozhikode Page 3

Presented by

Economics Politics & Social Sciences Interest GroupIndian Institute of Management Kozhikode


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Editorial

We are very happy to present you the inaugural volume of Pragati, magazine fromEconomics, Politics

and Social sciences (EPS) Interest Group of IIM Kozhikode. This is a result of tireless effort and

dedication from the student members of the group and endless inspiration and help from the faculty

members of our Faculty Advisory Board.

EPS Interest Group is a cohort of enthusiasts on economic, political and social issues. Main aim of this

group is to create awareness about recent related issues and sensitize the community on the importance ofhuman initiatives. As a group we facilitate debate, discussion, article writing and other activities. Our

teachers always say that creating awareness is the first step of mobilizing people. EPS strives to engage

people in various activities to create a vibrant and sensitive human community.

Pragati, one of the many activities undertaken by EPS, represents the thinking jewel within the academia.

The first issue of the magazine consists of independent researches by students about various pertinent

economic issues, novel social perspectives from faculty members and brief descriptions about some

activities done by EPS group till date.

Pragati aims to inspire thought leaders to come forward and articulate their research on contemporary

issues on economic, political and social importance. We hope that such endeavor will generate futuredebates or discussions in the intelligentsia.

Hope all of you will enjoy the magazine!

Sincerely,

Team EPS


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Contents

An Interview with Dr. Debashis Chatterjee, Director IIM Kozhikode 06

FDI in Multi Brand Retail in IndiaA Game Theory View 08

Foreign Investment in recent times - Trends, Issues and Challenges 12

Global Financial Crisis: Impact on India 15

The Impossible Trinity and its Implications on the Indian Economy 18

Crime and Misery: the Indian Case 21

Monetary Policy Transmission Mechanism 24

Fiscal DeficitAn Indian Perspective 27

The Current Account Deficit CrisisAn Analytical Insight 30

Evaluating decisions on Brand Ambassadors - a Game Theoretic Framework 33

Caste Politics in Karnataka - A Game Theory Perspective 37

Life between Shopping malls 41

Talk on the work of Nobel Laureate Economists Roth and Shapley 46

EPSiz: A Quizzical Journey 47

Pol-Trics 49

Talk & Tease 51

EPSThe Facebook page 52


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An Interview with Dr. Debashis Chatterjee, Director IIM Kozhikode

on 26 January, 2013 by Biswa Prateem Das & Debtanu Dutta, EPS members

We are seeing so many incidents of social crimes, what may be thereasons?

Todays youth is under pressure of huge expectations, backed by an

outbound life and a frantic mass media which is driving them for seduction

fulfillment. They always see a well-dressed woman as well packaged

merchandise. Thus they are such type of consumers who couldnt contain

their urge to consume. In a nut-shell todays youth are less contributor, and

more of a consumer who wants to consume at any cost.

Earlier people used to grow onions and potatoes in their field, and then used to consume them. Sothey had respect towards what they have produced. Today people are just buying them from

supermarkets and carelessly throwing them after their needs are fulfilled. We can see that there is

gross degeneration of institutional values as a whole making India a democracy that is not just

dented but also badly painted for the world to see (please refer to Elections 2014: Rethinking

democracy published in The Economic Times, dated 26th Jan, 2013).

In such scenario, how do you want to see IIM Kozhikode students making any difference tosociety?

The ecology of IIM Kozhikode helps the students to build their own capability which leads to

development of social capital that can be deployed at proper places in future. For example, take the

course of Social Transformation of India taught by Prof. A F Mathew to the PGP first year students.

In such a course the participants engage with the real modern day issues like gender and caste

discrimination etc. and thus develop a problem solving capability. This capability, which is since

intangible, remains with the students even after they leave this institution, and thus get transmitted in

to their career.

Also the students of IIMK have the priority towards contributing to the society. This is because, as

told to me by a senior manager from a reputed corporate house, IIMK students have sensitivitytowards social issues. You can refer it as some kind of unconscious conspiracy where the professors

are knowingly or unknowingly sending signals and students are assimilating them, and thus inheriting

the legacy. After all, an institutions culture always stays with the students, even after they leave the

place.


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What is that Indian thought which IIM Kozhikode strive to globalize as its vision?Globalization is not westernization. The western world is not the ideal global space. India has one-

sixth of worlds population and hence every Indian is by definition global but hedoesnt have any

voice. World Bank, IMF, Davos all are counter-points to the Global idea as they do not consider non-

western views as such.

The Indian thought is nothing but that binding idea which represents unity in pluralism, cosmos out

of chaos. In Indian market we can see a lot of diverse products consumed by diverse income group of

people. In recent times India has become testing land for all these products, we saw all conceivable

experiments happening in India. Take the case of Tata, one of the oldest Indian corporate houses.

Earlier Tata had their presence only in the Indian sub-continent. But soon they realized that unless

they become one of the top ten global players through expansion, they will lose their market share in

India. This proves that India is no more a local entity.

To globalize this Indian thought IIMK provides the platform for generating real ideas, diverse

thoughts and last but not the least the people who can perform. The social sensitivity, impregnated

deep into the DNA of these people can never be divorced fro m them. We dont always have to look

up to the western world to understand Leadership, as we can already find them in Bhagavad Gita

(see the bookTimeless Leadership: Learn the art of war from the Bhagavad Gita).

EPS interest group is a students initiative for learning and collaboration beyond classroomactivities. What are your views on EPSs role in IIM Kozhikode?

EPS interest group plays a very critical role in generating a vibrant intellectual life in the campus.Through its different activities like Pol-trics, Talk & Tease, EPSiz, etc. EPS creates an idea space

where different minds converge digitally or directly producing non-linear thinking. EPSs activities

are in line with IIMKs vision of Globalizing Indian thought. Such student-driven initiatives are the

core of any B-school and it is a great pleasure to me that such initiatives are carried out so

passionately in this campus.


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FDI in Multi Brand Retail in IndiaA Game Theory View

Sowmya R, Tarun Chadha, Chandraprakash, Ravi Giri

Batch 2011-13, PGP, IIM Kozhikode

Context

The current situation regarding multi-brand Retail FDI

in India can be constructed as a game by defining the

players involved and their strategies and payoffs.

Players: The Government, Opposing Allies (TMC and

Left) and Multinationals (like Walmart, will be

referred to as FDI henceforth for simplicity)

Strategies: Guided by factors like ideology of the

ruling Congress party, economic climate in India, the

quality of FDI expected, the expected benefits of FDI

inflow and the International economic climate, the

Government initially has two strategies towards FDI

in Multi Brand retail Show intent AND Do not

show intent for FDI in India. If the government shows

intent towards FDI, the Opposing Allies like TMC,

driven by political (vote bank politics, clout etc.) and

ideological motives, then have two options- be

extreme left and oppose the bill, i.e., Protest OR be a

moderate left and not protest, i.e., Dont Protest.

In response the government, driven by politics,

ideology and diplomacy in the international arena,makes a final call of allowing the FDI bill to pass in

the parliament (Allow FDI) ORretract and not pass

the bill (Do not Allow FDI). With the passing of the

FDI bill, the multinationals that enter the Indian

markets based on agreements, will have 2 major

strategies. A company like Walmart based on its

history, can play an aggressive role-expanding,

utilizing its financial and resource muscle to

monopolize the market. It may get influenced by the

norms of the land and if it notices lack of strength in

the institutions, may also indulge in bribery or

corruption. If the institutional frameworks are in place,

and arrangements are reached between the several

stakeholders, possible co-existence arises allowing all

the players to flourish. We call the two strategies as

Monopolize&Co Exist.

FDI in multi brand retail in India has been a

hotly debated issue for the last one year. The

ruling government and corporate honchos

argue that allowing FDI will usher in huge

benefits and create jobs; by creating a

sustainable back end infrastructure, supply

chain, benefitting the farm sector and also

by curtailing supply side inflation. But

opposition groups, traders and some allies ofthe government argue that allowing FDI will

hurt small stores and Kirana shops and

lead to massive job losses. While many

recognize the need for strong reforms

especially in the current poor economic

climate with huge dip in growth figures, the

question that remains to be answered is:

Can FDI in multi brand retail be allowed in

such a way that it does not hamper the

current unorganized market? What kind ofsafe guards or contractual agreements need

to be initiated such that it can be made

possible?

The paper approaches these questions from

a Game Theory perspective by analyzing the

strategies available to the various

stakeholders that have emerged as key in

the past year. It can be seen that by

introducing appropriate policy frameworksand a system of checks and balances, it can

be ensured that a conducive environment is

developed that favors coexistence of new

and existing players.


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The Game Tree

The different variables are:

-Q: government with no political will, stagnant and not interested in moving any policies

+q: strengthen of bilateral relationships on an international basis and with corporates)

-q: government loses on International and Corporate ties

R: gain in the governments ideology (increased clout and confidence), R > q

-R: loss in governments ideology given backlash, lack of political clout, etc.

-R - (R + beta); (beta: increased loss due to governments loss of face and clout), R < R

R R + q; (q: further increase in governments ideological clout), R R

gamma: decrease in ideology as because the public view is that they didnt protest beforehand.

A: revenue gain in capturing market share

A/n: revenues in a shared market scenario

B: cost involved in operations (aggressive mode of expansion and monopolization)B: cost of operations (during co-exist), B >> B

-c: cost of protest, c < q

c: time delay in passing the bill due to the protests across the country (opportunity cost)

x: the loss to the country in terms of employment and indigenous growth

L: strengthening of the Lefts ideology, R < L, L > c

L L + delta: an ideological gain for the Left (delta: the Wetold you before syndrome)

L - (L + delta): ideological loss in Left

omega: gain due to the early entry in FDI, as there were no protests in passing the bill.

L Lgamma: ideological gain for the left, L


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While the payoffs have been determined by analyzing strategies based on the above variables, a numerical

representation makes the payoffs more intuitive. These payoffs are obtained by setting constraints on the

variables based on common world observation. Each players payoffs must be viewed independent and

unrelated to the payoffs of the other players, thereby possessing information regarding relative strategies

for each player.

Playing the Game

This equilibrium explains the current scenario in which government is in. With intense protests there has

been a deadlock for the last one year and the FDI bill has not been passed.

While the desired condition for all the stakeholders considering the economic climate in India, need for animpetus for growth can be provided by the FDI. But at the same time considering the structure of retail

market in India, it is necessary to draft certain clauses and put checks and balances such that co-existence

becomes a Nash Equilibrium. Thus, Government Intent, Left Dont Protest, Government allow FDI,

FDI Co Exist, is the equilibrium point that can provide a favorable climate for all stakeholders.

It can be intuitively seen howthese payoffs make sense. As

an example consider the

governments payoffs which

are higher when it allows FDI

even if the left protests and

foreign players choose to co-

exist, resulting from ideologica

gain and improved internationa

relations compared to

governments payoffs if foreign

players monopolized.

Evaluating the payoffs and

rolling back it can be observed

that Government Intent, Left

Protest, Dont allow FDI

becomes a SPNE and an

equilibrium point.


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The Government can introduce checks and balances through policy frameworks to safeguard the interests

of all stakeholders. In order to ensure this, policy measures can be taken as such:

The limitations on the proposed multi-brand FDI should be strengthened. For example, the back-end infrastructure requirement should be more carefully defined and increased.

Detailed local sourcing requirements should stipulate production in India, rather than simplysourcing from an Indian supplier who has imported the product.

The retail giants should be required to recognize unions and bargain collectively. Regulations can be adopted which require foreign retailers to set prices of goods paid to suppliers

to be at or above cost so as to preclude monopsonistic purchasing practicesby big retailers.

Creation of a state run agency to monitor the application of established conditions with clearconsequences (heavy penalties) which can act as deterrent against undesirable behavior.

It can be seen that these policies would result in an additional cost to the Multinational retailers, therebymaking the Monopoly strategy less attractive than the Coexist strategy. By rollback it can be seen

that the SPNE now becomes Government Intent, LeftDont Protest, Government allow FDI, FDI Co

Exist. No player benefits from unilateral deviation from this equilibrium. The Government will thus be

able to resolve the current deadlock in matters of Retail FDI thereby spurring growth in this sector.

References

Neumark, David, Junfu Zhang, and Stephen Ciccarella, The Effects of Wal-Mart on Local LaborMarkets, IZA Discussion Paper, Jan 2007

Stone, Kenneth E, Georgeanne Artz and Albert Myles, The Economic Impact of Wal-MartSupercenters on Existing Businesses in Mississippi, Iowa State University, 2003

Switching channels: Global Powers of Retailing, Deloitte, 2012. Affidavit of Kenneth Jacobs to the Competition Tribunal of South Africa , CT Case No.

73/LM/Nov10.

Andrajit Dube, T. William Lester and Barry Eidlin, Firm Entry and Wages: Impact of Wal-MartGrowth on Earnings Throughout the Retail Sector, Institute of Industrial Relations Working

Paper No. iirwps-126-05.

It can be seen that by ensuring that

coexisting becomes the strategy of

choice for FDI, the Government

can garner political consensus

resulting in No Protest by the

Left.


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Foreign Investment in recent times - Trends, Issues and Challenges

Amit Kr. Das, Biswa Prateem Das, Mohul Roy, Rohit Kumar, Shruti, Tapas Rastogi


Putting the issue in context

The Indian economy has been on a downward spiral for the

past few quarters with growth slumping to 5.3% in Q2 of the

current fiscal from 6.7% in the same period in FY12, along

with bloated public finances (the budgetary target of fiscal

deficit at 5.1% of GDP is likely to be breached) and chronic

inflation (it refuses to come down to RBIs comfort zone of

5% inspite of 13 consecutive rate hikes amounting to a 325 bps

increase till October 2011). The principal factors blamed for

this gloomy economic scenario have been policy paralysis,anaemic global growth and structural factors like outdated

infrastructure, supply chain bottlenecks et al. The ruling UPA

coalition, cornered by charges of lack of decision making and

crony capitalism, suddenly sprang into action with a slew of

reforms like FDI in multi-brand retail and aviation and pruning

of wasteful petroleum subsidies. Apart from these measures,

there have been other steps taken to encourage foreign

investments like: -

A systematic increase in the limits set for FIIin government and corporate bonds

Postponement of measures like the General Antiavoidance rules (GAAR) which were perceived

as an avenue of harassment of foreign investors

at the hands of the taxman

In this backdrop, the report aims to examine the following:-

Trends and issues in Foreign investmentsflowing into India since 2001

Determinants of FDI flows

Influence of FDI and FII on GDP growth andcapital markets

In light of the recent debate on

Foreign Direct Investment (FDI)

in multi-brand retail, we examine

the impact that foreign money

can have on the economy of a

country. Our results suggest the

benefits may accrue more to the

capital markets than the broadereconomy, at least in the short

run, but it does bring in

technological efficiency and

global management practices

which improves Indian

competitiveness.

Key Findings

FII flows dominate FDI flows

Foreign flow depends on a

host of factors

Spatial and sectoral trend in

foreign investment have

remained stable over the

years

No significant correlation

between Foreign Investment

and GDP growth Foreign capital flows largely

determine the movement of

headline indices


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Key Trends and Issues in Foreign inflows in recent years

FII flows dominate FDI flowsPortfolio investments have started

dominating FDI ever since 2003-04when the global economic boom began.

In FY2011, the gap has grown to $14

billion, official figures suggest. Over

the past decade, FII flows have been

approximately 50% more volatile than

FDI flows. Although its good for

financial assets, it has led to concerns

that Indias capital account surplus is being increasingly financedby hot money which are unstable and

hence their reversal can bring about a systemic crisis , given Indias high current account deficit (at 3.9%

of GDP in Q1FY12). Hence, policy measures must be geared more towards encouraging stable FDI flowsthan fair weather friend FIIs.

Foreign money is influenced by a host of macroeconomic factorsPolicymakers have sometimes given the impression that higher economic growth will de

facto boost foreign money inflows. But our analysis suggests that Indias attractiveness as a

destination for foreign capital will depend on various factors like:

EXRt : Exchange Rates RESGDPt : External financial robustness (measured by forex reserves/GDP) TRADEGDPt : Trade Openness (measured by total trade/GDP ratio) FIN. Positiont : Ratio of External Debt to Export (used as a proxy for financial position) INTt : Interest Rates (bank lending rate)We estimate that the FDI amount is a function of the above factors with the help of theordinary least squares regression technique using annual data from 2001-12 :

ln FDIt = 5.88 0.05 EXRt + 0.02 RESGDPt + 0.02 TRADEGDPt + 0.62 FIN. Positiont - 0.13 INTt

(P-value) (0.04) (0.14) (0.47) (0.06) (0.13) (0.27)

We determine that the above mentioned factors can explain around 90% of the FDI flows.

Impact of Foreign capital on GDP growth:One of the major arguments put forward by the pro-foreign investment camp has been that it boosts

GDP growth. But our analysis suggests that foreign capital can have only a minimal impact on GDP

growth.

The coefficient of determination, R2 of 16% for FDI growth and of 1.77% for FII suggests

that foreign investments have not had too much of an impact on Indian GDP growth.

-30000

-20000

-10000

0

10000

20000

30000

2000-2001

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

FDI Variance

FII Variance


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Impact of Foreign Capital on Capital Markets: -We studied the impact of foreign capital on Indian stock market indices with the help of the

ordinary least squares regression technique using annual data from 2001-12 as follows:

BSE Sensex = 1828.79 + 0.33 FDI (mn USD) + 0.24 FII (mn USD)

(P-value) (0.06) (5.55) (0.001)

S&P CNX Nifty = 628.70 + 0.10 FDI (mn USD) + 0.07 FII (mn USD)

(P-value) (0.03) (5E-06) (0.001)

Using the Sensex as a proxy for the capital markets, we estimate that FDIs and FIIs have a

very strong effect on the index movements as measured by R2 of 93.76%.

Insights

It is evident from the study that foreign investment does not bring any economic growthin the short run.

But over time, its likely that it will have a beneficial impact on the country through : new technologies coming in through Technology Transfer management practices which improve efficiency in operation more industrialization which can be expected to generate employment over time

References

Rajput Namita et al., Relationship of FDI and growth in India: A diagnostic study inAsian Journal of Management Research, Vol 2, No. 2 - 2012

K, S Chalapati Rao and Dhar, Biswajit, India's FDI Inflows: Trends and Concepts inworking paper of Institute for Studies in Industrial Development, Feb 2011

Sultana Syed, Pardhasaradhi S., Impact of Flow of FDI & FII on Indian StockMarket, in Finance Research Vol1 No.3, July 2012

y = 0.0141x + 7.1288

R = 0.1656

3.00

5.00

7.00

9.00

11.00

-50 0 50 100 150 200

GDPgrowth

(inmnUSD)

FDI growth (in mn USD)

GDP growth vs FDI growth

y = 0.0471x + 7.493

R = 0.0177

3.00

5.00

7.00

9.00

11.00

-4 1 6 11 16GDPgrowth(

inmnUSD)

FII growth (in mn USD)

GDP growth vs FII growth


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Global Financial Crisis: Impact on India

Kanika Vanvari, Karthik V, Vardan Walia, Chhavi, Bala Meenakshi, Bahniman Rynjah


Background

Two different countries meaning two different worlds are the

stories of the past. With the rise of globalization, the entire

planet has been reduced to a global village. People,

governments, firms etc. transact easily across the globe. But

globalization did bring along its share of ill-effects on the

economies. When the crisis broke, both advanced and

emerging economies resorted to frenetic macroeconomic

measures to avert financial catastrophe and assure global

confidence in the international financial system could return.

Major reasons for the global financial crisis were two. One,

the Subprime Crisis in USA which started around 2007,

mainly because of real estate bubble burst, leading to a series

of economic failures and financial institutions like Lehman

Brothers turning bankrupt overnight. Second, the European

Sovereign Debt Crisis in Eurozone which is mainly caused

by the Euro area being unable to repay or re-finance their

government debt due to overspending by government on

public workers. Since there is a monetary union there, they

could not go for seigniorage to bail out their own economies

and had to rely on European Central Bank.

With major financial disasters taking place in various parts of

the world, Indian economy couldnt keep itself immune to the

world activities. The FIIs lost confidence and withdrew

money to feed their own ailing economies, resulting in a

severe fall in the stock market and depreciation of INR. There

was a rise in food and commodity prices around the world,

leading to high levels of inflation. With the economies failing

in the other parts of the world, Indias exports fell due toinability of those nations to import goods like gems and

jewelry from India. This subsequently led to increase in

unemployment level and a fall in GDP growth rate, which

explains the Okuns law, establishing an inverse relationship

between the two.

With the current economic

scenario with huge economies- US

and EU experiencing a major

slowdown, we examine its impact

on India. The most significant

effect has been on our Trade

balance which has trickled down

to other areas of the economy

including currency, inflation aswell as the stock market. Our

analysis suggests that Fiscal deficit

will be one of the key challenges in

this scenario.

In addition, we have analyzed the

impact of the policy measures

initiated by our government to

curb these problems and thereby

restore growth.

Findings:

Reduction in Exports

Validation of Okuns Law of

inverse relationship between

unemployment and GDP

Correlation of Indias exports

to Worlds imports is 0.8

Indias fiscal response was

initiation of rural employment

schemes and increase insubsidies

Monetary response was

decrease in CRR as well as

introduction of Market Scheme

Stabilization Securities.


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Key Trends and Issues

Reduction in Net Exports along with currency depreciation

Indian Rupee depreciated significantly in the year 2008-09: This should have increased our exportsand hence led to a decrease in the trade deficit or in other words an increase in Net Exports. However,

this did not take place due to the high proportion of Indias trade with US

Same phenomenon observed in 2011-12: The effect was all the more high because of decrease intrade with both EU and US. This has been due to a combination of Euro crisis and the slowdown of

US economy. EU occupies 26% of Indias exports

As a result, , India has been unable to reap the benefits of depreciating currency due to the GlobalEconomic slowdown

Interdependence of FIIs, Sensex and Exchange RateWith the slowdown in the world economy, foreign investors lost confidence in the Indian markets.

Also, they had to feed their own ailing economies at the first place. This fall in FIIs invariably

resulted in fall in Sensex, which fell by about 8000 points in 2008-09. This caused depreciation of

INR as well. The markets revived in 2009-10 a bit and showed some promise as FIIs came back to

India. Much to disappointment, it again went down in the next 2 FYs.

Impact on Foreign Direct Investment: From US $3250 million in 2004-05, the FDI has

leaped to over US $247329 million in 2008-09

However, since February 2008, a reversal in the trend

was observed. Monthly inflow of FDI between

January 2008 and January 2010 suggests a cleardecline over a period of 24 months

In fact, the current FDI may also prove to b temporary

as the emerging economies are considered as safe

havens. Once, US and EU economies recover, reverse

trend may be observed


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Monetary and Fiscal Responses

India resorted to extreme measures like unwinding of MSS securities, changes in CRR etc. rather than

only Open Market Operations (OMO). The repo rate (by 425 bsp), reverse repo rate (by 275 bsp) and

CRR (by 400 bsp) were reduced to aid the crisis by easing the economy through higher money supply.

Decreasing CRR induced Rs. 1.6 Trillion liquidity into the Banking system.

Indian government had taken a few measures before the crisis, which protected India to a great extent.

These measures included increase in public outlays, employment guarantee schemes, pay commission

rewards, Bharat Nirman, PMs Rural Road Programme, increase in food subsidies etc. All this lead to an

increase in GDP and NREGP helped reduce the unemployment levels in rural areas. Government

increased their expenditure in agriculture and consumption in India didnt fell at a fast pace.

Visions

Leveraging on US policy of Quantitative Easing: This would strengthen Rupee resulting indecrease the value of imports. Foreign investments would also rise due to higher expected returns

Pursue a Twin-Prolonged Strategy: Educating people to adopt other investments apart from goldalso. And use modern technology (eg. Ashanti from South Africa) to exploit our current gold

reserves better

Structural reforms: Promote SMEs in both domestic and foreign sector. Also encourage smallbusinesses as an attraction for FDIs

Facilitate ease of doing business in India: By reducing and speeding the processes of paperworkand sanctioning of permits.Currently India ranks 132 in World Banks Doing Business Ranking

Development of Manufacturing Sector: By setting up more manufacturing hubs or Life-spaces topromote manufacturing

Attraction of FDI: By granting tax holidays and gaining Investors confidence. At present, Indiadoes not feature in the top 10 of the FDI Attraction Index. With countries like Hong Kong, China,Singapore, Malaysia etc., India has to adopt measures to encourage FDI

Investment in R&D to foster innovation: With opening up of sectors for FDIs, government shouldalso ensure that our domestic businesses are strong enough to compete with them. Presently, India

invests only 0.9% of GDP which should go up to at least 2%

References

Global Investment Trends & Regional Trends in FDI, United Nations Conference on TradeAnd Development (UNCTAD), World Investment Report, July, 2012

Eurozone crisis: three years of paininteractive timeline,Nick Mead and Garry Blight, TheGuardian, 2nd Nov 2012

Indias Gold Mine, Minhaz Merchant, The Economic Times (Mumbai Edition), 11th Dec 2012,The Edit Page (page 14)

Global Transparency Index: Rankings, Jones Lang Lasalle (http://www.joneslanglasalle.co.in) Corruption Perception Index 2012, Transparency International (http://www.transparency.org)
http://www.guardian.co.uk/profile/nickmeadhttp://www.guardian.co.uk/profile/nickmeadhttp://www.guardian.co.uk/profile/garry-blighthttp://www.guardian.co.uk/profile/garry-blighthttp://www.guardian.co.uk/profile/nickmead


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The Impossible Trinity and its Implications on the Indian Economy

Gunveer Singh, Mamata Madhumita, R A Raghavendra, Silajeet Debnath, Vaibhav Sharma,

Zeeshan Hassan


Context

The Impossible Trinity also known as the Unholy Trinity,

the Irreconcilable Trinity, the Inconsistent Trinityor the

Mundell-Fleming trilemma means that an economy cannot

simultaneously maintain a fixed exchange rate, free capital

movement and an independent monetary policy. As a result, a

country has to make a tradeoff between three policies i.e.

choosing exchange rate flexibility, or means to have a stable

domestic economy, or policies imposing restrictions on the

openness of trade. With this backdrop, the report aims toexamine the following:-

Relevance of the concept in the Indian context Indias stance in different economic conditions Shifting paradigm in todays times

Indian Economy and the Impossible Trinity

The dilemma faced by India is to choose two out of the three

options, each one having its own advantages-

Necessity for Free Capital Flow

Access to foreign savings, promoting growth Access to wide range of investment opportunities FDI brings in technological growth Improves institutional quality of financial markets

Necessity for fixed exchange rate

Rising exchange rates damage export sector Falling exchange rates impair investor confidence,

and sparks inflation

Necessity for independent monetary policy

Stability during domestic and exogenous shocks Execution lag is much smaller than fiscal policy Low inflation and reduced volatility Good investment climate

Abstract

The study is in tandem with the

economic stance taken by India

to combat the dilemma posed by

the trinity. From the early 1990s

to 2007, INR was allowed to

appreciate only by 15% despite

great upward pressure on therupee, indicating greater

emphasis on exchange rate

stability, less monetary

independence and free capital

flow. However, following the

global crisis, a more managed

float rate has been adopted. The

report goes on to quantify the

three trinity parameters, and

validates the economic policies

adopted by the RBI over the

years. Also, the capital flows in

developing Asian countries is

analyzed in conjunction with the

FOREX reserves over the ears.

Exchange

Rate

Volatility

Closed

Economy

Domestic

Stabilization

Fixed

ExchangeRate

Independent

MonetaryPolicy

Free Capital Flows

The

Impossible

Trinity


19/55


Combating the Impossible Trinity-Trends in Indian Economy Early 1980s: Very limited capital movement was allowed and very less foreign reserves were

present, as India was still following a nearly fixed exchange rate system. So India had greater

monetary independence and exchange rate stability.

Late 1980s: Indias macroeconomic health began to deteriorate, because of the huge CurrentAccount Deficit (CAD). To finance this CAD, capital controls were relaxed, and hence, exchange

rate stability as well as monetary independence decreased.

1993-1995: There was a surge in capital inflows, and the RBI chose strict exchange rate stabilityover monetary independence-maintaining it at Rs.31/dollar from April 93 to August 95,

resulting in lesser monetary independence and free capital flows.

Late 1990s: Crises in Latin America, South Asia, and India reduced capital inflows and promptedthe RBI to let the rupee depreciate, loosening exchange rate but gaining more monetary

independence.

1999-2003: The declining capital inflow revived, and there was a current account surplus. Thiswas countered by the RBI by selling bonds and thus increasing dollar reserves to over $40bn in

order to maintain exchange rate stability but compromising on monetary independence.

2003-2008: Due to appreciating currency, RBI resorted tosterilization to prevent intervention inthe FOREX market which could have led to a sharp increase in monetary base. However, the

rising cost of instruments such as Market Stabilization Scheme led to an incomplete sterilization

and increase in money supply growth. Thus, there was less Monetary Index (MI), free capital

flow and exchange rate stability.

2009-2012: After the global financial crisis subsided, RBI faced increasing capital inflows, butdid not intervene in the FOREX market and focused on exchange rate stability. Thus, rupee

appreciated 17.5% from March 2009 to April 2010. However, it depreciated 20% in 2011 due to

global risk aversion and the RBI admittedly intervened only slightly. So, the RBI followed a

Managed Float Rate.

Quantifying the Trinity parameters and their evolution over the years(adapted from Indias Trilemma: Financial Liberalisation, Exchange Rates and Monetary Policy Michael

Hutchison, Rajeswari Sengupta and Nirvikar Singh, The World Economy, Vol. 35, pp 3-18, Jan 2012.)

1996:Q2-

'00:Q3

2000:Q4-

'05:Q1

2005:Q2-

'09:Q3

Means

MI 0.5348 0.4197 0.4828

ES 0.7601 0.8107 0.5901

KO 0.0385 0.0788 0.314

Coefficients

MI 0.64 -0.063 0.515ES 1.798 2.041 2.294

KO 6.169 4.021 1.148

Observations 21 18 15

R2 0.9738 0.9921 0.971

Contributions

MI 0.342 -0.026 0.249

ES 1.367 1.654 1.354

KO 0.238 0.317 0.361

Sum 1.947 1.945 1.963

2= aMI + bES + cKO

The RHS is equated to two because we can

have absolute control over only two parameters

of the Impossible Trinity

Monetary Index (MI)-Reciprocal of

correlation between interest rates in India and

United States

Exchange Stability (ES) Index-Measures the

quarterly standard deviations of the change in

log of Rupee to US dollar exchange rate

Capital Account Openness (KO) Index-Ratio

of sum of inward and outward foreign

investments to GDP


20/55


Capital Flows of Developing Countries

The capital flows of developing Asian countries have been consistently improving over the past 10 years.

However, the FOREX reserves of these countries too have been increasing over this time-India (4 times),

China (3 times), Korea (8 times), and Malaysia (3 times). This validates the choice of these countries-

independent monetary policy and relatively stable exchange rates.

References Fear of Floating, Calvo and Reinhart, NBER Working Paper No. 7993, Nov 2000 The Dynamics of Exchange Rate Regimes: Fixes, Floats, and Flips, Klein and Shambaugh"

Journal of International Economics, Elsevier, vol. 75(1), pp 70-92, May, 2008

The Impossible Trinity-from Policy Trilemma to Policy Quadrilemma Aizenman, Joshua,2011, Working Paper Series, Department of Economics, UC Santa Cruz.

Price stability, financial stability and sovereign debt sustainability policy challenges from theNew Trilemma, Dr. D. Subbarao, 2nd International Research Conference of the RBI, 1 Feb 2012

Interpretation

Although the coefficients in the table do not have

great precision, the high R2 values suggest a very

good fit. The means of the three indices are used to

arrive at the contribution for each index. We thus see

that in all three sub-periods, MI is in an intermediate

range. It reduces in the second period and then rises

up in the third. ES has high values in the first two

periods and then decreases in the third. In the first

two periods, KO increases only a little, but takes a

very high value in the third. The average

contributions are obtained by multiplying the

coefficients with the means for each sub eriod. Due

value, it is found that the contributions add up to nearly two in each sub-period. It is found that in the

three sub-periods, ES receives a high policy weightage. In the second sub-period, as KO increases, thecontrol over MI is forsaken completely, whereas ES seeks to strengthen by having a greater value than

the previous period. The KO continues to increase in the third sub-period, and with it, ES is somewhat

sacrificed to salvage some MI. But, when compared to the first sub-period, MI reaches a lesser value and

KO a greater value in the final sub-period.


21/55


Without going into

details of any specific

instance or type of

crime, the objective of

this study is to

understand the general

relationship between

economic conditions and

crime rate.

International research

has reported mixed

results. Some studiesshow that deteriorating

economic situation may

lead to less crime (e.g.

for the US evidence see

Cantor and Land, 1985)

while others find that it

leads to more crime (e.g.

for the UK evidence see

Bandopadhyay et al.

2012).

This study finds that for

Indian states economic

conditions measured by

the misery index (that

takes into account both

unemployment and

inflation) is positivelycorrelated with crime.

That is, more miserable

economic condition is

associated with higher

crime rate.

Crime and Misery: the Indian Case

Prof. Rudra Sensarma

Indian Institute of Management Kozhikode

The opposing views on the crime - economic

condition nexus

Economists have explained criminal behavior using two effects viz.

the motivational effect and the opportunity effect. Becker (1968)

suggested the first which means that criminals commit crime if their

returns from doing so exceed the returns from legitimate work. In

other words, during economic decline, a potential criminal is

encouraged to commit an offense if he feels that he can earn good

money by say robbing someone rather than looking for a job where

the expected benefits will be very low (given the low probability of

finding work as well as the low remuneration even if he finds

work). According to this explanation, crime rates should rise when

unemployment is high. Others (such as Ehrlich, 1973) have posited

that crime is pro-cyclical which means that growth generates wealth

in the neighborhood that attracts criminals. Therefore, when

unemployment is high, crime rate should be low. There is no

consensus on which effect is stronger in India.

However unemployment is not the only determinant of economic

conditions. To go beyond unemployment I consider the so-called

misery index which is a simple yet comprehensive measure of

general well being. Initiated by Arthur Okun in the 1970s, the

misery index is the sum of the unemployment rate and the inflation

rate. It denotes the combined effect of people being out of work and

prices rising both of which cause economic hardship and can have

severe social costs. International evidence (e.g. Tang and Lean,

2009) suggests that the misery index is positively correlated with

crime rate which means that the criminal motivational effect is

stronger than the opportunity effect. This study is an attempt to

uncover the nature of this relationship for the Indian case.


22/55


Macroeconomic analysisI compare the rate of violent crimes in India during

2002-2011 with inflation (based on consumer price

index) and unemployment (see figure 1). Till the

outbreak of the financial crisis it seems that crime rate

was falling (since 2003) along with unemploymentindicating the presence of criminal motivational effect.

The link with inflation is not very clear since inflation

remained largely stable during this period. However in

the crisis period crime rates went down while both

unemployment and inflation increased. In fact the

correlation between crime rate and the misery index

during the entire period shown in the graph comes up

as -0.68 with a probability value of 0.03. This suggests

that there is a negative and statistically significant correlation between crime rate and misery index.

To ascertain the nature of relationship between crime rate and misery index, I conducted an ordinary leastsquares regression analysis which generated the following equation:

Crime rate = 3.28 0.11 x Misery index

(P-value) (0.001) (0.03)

While it is tempting to interpret this finding as evidence in favor of the opportunity effect (i.e. declining

economic conditions offering less opportunities for criminals), one must be careful of the pitfalls of time-

series analysis. For example, the above analysis has not considered lagged response of crime to economic

conditions. Indeed the crisis may be a temporary shock which may not alter the fundamental relationship

between crime and economic conditions. Finally the time period may be too short to arrive at a firm

conclusion.

What do data from Indian states tell us?

To avoid the problems of time-series

analysis, I constructed misery indices for

Indian states to the extent that publicly

available data allow. Complete information

was available only for 10 states and union

territories for 2005. Interestingly Kerala a

state known for high human development

factors shows the highest unemployment rateas well as crime rate. On the other hand,

West Bengal not known to be amongst

developed states shows the lowest crime rate

and a low unemployment rate.

0

5

10

15

Unemp Inflation Violentcrime

Figure 1: Violent crime & economic conditions -India

0102030

Inflation Unemp Violent crime

Figure 2: Violent crime & economic conditions - Indian states in2005

Source: NCRB, RBI websites

Source: Indiastat website


23/55


The cross-state correlation between crime rate and misery index turned out to be 0.57 with a probability

value of 0.08 indicating that across the states of India criminal motivational effect may be stronger than

opportunity effect. To support the correlation analysis I estimated the following regression using the

ordinary least squares method:

Crime rate = 13.43 + 0.65 x Misery index(P-value) (0.006) (0.08)

The regression result shows that if a states misery index is lower by 1 percent, then crime rate could

come down by 0.65. This finding has interesting policy implications.

Implications

While all-India data show some evidence for criminals in India being driven by opportunityeffect, cross-state data show that miserable economic conditions are associated with higher

crime i.e. the motivational effect may be stronger. Macroeconomic policymakers should be cognizant of the socio-economic effects of their

policy changes such as the impact on crime in society.

Policing or crime fighting strategies especially for acquisitive crimes such as burglary orrobbery should be complemented by policies that generate employment and stabilize price

rise.

This study is only a first attempt at unraveling the relationship between crime and economicconditions in India and is by no means exhaustive. More detailed research is needed to

understand the dynamics and strength of the crimeeconomic condition nexus.

References

Bandyopadhyay, S., Bhattacharya, S and Sensarma, R. (2011) "An Analysis of the Factors

Determining Crime in England and Wales: A Quantile Regression Approach", Discussion Papers

11-12, Department of Economics, University of Birmingham.

Becker, G. (1968) Crime and Punishment: An Economic Approach, The Journal of Political

Economy, 76 (2): 169-217

Cantor, D and Land, K. (1985) Unemployment and Crime Rates in the Post-World War II

United States: A Theoretical and Empirical Analysis, American Sociological Review, 50 (3):317-332

Ehrlich, I., (1973) Participation in Illegitimate Activities: A Theoretical and Empirical

Investigation, The Journal of Political Economy, 81 (3): 521-565

Tang, C and Lean H., (2009) "New evidence from the misery index in the crime function",

Economics Letters, 102(2): 112-115


24/55


Monetary Policy Transmission Mechanism

Alok Kr. Singh, Depak D K, Karthi Vignes S E, Pankaj Kumar, Saumya Dikshit, Umakanta Sahu


Context

According to the standard monetary transmission mechanism,

variations in interest rates first impact aggregate demand and GDP

growth, which, in turn, then impact inflation. Therefore, inflation

management needs some temporary loss of output. In this context,

as the Economic Survey 2011-12 (Government of India (GoI),

2012) observes, the question is: How sharp are the connections

between monetary policy instruments and inflation? While the

simple correlation between the policy instruments and inflation is

slender, a careful statistical analysis by putting in lags indicatesthat the policy instruments do have an impact on inflation wi th a

lag.

Monetary Policy Transmission Channels

There are four key channels of monetary transmission: (a) interest

rate channel; (b) quantum channel relating to credit; (c) asset price

channel; and (d) exchange rate channel.

Channel Explanations

The first channel - the interest rate channel - is the key channel of

monetary transmission in market-based economies and refers to

changes in domestic demand and inflation brought about by

changes in the policy interest rate. Credit channel complements and amplifies the interest rate channel.

The credit channel operates through the availability of bank credit and through the impact of interest rates

on asset prices, and cash flows and net worth of borrowers .For bank dominated economies, the narrow

credit channel is important and for financial market dominated economies, the broader credit channel is

Inflation and GDP growth are

towards which people and

policymakers are attracted.

However, Monetary Policies

help in controlling inflation.

We examine the impact of

monetary policy over inflation

and the channel involved

through which transmission

occurs. We determined that

there is a lag between

Monitory Policy and inflation.

Highlights

Correlation between the

policy instruments and

inflation is slender

Growth in GDP increasesWPI but with a lag of some

time

Total time lag is come out

to be two Quarter i.e.

approximately six months

The empirical results in

the augmented VAR

models suggest the

importance of the bank

lending channel in India


25/55


26/55


The analysis of monetary transmission mechanisms is sensitive to the choice of interest rate used to

capture the monetary policy stance. Interest rate channel has been chosen for analysis, i.e. when RBI uses

any of its monetary tools like Bank rate, CRR or Repo rate.

The above Indicates when repo rate change Call money rate changes and hence it changes GDP. However

if we closely look at the graph we observe that when repo rate changes , average call money rate changes

in same quarter however change in GDP is not reflected in the same quarter . For example Repo rate has

been increased in quarter 1, 2010, Changes in Average call rate has been reflected in same quarter.

However change in GDP has been reflected in quarter 3, 2010. This is defined as lag and optimal lag in

terms of quarter has been calculated by Vector auto regression (VAR) method.

Insights and Conclusions

It has been inferred that Indian Monetary Policy is constrained by monetary tools and policy ofReserve Bank of India. Therefore an analysis of Indian monetary policy requires the inclusion of

fund rates such as Bank rate, repo rate, and reverse repo rate and, Cash reserve ratio. A proper model specification, considering the external constraints on monetary policy and

controlling for international economic events, reduces the bias.

A proper comprehension of the monetary transmission mechanism in India requires the analysisnot only of the response of GDP, but also of the response of the exchange rate to a monetary

policy shock.

It has also been noticed that banks play an important role in financial in intermediation in theIndian economy, and their strong representation reflects the lack of alternative sources role in

financial of funding for the private sector.

References

Transmission mechanism of monetary policy in India ;Abdul Aleem,Journal of Asian Economics21 (2010) 186197

How effective are monetary policy signals in India? - Indranil Bhattacharyya, Rudra SensarmaJournal of Policy Modeling, 30(1), pp 169-183, 2008

-0.02

0

0.02

0.040.06

0.08

02468

1012

Q1,2001

Q1,2002

Q1,2003

Q1,2004

Q1,2005

Q1,2006

Q1,2007

Q1,2008

Q1,2009

Q1,2010

Q1,2011

Q1,2012

-0.02

0

0.02

0.040.06

0.08

0.050.0

100.0150.0200.0250.0300.0

Q1,2001

Q1,2002

Q1,2003

Q1,2004

Q1,2005

Q1,2006

Q1,2007

Q1,2008

Q1,2009

Q1,2010

Q1,2011

Q1,2012


27/55


Fiscal DeficitAn Indian Perspective

Ankit Agarwal, Anuj Kr. Loomba, Kanupriya Tibrewal, Prapti, Prateek Gupta, Sahil Jindal,

T Durgalakshmi


Context

While the euro zone is under constant threat of falling apart

because of large accumulated debt and high fiscal deficit in a

number of countries, lawmakers in the US do not see eye to eye

on any deficit reduction plan. The situation in India is not very

different. India faces the serious threat of being downgraded to

junk status if the deficit is not quickly brought under control;

the government is targeting a fiscal deficit of 5.3% of the gross

domestic product (GDP) in the current fiscal. The current

economic situation in India can be described as follows:

Fiscal deficit for the year to end-March 2013 could beas high as 6 percent of GDP. The emergence of current account

deficit (CAD) in the balance of payments at an unsustainable

level of 4.2% of GDP has further aggravated the situation with

the potential risks of twin deficit

Government could be forced to borrow extra Rs 40,000crore via bonds. The International Monetary Fund sharply cut

its economic growth forecast for India for 2012 to 4.9 percent

from 6.1 percent previously

This report aims to examine the following in greater detail:

Impact of fiscal deficit on macroeconomic variables Financing of fiscal deficit Reasons for high fiscal deficit in India Reduction of fiscal deficit and its implications

Impact of Fiscal Deficit on Macroeconomic

Variables1. Impact of Fiscal Deficit on Interest Rates:Prima facie it seems very plausible that a higher fiscal deficit

would raise interest rates: the government borrowing more

leading to an increase in the demand for credit, everything else

remaining constant, which would lead to an increase in the

interest rate. However, the above argument assumes that the pool of savings is fixed. If the

government borrows to finance expenditure, it leads to higher income and savings, supply of the

credit increases by the same amount as demand, no consequent rise in price of credit.

In light of the recent discussions

on the growing fiscal deficit in

India, we examine the impact of

fiscal deficit on various

macroeconomic variables . We

also carry out a brief historical

perspective on fiscal deficit and

study the reasons for high deficit

in India. We also study the

measures taken by theGovernment towards reducing

deficit and its implications.

Findings

To restrict fiscal deficit,

financed primarily through

market borrowings, to its

target of 3% of GDP by 2016,

the government needs to take

taking tough policy measures

Increase revenues by

implementing Direct Tax

Code, increasing FDI and

Disinvestment and widening

ambit of service sector tax

Reduce expenditure by

regulating populist policies,

fuel prices, other subsidies

and curtailment of defenseexpenditure


28/55


2. Impact of Fiscal Deficit on Trade:This can be explained using the twin deficit hypothesis, which says that a fiscal deficit is

accompanied by a concomitant current account deficit. It is also explained by the Ricardian

equivalence hypothesis which states that economic agents will increase their savings in anticipation of

higher future taxes owing to fiscal deficit. Hence, there is no impact on trade deficit.

3. Impact of Fiscal Deficit on Capital Inflow:An increase in the fiscal deficit, results in an increase in investment or fall in NX.

Imports +Capital outflow = Exports + Capital Inflow

Trade Deficit = Net Capital Inflow

4. Economic Growth and Fiscal Deficit:The fiscal deficits can be financed through

domestic borrowing, foreign borrowing or by

printing money. While excessive domestic

borrowing can lead to a hardening of interest

rates, too much of foreign borrowings canculminate in an external debt crisis. Printing

money stokes inflationary pressures. The

same level of deficit can have different

implications, depending upon how it is used. For instance, a fiscal deficit used for creating infrastructure

and human capital will have a different impact than if it is used for financing ill-targeted subsidies and

wasteful recurrent expenditure. A large fiscal deficit implies high government borrowing and high debt

servicing (the total debt servicing will be 37 per cent of revenue expenditure in 2009-10), which in turn

could mean a cut back in spending on critical sectors like health, education and infrastructure. This

reduces growth in human and physical capital, both of which have a long-term impact on economic

growth. Large public borrowing can also lead to crowding out of private investment, inflation and

exchange rate fluctuations (impacting exports).We observe that, for the period 1981-82 to 2007-08, the

GDP growth is lower when the GFD-GDP ratio of the Government is high as shown above.

Reasons for High Fiscal Deficit in IndiaFiscal deficit in India remains high due to

Subdued tax revenues High spending

Substantial interest payments due to a high debt burden (16%) High social spending including health, education and welfare schemes (24%) Fuel, food and fertilizer subsidies (8.6% of general government expenditure)

Global macroeconomic situationFinancing Fiscal Deficit

Fiscal deficit could be financed either by foreign borrowing or by borrowing from the domestic market

(from commercial banks or individuals) or by borrowing from the central bank popularly known as

monetization. The government has resorted to market borrowing to fund its fiscal deficit primarily.

Fig 2: Showing the relation between growth and fiscal deficit

Capital inflow should

increase to account for

increase in fiscal deficit.


29/55


Reduction of Fiscal Deficit and Its Implications

Fiscal consolidation can be achieved in the following ways:

Government could increase its revenues by By increasing the tax rate on existing items and improving the efficiency of collection-reform

in trade and excise taxes

Rightsizing the size of Plan support Disinvestment in the loss making PSUs Go for massive useless asset sale Stimulating foreign investment in key sectors like retail, aviation, defense, pensions Easy Implementation of DTC

Government should reduce its expenditure by: Efficient management of subsidies- reduce subsidy, increasing administrative price, switching

to direct cash payment.

Better PDS Reduce populist measures like farm loan waiver which make the fiscal situation vulnerable. Taking substantial steps to reform public enterprises which are making huge losses

Conclusion

As per Kelkar Committee report the country's fiscal deficit for FY 2012-13 could touch 6.1 percent of GDP. FRBM targets to reduce Indias fiscal deficit to 3.5%

The Indian fiscal deficit is mainly financed through market borrowings A high fiscal deficit leads to a vicious cycle where in countries are forced to borrow to finance

their interest expenditure rather than utilizing the funds for planned capital expenditure

The government has to ensure that its policies, global economic scenario and the sentiments ofthe investors and public at large area all in tandem.

References

On Financing the Fiscal Deficit and Availability of Loanable Funds in India, Surajit Das, April10, 2010, Vol. XLV No. 15, Economic & Political Weekly

Does Fiscal Deficit in India influence Trade Deficit in India? An Econometric Enquiry,Debabrata Datta, Suparna Basu, July 23-29, 2005, Vol. XL No. 30, Economic & Political Weekly

0200

400

600

800

1,000

1,200

0500

1,0001,5002,0002,5003,0003,500

Rs. bn Rs. bn

Fig 3 Fiscal deficit funding at state Fig 4 Fiscal deficit funding at center


30/55


The Current Account Deficit CrisisAn Analytical Insight

Anant Dayal, Dipankar Biswas, Kunal Kumar, Nandini Priya M, Saksham Srivastava, Supriya S M


The Challenge: Increasing CAD

Just about a decade ago, the Indian economy had a positive

current account balance. But the trends have changed in the

recent past and since the fiscal 2005-06, India is running a

large trade deficit.

According to the Reserve Bank of India, the Current

Account Deficit (CAD) is likely to remain high in the near

future on the back of feeble export growth and volatile crude

oil prices. The central bank also pointed out that financingof the CAD would be an enormous challenge in light of

sluggish demand from advanced economies that has led to

deceleration of exports. RBI also expects global growth to

be lower than anticipated due to negative growth in euro

zone. High crude oil prices also pose a risk to Indians

Current Account balance.

The constant increase in the Current Account Deficit has led

people to fear that the country is losing its competitiveness.

The need for imminent corrective measures is being felt.

This report provides insights into the causes andimplications of Indias large Current Account Deficit. The

report further goes on to provide recommendations that can

be implemented to curtail the widening CAD.

Causes of Indias large CAD Our Claims

Indian CAD is countercyclicalIf oil shocks raise import costs, the growth rate in an economy falls and CAD would rise along withfalling growth. On the other hand, when export rise, they raise the income and reduce the CAD and

vice-versa when there is a sudden collapse of export markets. In year 2011-12, India saw both a sharp

rise in oil prices and fall in growth raising CAD to its peak value of 4.2% of GDP. However, CAD

was only 1.3% of GDP in 2007-08 when there was a high consumption, investment and output

growth.

This study provides an insight into

the causes and implications of

increasing current account deficit

in Indian economy and suggests

ways to curtail (if not eliminate)

the current account deficit crisis.

Key Findings

Indian CAD is countercyclical.

Indian CAD is fuelled by heavy

gold and crude oil imports.

Expansion of fiscal deficit leads

to large Indian CAD.

CAD is enhanced by increasing

MPC.

Depreciation of rupee against

dollar is not an effective

measure to ascertain CAD.


31/55


Indias large CAD is fuelled by heavy gold and crude oil importsTwo separate regression analyses were performed between (i) Oil imports and GDP, and (ii) Gold

imports and GDP and a relatively high correlation was found in both the analyses.

Expansion of the fiscal deficit (G-T) leads to large Indian CAD

Reduction in private saving rate or increase in marginal propensity to consume enhances CAD

1.230.98

0.65

2.53

1.9

y = 0.001 x - 0.592

R = 0.233

0

0.5

1

1.5

2

2.5

3

2000 2500 3000 3500

CAD

Oil import VS CAD

-1.35 -1.42

-0.11

1.23 0.980.65

2.531.9

3.07

4.2

y = 0.138 x + 2.200

R = 0.020

-2

0

2

4

6

-12 -10 -8 -6 -4 -2 0

CAD

Fiscal Deficit (% of GDP)

Fiscal Deficit VS CAD

y = -0.004 x + 7.581R = 0.258

-2

-1

0

1

2

3

4

1500 1700 1900 2100 2300

CAD

Private Fixed Investment(USD) versus CAD

Private Fixed Investments

Since the expansion of fiscal

deficit lowers public saving

therefore it reduces national

saving thereby widening the CAD.

The results of the regression

analysis shows a low correlation(correlation coefficient = 0.143)

due to crowding out of private

investment and consumption.

A negative correlation betweenprivate fixed investments and

CAD suggests the structural shift

in saving and spending behaviour.

Gold Imports (in tonnes)

CAD

Oil Imports (k bbl/day)


32/55


Depreciation of rupee against dollar is not an effective instrument for ascertaining CAD

Recommendations

Based on our analysis we suggest few recommendations which are enlisted below:

Building a strong manufacturing base and diversification of current economic basket Encouraging inflow of FDI/FII through policies such as FDI in retail and aviation. Replication of an agricultural model like Green Revolution of the 1970s to enhance exports. Reducing gold imports by increasing domestic gold production and reducing domestic gold demand. Reducing total demand in the economy through deflationary fiscal policies Imposing foreign exchange controls which increase the black market premium.

ConclusionCurrent Account Deficit is one macroeconomic parameter that has received much attention in the last

decade. Increasing CAD has developed a fear that Indian economy is losing its competitiveness and a

corrective measure is required. As a matter of fact, negative CAD is not necessarily bad for an economy.

Developing countries may choose to run a CAD in the short term to increase local productivity and

exports in the future. However, going forward, India should monitor its external sector very critically.

Today, the economy is well poised to absorb the widening CAD but this shall not be a persisting trend.

References

Higgins, M. and Klitgaard, T. (Dec 1998) Viewing the Current Account Deficit as a CapitalInflow in Current Issues in Economics and Finance Vol . 4[13].

Shah, A. and Patnaik, I. (2005) Indias Experience with Capital Flows: The Elusive Quest for aSustainable Current Account Deficit in NBER Working Paper Series.

Williams, M.F. (2009) A Short Run Model of a Large Open Economy with Floating Excha ngeRates getyourecon.com, (retrieved from http://getyourecon.com/macro/macro-openmacro.pdf,

Dec 10, 2012)

-10,849.50-11774.6

-6341.1-7095.4

-4713.7

-10308.4

y = 95.333 x - 12,778.239

R = 0.006

-14,000.00

-12,000.00

-10,000.00

-8,000.00

-6,000.00

-4,000.00

-2,000.00

0.00

30 35 40 45 50

CAD

Exchange Rate

Exchange Rate Versus Trade DeficitA regression analysis

between USD-INR

exchange rate and trade

deficit depicts almost no

correlation between the two.

While gold and crude oil

form major share of imports,

machinery and intermediate

goods are inputs which

increase production costs.

Effect of depreciation on

exports is delayed and

uncertain.
http://getyourecon.com/http://getyourecon.com/


33/55


Evaluating decisions on Brand Ambassadors - a Game Theoretic Framework

K Shiv Shankar, Namith Najeeb, Nithya M, AkshayAnand


IntroductionIn this article, we have tried to create a game theoretic framework

for to analyze the factors that go into the consideration for the set of

managers when they decide on whether or not to go for celebrity

endorsement, and if yes, who the Brand Ambassador has to be.

The companies would have to make their decision based on the

value that these personalities would add to improving their brand

image against the expenditure that they would have to incur to do

the same. This game would have multiple stages for each company

to decide on which personality to use for brand endorsement. Given

the costs and payoffs associated with a Player, a Brand Managerhas to decide on the Brand Ambassador to use. This is also a

function of the popularity, current and forecasted fan base of the

player.

The Game

This game can be illustrated in a simple manner by taking Pepsi

and Coke, the major players of the bottled beverage industry, as an

example. Let us say that the brand managers here have an option of

choosing one of the two famous personalities (Sachin Tendulkar

and Virat Kohli in this case) or choosing neither. At each node ofdecision making, the brand managers base their decisions on the

revenue that would be generated by using the player as their brand

ambassador and the cost incurred in employing the personality. It

has been assumed, for simplicity, that the personalities accept the

offer that is made to them irrespective of which of the two

companies make the offer. This is a sequential game consisting of

several stages, which can be repeated again.

At every stage, the company at play can either choose to select a

celebrity or reject him. It is assumed that each celebrity can endorse

only for ONE brand and once the offer is made to him (at the valueof the average endorsement fee calculated), he chooses to accept it

and endorse the product). The game is played till both the soft drink

giants have either accepted or rejected either of the two maestros of

cricket. There is an underlying assumption that a company cannot

choose a player after it has rejected it once.

We all know that a company is

represented in the minds of the

consumer through the Brand

Ambassador and once a person

thinks about any particular

brand, he/she will immediately

be able to reconnect it through

the image of the popular

person who endorses it in the

popular TV Commercial

(popularly called as Ads). One

can take examples of beverage

companies (like Coke/Pepsi),

Sports Apparel (Nike/Adidas),

Watch Companies (Rolex/Fast

Track), Textile Companies.

They are many. Companies

spend crores of money inbranding and in advertising in

order to get their intended

image to the customers

through a celebrity who is

generally a sportsman/actor

/model, etc. But have we ever

thought on what goes in the

drawing board in the

companies while making these

decisions? What sort ofmethodologies do they adopt in

selecting the right person?

How do they evaluate the net

payoffs coming from the

celebrity?


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The payoffs for each stage of the game are calculated based on real-life data. For example, the total size

of the Indian Carbonated drinks market as taken from secondary data is at Rs. 60 Billion, out of which

Pepsi commands nearly 65% of the market share and Coke the remaining. However, out of the total value,

only a small percentage is taken to be the actual size which can be targeted by Pepsi and Coke brands

specifically as the companies portfolios also consist of other Brands. In order to find the reach of every

celebrity, a proxy of the fan base size in Facebook has been considered. For Sachin, the fan size is around7.5 Million and it is around 2.2 Million for Kohli. It is considered to be 50% of Kohlis fan base i.e. 1.1

Million are fans of both Sachin and Kohli. In case of both the people endorsing different brands, out of

the 1.1 Million, it is assumed that 50% is considered to follow the endorsement of Pepsi and the rest to

follow Coke for simplicity.

Another important point with regard to payoffs which must be considered here is the reduction in the base

market share in case the corresponding company doesnt use any brand ambassador and in the eventuality

of the other player using him. For this condition, some percentage of market share erosion must be taken

into account. Here, in case of Sachin endorsing a brand the competitor not employing any personality, the

erosion is taken as 20% and in case of Kohli, it is taken as 10%. The average endorsement fee for Sachin

was found out to be Rs. 55 Million and for Kohli to be Rs. 30 Million. Table A provides the details ofincremental revenues and endorsement fees for each player.

From the table, it can be found out that Kohlis charges a much higher endorsement fee on a per fan basis.

Also, the total endorsement fee exceeds the incremental revenue thereby justifying the initial assumption

of the companies choosing Sachin over Kohli. Table B in Appendix provides how the payoffs were

arrived at each node.

Pepsi is considered to be the first-mover in this game. This is a game of complete information wherein

each player knows the others decisions. The payoffs as explained earlier are decided based on the base

revenue, the incremental revenue from brand endorsement and the endorsement costs.

TABLE A: Incremental Revenues and Endorsement Fees

NameEndorsement Fee(Rs. Millions)

Fan base(Millions)

Incremental Revenuefrom endorsement(Rs. Millions)

Cost per fan(Rs.)

Sachin Tendulkar 55 7.5 75 7.33

Virat Kohli 30 2.2 22 13.63

TABLE B: Payoff Calculation at different nodes

NodeDecisio

nPepsi's Payoff Calculation Net Coke's Payoff Calculation Net

B

CokeChoosesKohli

Base revenue +IncrementalRevenue fromSachin - Revenuelost from Kohli'sendorsement -Sachin'sendorsement

3802+75-0.5*0.5*22-55

3816.5

Base revenue +Incremental Revenuefrom Kohli - Revenuelost from Sachin'sendorsement - Kohli'sEndorsement fee

2197+30-0.5*0.5*22+22

2183.5


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CokeDoesn'tchooseKohli

Base revenue +Incrementalrevenue fromSachin - Sachin'sEndorsement fee

3802+75-55 3822Base revenue - Revenueslost from Sachin'sendorsement

2197-2197*0.2

1757.6

C

Coke

choosesSachin

Base revenue -

Revenues lost fromSachin'sendorsement

3802-3802*0.2 3041.6

Base revenue +

Incremental Revenuefrom Sachin - Sachin'sEndorsement fee

2197+75-55 2217

D

PepsichoosesKohli

Base revenue +Incrementalrevenue from Kohli- Kohli'sEndorsement fee

3802+22-30 3794

Base revenue - Revenueslost from Kohli'sendorsement fee

2197-2197*0.1

1977.3

E

CokechoosesKohli

Base revenue -Revenues lost fromKohli'sendorsement

3802-3802*0.1

3421.8

Base revenue +Incremental revenuesfrom Kohli'sendorsement - Kohli'sendorsement fee

2197+22-30 2189

CokeDoesn'tchooseKohli

Base revenue 3802 3802 Base revenue 2197 2197

The game tree is shown in the above Figure. For the game, a method known as rollback equilibrium is

employed where the best strategy at the end nodes are taken first and then the game is brought back to the

preceding nodes to find out the other players best decision. From the methodology, at node E, it can be

seen that Coke chooses not to go for Kohli as it gets a better payoff (2197 > 2189). Seeing this, Pepsi, in

node D, chooses not to go for Kohli as the payoff is better in that case (3802 > 3794). Rolling back to the

previous stage, Coke sees this and opts to go for Sachin for endorsement in node C (2217 > 2197). Also,

in node B, Coke chooses to go for Kohli for endorsement as it gets a better payoff (2183 > 1757). Now, in

node A, Pepsi opts to go for Sachin as 3816 > 3041.

The Game Tree


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Therefore, the Nash equilibrium (Where no player unilaterally deviates) is given as:

(Pepsi : Coke) :: (Sachin at A, No Kohli at D; Kohli at B, Sachin at C, No Kohli at E)

The way to understand this is that, the optimal strategy for Pepsi at node A is to select Sachin and at node

D is NOT to go for Kohli. For Coke, this means that, given Pepsi doesnt unilaterally deviate from its

Nash Equilibrium, it would now opt for Kohli at node B, Sachin at node C and would NOT go for Kohli

at node E.

At the equilibrium path, the game would end with Pepsi opting for Sachin and Coke opting for Kohli for

endorsements.

At every node of decision making, companies have a choice of hiring or not hiring one of the sportsmen.

There exists a value for the fee that is paid to the personality at which the companies are indifferent

between choosing and not choosing him. This value can be evaluated for different conditions and is called

the inflexion point.

Taking one of the nodes as an example, Node b. Pepsi has already chosen Sachin and now Coke has tochoose between hiring/not hiring Kohli. Assuming the fee to be paid to Kohli is x, the condition for Coke

to indifferent between choosing and not choosing is Base revenue+ Additional revenue through Kohli

Kohlis fee = Base Revenue Drop in revenue due to Pepsi employing Sachin. That is: 2197+16.5 - x =

21970.2*2197. We get x to be as high as 465.5 Million INR. The implication here is that it does not

make sense for Coke to not hire Kohli as long as his fee is as high as 466 million INR, given Pepsi is

hiring Sachin.

Taking another example at Node e. Pepsi and Coke have already decided not to opt for Sachin and Pepsi

has also chosen not to hire Kohli. Now, Coke has to choose between hiring/not hiring Kohli. We get the

Inflection point,x to be 22 million INR. The Managerial Implication here is that Coke would hire Kohli

only if the fee he charges is lesser than 22 million INR. As is seen from the game tree, under the givencondition of Kohlis fee= 30 Million INR, Coke would be better off by not hiring him.

Therefore, it can be seen that there are many Managerial Implications of this game provided we take the

assumptions which come with it. Also, this game can be played for any industry which opts to make a

decision of going for celebrity endorsement.

References

Magotra, A. (2012, March 21), "Will soaring brand value kill Virat Kohlis cricket?"FIRSTPOST SPORTS

Rahul Gupta Choudhury, N. K. (2011), "MARKET ANALYSIS AND BRAND PREFERENCESFOR COCA-COLA SLIM CANS", International Journal of Research in IT & Management.

Srivastava, M. (2010, Sept 16), "For India's Consumers, Pepsi Is the Real Thing", BloombergBusiness Week.


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Caste Politics in Karnataka - A Game Theory Perspective

Darshan Sullia, K.V.Thanmai, Nishanth Appaiah Mittu, Shushanta GuhaBatch 2011-13, PGP, IIM Kozhikode

Introduction

The Bharatiya Janata Party (BJP) has been in power in

Karnataka since 2008. Following his indictment by the

Lokayukta for illegal mining in the state, Chief Minister B S

Yeddyurappa was told to step down by the High Command in

July 2011. There has been a lot on infighting in the party since

then and caste considerations have played a considerable role,

primarily between the Lingayats and the Vokkaligas. The party

is in crisis and even L K Advani has blogged about the

scandalous rule of BJP in the state.

This issue is important because the political infighting has

consequences not just for the two caste groups within the party

but also for the general public. On 12 July 2012 when we had

to submit our term paper proposal, Jagadish Shettar was

appointed the third Karnataka CM in four years, replacing

D.V. Sadananda Gowda who in turn had replaced

Yeddyurappa. And being residents of Karnataka, this situation

is highly relevant and of specific interest to us. We are looking

at the issue from the perspective of game theorists and

observing how the situation unfolds by applying game modelsand concepts that we have learnt in the course.

The Game

Figure 1: Resource distribution

bLINGAYAT

MLAs

VOKKALIGA

MLAs

ZERO

ZEROONE

ONE

L1

MinL MinV

a

V1

x y

P1P2

P3

V0

L0

On 12 July 2012, Karnataka

witnessed a third leadership

change in four years of

Bharatiya Janata Party (BJP)

rule; hit by intra party feud.

Caste considerations have

played a dominant role for the

party to survive in power and

performance has taken a back

seat. The public has suffered in

this battle of power in the BJP

between the Vokkaliagas and

the Lingayats. The party high

command has played a

mediating role to try and keep

everybody satisfied.

The players involved in the

game are the Vokkaliga MLAs,

the Lingayat MLAs and the BJP

High Command. We have tried

to explain the intra party

politics as a bargaining game

between the Lingayats and the

Vokkaligas with the High

Command playing the role of a

mediator. The objective of the

party is to stay in power by

appeasing the demands of thetwo factions. While this model is

a simplified form of reality, it is

very much applicable in the

Indian political scenario and

such caste based negotiations

are common in other states.


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Here:

V0 = Point of minimum resource (power) for the Vokkaliga MLAs

V1 = Point of maximum resource (power) for the Vokkaliga MLAs

L0 = Point of minimum resource (power) for the Lingayat MLAs

L1 = Point of minimum resource (power) for the Lingayat MLAs

The line ab represents the power continuum. Power in this case takes the form of the following

possibilities-

Appointment of CM from the concerned faction Appointment of Deputy CM belonging to the concerned caste Appointment of MLAs of the particular caste to key ministries in the cabinet such as Home,

Public Works Department, Revenue , Road and Transport

Increase funding to constituencies headed by the Minister of the respective factionax = Min L:

Given the above scenario, the distance ax represents the minimum demands for power made by the

Lingayat MLAs. It is to be noted that the minimum power demanded by the Lingayats effectively

corresponds to the power that they can unilaterally obtain independent of the BJP, by withdrawing their

support of the party and becoming a part of the Congress, which is also open to including Lingayats in

their fold.

by = MinV:

This distance represents the minimum demands for power made by the Vokkaliga MLAs. As is the

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