Focus February Vol1

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August Vol 2 , 2010. Ecobizz Newsletter

From The Editors Desk

Neha Sharma

IBS Hyderabad

February Vol 1, 2011. Ecobizz Newsletter

Inside the Issue:

Mummy Land Impacts

India

-Antariksh V.Social NetworkingAn

Idea or a Concept?

-Aditi Kulkarni

The Puzzle of Food

Inflation

- Tinu Dalal

Infrastructure DeficitThe Choking Factor of In-

dias Growth Story

- Neha Sharma

Depreciation of

CurrencyA Boon in Dis-

guise or An Evil?

- Rahul Mukerji

Hey There,

As we move on to a New Term and start upwith the Summer Internship, Im sureyouve got a lot planned out for this Sum-

mer!

For many this is the very first trystwith the Corporate Culture and for the oth-ers, its a Welcome change with a reverie oftheir Work-Ex days. Whichever categoryyou may belong to, Team Ecobizz is here toensure that you dont miss out on the KeyDevelopments across the globe and on the

Home-Front too!

Heres an analytic lowdown of themost critical aspects having an impact onthe Economy. Starting from the EgyptianCrisis to Food Inflation, Currency Deprecia-tion to Infrastructure Deficit along with theone thing we spend most time on when inCampusFacebook! Youve got it all in this

Issue.

As always were open to Feedback, Ideas

and Suggestions to Build on.

Heres hoping you have a Great and Enrich-

ing Read!

Warm Regards,

Neha Sharma.


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IBS Hyderabad

Mummy Land Impacts India- Antariksh V

August Vol 2, 2010. Ecobizz Newsletter

accentuating the protests.

Is this Important?

Well the Tunisian crisis hasnt spelled any con-cerns on the world economics, but Egyptian crisishas an adverse impact. This revolution in Egypt is

important for two major reasons. Firstly it is incontinuation to the Tunisian

revolution. Both thecountries are currently

facing similar hardships and

oppressions and they arepart of the Arab belt. Boththe countries had a longstanding ruler who dictated

the whole proceedings inthe nation. Therein lays thesecond major importance of

this turmoil. There arechances of these countriesbecoming democratic intheir proceedings and reject-ing the kingship. Thiseffect may spread to other

Arabian countries triggeringa series of government

downfalls.

The Egyptian crisis has led to a major concern andthat is of disruption of oil supply. Even thoughEgypt isnt the biggest producer of oil, but it facili-

tates the route which caters the heaviest oil trafficfor the world, the Suez Canal. Its the narrow ca-nal made in Egypt connecting the MediterraneanSea and the Red Sea reducing the oil route dis-tance by nearly half. There is huge business atstake now because of this crisis. The security ofthis canal has scared the consumers of the con-tinuous supply of oil, pushing up the oil prices to

nearly $100 a barrel.

What has happened? In a span of two months apresident was forced to resign and another facingthe exit, and who has done this the citizens oftheir own country. These presidents were the rul-ers of their countries for more than a couple ofdecades. They had brought their countries from

rags to riches, and brought many important longlasting changes. Yes I am talking about the twocountries Tunisia andEgypt. Both the countries

had an issue in common Unemployment. It all beganwith Tunisia. The govern-ment had brought about few

good developmental re-forms in terms of educationand cultural freedom for itscitizens. But its steady and

slow economic growthwhich was localised to theelite class with less job offer-ings for the fresh graduates

of the country triggered the jasmine revolution. Themajor tourist destinationwas facing a long period of

unemployment & oppression.

It all started with the selfimmolation of a street vendor who was desperate

to earn some money and the law prevented him

from doing so. The protest slowly spread acrossthe nation fuelled by the citizen frustration of theruling elite and political suppression. Also thecruel response of the government against the citi-

zens resulting in more than 80 deaths fuelled theprotests further. Economic growth was highlylocalised to elite class widening the gap betweenthe rich and poor. There were also many indica-

tors of corruption within the elite class further

How can a crisis in Egypt

impact our own Countrys

Economy? We might be forced

to buy the black gold at higher

rupee cost, impacting adverselyour current account balance.

World powers are at stake with

this Egyptian crisis.



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developmental projects. With the nation facing thehigh inflation and higher crude oil prices; the sys-

tem has to play the balancing act. It might have tostop few developmental projects to fund pur-

chases. This may result in the crude oil price riseto creep deep into the core inflation, making the

headline inflation hit harder.

Inflation is also hitting the profitability of our in-dustries. The companies are struggling to keep

price rise under control. They may not be able tosustain the increase in raw material costs forlonger period and may have to increase their

product prices.

An Afterthought

After Tunisia, protests were witnessed in Algeria,Yemen and Jordan. Other Arab nations may alsorise against their rulers. For the Egyptian situation

it has lot more at stake than just economics, it has

geopolitical stakes too.

Firstly from the point of view of United States.

The US has found its major ally in Egypt. Egypthas provided US a strong foothold into the politi-cal scenario of the Arab world. All of this had an-gered the Arabs and the Russians. Egypt provided

US the intelligence against Osama and has beeninstrumental in curtailing the spread of terrorism.

Secondly for Iran, if there is radical Muslim broth-erhood which comes to power in Egypt, the Ira-

nian influence will decline. Centre of powerwould be divided between the two nations. All ofthese have a profound impact on the world poli-tics. The centre of Arab world has now become

the centre stage of world politics.

If Egypt sees a peaceful transition towards democ-racy, it will herald a revolution in the entire re-

gion, confirming in a sense the trend that the USvice president described as a lot going onacross from Tunisia to all the way to Pakistan.

Can this be linked to certain conspiracy, as just bylooking at the perfect timing and connections ofthe uprising and the huge stakes? But whateverthe case might be, if the end benefits the citizens

of the world, then is the toppling justified?

The Indian connection

There is no denying the fact that the events in

Egypt are going to benefit their nation in longterm, but at this moment India is on the verge of

facing the biggest challenge. We are already facingthe worst situation high inflation. I was reallyamazed after checking the rates of items I used topurchase regularly before start of MBA. Theyhave risen quite high; some of them even jumped

by more than 90% of their previous purchase rate.Now if this continues, which at the moment seemsto be quite possible, then the situation is only go-

ing to worsen.

The crude oil price has risen and now hovers toaround $100 barrel mostly due to speculations onthe Egyptian crisis. Some might say that the prices

wont be having much of an impact on India aswe have already faced such kind of situation al-ready during 2007-08. But during that crude pricerise we had a benefit; the US dollar was weaken-

ing, allowing India to buy the crude at a cheaperrupee cost. There was heavy inflow of US dollarsinto the country bulging up our forex reserve. Soeven when the crude was selling at $140 a barrel

we had enough cash to buy it. This time thoughthis is not the case. The dollar is not weakening

enough and there is no inward movement of thedollar. In fact the dollar is moving outwards. This

is evident by the stronger selling by the FIIs and

dropping equity markets.

We are forced to buy the black gold at higher cost.

This is going to adversely impact our current ac-count balance. Currently the government is run-ning under deficit and sponsoring the various


IBS Hyderabad


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IBS Hyderabad

MOVEMENTSIN S&P 500 V/S NIFTY

- Lakshay Mehta

days for a reply. Real time connectivity has be-

come of utmost importance. But we are not here

to talk about the leverage provided by these so-cial networking sites. I am sure we all are profi-

cient at that already. What we are here for is tounderstand for ourselves how social networking

sites are being used asnot just the parapher

nalia to interact withother people but as radi-

cal method

of creating cog-nizance among the

masses.

We have exceptionalexamples of Pepsi Re-

fresh Campaign andDell Hell which used

social networking sitesas a channel to save theirthinning ad campaigns

or products. Social net-working sites are an ef-

fective, zealous and pro-ficient mode used by

marketers these days.They are ever changing

and ever growing! This

can be seen from the very fact that there were4000 websites in 1994; now there are approxi-

mately 170 million sites. They have affectedevery industry. They have paved way for the

entrepreneurs to target the niche market quitedexterously, which in a way would affect the

economy as it gives rise to more business pros-pects. They have been used as a powerful me-dium for brand building as well. The use of so-

cial networking sites for brand building could bea campaign lead or a more strategic long term

Isnt this picture perfect as my profile pic? orHave you seen his latest pics on Facebook?seem to be the commonly asked questions these

days. It is quite intriguing to see how these social

networking sites have become a part of ourmainstream culture. In fact so much so that it has

now become a taboo tonot be active or at leastvisible on these social net-

working sites.

Essentially social net-working sites are basedon the concept of Six

Degrees Separation (the

idea that any two peopleon the planet could make

contact through a chain of

not more than five inter-mediaries). Now, a fewmajor aspects form the

foundation of social net-

working sites. First andforemost being Syndica-

tion. These social net-working sites are funda-

mentally based on the

concept of Syndication.Without the same there would be no substance inthe social networking sites. Reward and R eaction

would be next important aspects. Radical waysof rewarding people and not necessarily in terms

of money, have been brought forward throughthese sites. And of course not missing out on in-

teractivity and connectivity. Today social net-working sites have connected millions of people.Gone are the primitive days when people used tosend a message and wait for some time or even

Social NetworkingAn Idea or

a Concept? -Aditi Kulkarni

Everyone uses Social Networking

sites. But what is the impact these

networking sites can have on the

Casual Consumer and how can it

affect and Organizations Culture?Is this the Next Breeding Ground

for Innovation?.



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tary activity to communal activity. Very rightlysaid by Mr. Joe Kraus of Google Today, social

networking is not a site; its a concept.

However the challenge lies in measuring the ef-fectiveness or ROI of the use of the social net-working sites. The studies have shown that the

response rates havent been great with respect tosocial media ads. But that does not undermine

the significance the social networking sites hold

in todays world. In the end I would like to saythat social network sites are an opportunity to

breathe life into products and services that manyconsumers may find lifeless. Social networking

sites would definitely be the next mantra for the

marketing gurus!

initiative.

Mini USA, the American branch of BMWs MiniCooper line, designs its advertising campaigns

after tracking everything being said about itsbrand everywhere on line in blogs, discussiongroups, forums, Facebook pages and much. At

Hewlett-Packard, 50 executives log into their in-dividual blogs everyday to take part in the ongo-

ing online conversation about each of their prod-uct lines, addressing customer problems and

concernsat the same time. Ernst & Young uses a

career group on Facebook, where it not onlyposts job information but also answers individ-

ual questions from prospective employees to re-cruit many of the 3,500 graduates it recruits

every year. All the companies mentioned aboveused a technique called Groundswell to im-

prove their businesses in different manners. The

Groundswell is a social trend in which peopleuse technologies to get the things they need from

each other, rather than from traditional institu-tions like corporations. With the changing trends

consumers are more empowered and independ-ent. Information sharing has changed from soli-

IBS Hyderabad



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- Lakshay Mehta

30.97 percent in the week, compared with 46.7

percent rise in the prior period, while fruits rose

7.87 percent, less than 10.35 percent. Milk prices

increased 12.6 percent from 13.6 percent.

Economists suggest that the increase in the prices

indicates a shift from the Goldilocks Era - a pe-

riod that extended upto 30 years back, wherethe prices of the food

and other commodi-ties more or less re-

mained constant. The

IMF's index of foodprices in 2005 was

slightly lower than ithad been in 1974,

which means that inreal terms food prices

fell during those 30

years by three-quarters. But now it

seems that the longperiod of stability iscoming to an end.

For India, an increasein food prices means

real suffering. A coun-try which is still

marred with the hor-

rors of hunger and

malnutrition, andwhich is home to 25%

of the worlds hungry population an increase in

the food price can paralyze the whole economy.The further increase in food prices will mean,

wages will go up because workers will demand

high wages. Wages going up make cost of prod-ucts go up, and manufacturers will try to pass it

on to the consumer. It's called a wage-price spi-

Were in the midst of a global food crisisthesecond in three years. World food prices hit arecord in January, driven by huge increases in

the prices of wheat, corn, sugar and oils. The

specter of another food crisis has the wholeworld nervous. But in India, skyrocketing food

prices have threatened to send the entire econ-

omy into a tailspin, asthe government strug-gles to balance growth

and inflation and

create a safety net forthe millions still

mired in poverty. The

last couple of monthshave witnessed al-

most a run way typeof increase in the food

inflation especially inIndia. The food infla-

tion rose to 18.32% by

January end, with theprices of onions and

other vegetables

reaching all time high.

An index of food arti-

cles compiled by thecommerce ministry

increased 18.22 percent

in the week ended

Dec. 26 from a year earlier, following a 19.83percent gain in the previous week. Food-price

inflation accelerated to 19.95 percent in theweek to Dec. 5, the fastest pace since Dec.

1998.Price gains eased in the week to Dec. 26

from the previous week as costs of some fooditems softened. Prices of vegetables gained

Food price inflation could really go

into double digits across the region and

rise to such an extent that it

undermines the purchasing power of

households and as a result then slows

consumer demand and overall economic

growth," said Frederic Neumann,

regional economist at HSBC in Hong

Kong

IBS Hyderabad

The Puzzle of Food Inflation

IBS Hyderabad

-Tinu Dalal



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8

ral, leading to a further increase in the inflation

rate.

Usually the prices of vegetables and fruits are

expected to he the lowest in the winters, but this

year it wasnt the case. This time it was the highfood inflation, which caused the increase in the

inflation rate in the other sectors. Understandingthe causes leading to inflation is a complex affair,

however there might be a few grass root levelproblems that need to be first understood in or-der to tackle the soaring food inflation.

The first and the foremost reason for the un-

precedented increase in the prices, is the growthin the population which has put a lot of pressure

on all the available resources like land, water,soil etc. Indian agriculture is in a crisis and the

peasantry continues to be in distress with 2.5

Lakh farmers committing suicide over the past15years. We are not producing enough to meet

the needs of the growing population.

The increase in the growing population, has lead

to the increase in demand of the food grains/

cereals and other basic commodities. Demandthough is only one side of the equation. Supply is

another. A study on the production of cereals/

IBS Hyderabad

food grains by FAO, suggests that this year the

overall production of all cereals will be around53m tones, this is a very rough indication of

how much demand is outstripping supply.This imbalance between the demand and sup-

ply in the economy indicates a further rise in

the prices of the cereals, vegetables and fruits.

Another factor affecting the prices is the su bsi-

dies offered by the government on productionof certain agriculture products like soya-beans,cotton, tobacco, peanuts. Due to the grants of-

fered by the government on such products thefarmers prefer growing them rather than cere-

als and food grains. The land under cultivationfor food grains has shrunk considerably, owing

to these reasons, and hence the production hasgone down, contributing towards the imbal-ance between the demand-supply sides of the

equation.

India has come a long way in terms of foodgrain productivity. Considering the huge

population, production may be a slightly shortof demand but then this can be tackled by im-

porting. The problem is the middleman. Thereexists a huge difference between the cost of



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We are not sure whether we have all the toolsin our hands to control food inflation, former

Finance Minister P. Chidambaram

The unexpected increase in the percentage offood inflation forced government and the RBI to

intervene. The finance ministry said it wouldmake an effort on all possible fronts to curb pricepressures. There are speculations that the RBI

will further increase its policy interest rate by 25points and the government will tighten its mone-

tary policy.

However what we need is a long term strategy tofight inflation. The first and foremost step will be

to strengthen state intervention in the food econ-

omy, both in food distribution and production.The government also needs to work on the rec-

ommendations made by the National farmersCommission, according to which agriculture

storage and marketing should be opened forpublic investment. Finally the government needs

to control the costs of agriculture inputs like fuel,

fertilizers. Deregulation of fuel and fertilizerprices will raise agricultural costs and contribute

to food inflation.

All these issues need to be addressed if we are todeal with this rampant problem of food inflation.

The policies adopted by the government and theRBI, might bring down the inflation rate tempo-

rarily. But the greater question of achieving sus-tainable growth will not be answered until the

government addresses these issues which are too

big to notice and too s mall to ignore.

production and the actual cost that the consumer

pays, followed by the problem of hoarding and

black marketing by the sellers to earn higher

profits.

A few steps that the government needs to tackle

in this regard is to promote the policy of directfarmers to retailers. E-choupal is one such initia-

tive, with the aim of eliminating the middleman,and selling directly to the retailers at the price.

This scheme presently covers 40000 villages tilldate, empowering 4million farmers; however the

scheme still has a long way to go, covering the

remaining villages. Other initiatives that the gov-ernment can take is to impose a limit on the re-

tailers, on the quantity that they can purchasefrom the farmers, this will check the black mar-

keting and other practices like hoarding, which

creates artificial scarcity of food, leading to in-crease in the prices of the same.

Wastage is another problem that we need totackle. Production we have raised. But when it

comes to storing, we are lagging behind in termsof the facilities and the technology available tominimize the wastage. Even the governments

buffer stock goes unused till its rotten. The gov-ernment needs to take precautions on the storage

of the buffer and its release to check the inflation.

The growing role of food corporate in the food

economy and international trading of the fooditems has also impacted the price rise. The shareof corporate retail has tripled over the past four

years. Trade policies were manipulated by thegovernment to allow for bigger corporate housesto make huge profits through exports and import

of essential food items. However the policy hasboomeranged on the government as now the

government has little capacity to control the food

prices.

IBS Hyderabad


Inflation is when you pay fifteen dollars for the ten-

dollar haircut you used to get for five dollars when you had

hair.

-Sam Ewing


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- Lakshay Mehta

We boast of having one of the best regulated fi-

nancial systems in the world which has helped

us insure our economy against any of the bubbleslike the dot-com bust and real estate boom that

lead to stock markets crashing across the globe.Then Why should we be left behind as just an-

other developing economy while were posting

some of the best growth rates in this time of re-covery? Analysts might say our industrial output

is not up to mark and we

need to improve production

facilities to balance thesupply demand dynamics.

However we cant justlook at the recent slow-

down in industrial growthas a reason. It must be

noted that the benchmark

for industrial growth isoutdated and needs to be

revised. Apart from this,we had beyond normal

industrial output growthrates last year. This was

due to the seething de-

mand pattern as the econ-omy was recovering

backed by the emergingmiddle class. Inflation and

overheating are some ofthe other factors that are

burning holes in the economic fabric of our coun-

try.

The infrastructure deficit is an indicator of some-

thing being wrong at a much greater level. This is

in terms of the government and the ambitiousgrowth plans it has been throwing at the com-

mon man in a blatant demand for power. At thispoint it is noteworthy that the government has

implemented plans to uplift the major chunk of

The seeding economic growth that our coun-try achieved through the times is now breakingnew ground. Heres an economy that had

nearly decoupled itself from the global finan-

cial crisis and managed to easily manoeuvreitself out of the slowdown that affected it for

nearly 1.5 years. However, there is one critical

area where we are yet to catch up on. It is theInfrastructure deficit that is stifling the rapidgrowth potential of our

country on all levels.

Infrastructure deficithas a huge social cost

apart from meagrely

acting as a bottleneck inthe Indian growth

story. There is a grow-ing need of meeting the

basic requirements topush the economy to a

double digit GDP

growth rate. The prob-lems were currently

facing range from Traf-fic choked congested

roads, dilapidatedbridges, and underde-

veloped modes of trans-

portation, under-funded

schools, R&D programs and inefficient means

of wastage disposal. The course of Charting onto a better economy has been a dim one in theliteral sense as well with load shedding across

major cities and industrial hubs across thecountry. As per the Planning Commission, eco-

nomic losses due to poor infrastructure are tothe tune of $6 billion a year. Talk about hearing

it from the Horses mouth itself!

Infrastructure Deficit: The ChokingFactor of Indias Growth Story

IBS Hyderabad

There is a Plethora of problems

that are influencing the India

Growth story. The biggest one of

them all is the InfrastructureDeficit. It has an impact on all

sectors of the economy. Whats the

reason for it and what measure has

the Government taken till now?

-Neha Sharma



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11

in shortening the infrastructure gap would have

been foreign investments in terms of FDIs. Even

though the government did frame congenial poli-cies to better facilitate investments in infrastruc-

ture, there is still a huge shortfall of funds. Thiscan be linked to the Co-ordination problem in

popular economic theory. Major planning for theeconomy on a whole happens at one avenue. The

entire planning and decision making process iscentralized. If you were to look at the states

alone, then Gujarat, Andhra Pradesh and West

Bengal have achieved landmark growth rateskeeping in mind the operational efficiencies in-

volved. This has been possible due to differentstates following a varied set of rules for invest-

ments with the extent of roles that the State &Central governments play along with the Private

players being limited. This is one of the factors

thats discouraging investors from putting their

money where we really need it.

Currently the roads are still under-developed to

handle the great traffic load that is being trans-ported around India. Truckloads after truckloads

are being used and extensive distribution net-works have been setup. There has been a shift

from the railways to road transport as a meansfor distributing products. Our ports are grossly

over-utilized and are running at full capacity al-

ready. The central government with its liberalfiscal policy has subsidized the electricity, waterand commodity rates. Not only is this adding tothe fiscal deficit already prevalent, but its also

increasing the burden on the tax payer. No mat-ter the tax accountability has improved in recent

times; however this is not the only means to meet

the fiscal deficit leave alone the infrastructure

deficit.

Mckinsey the consulting powerhouse has recom-

mended an action plan calling upon higher in-vestments, sourcing new investors, infrastructure

funds and newer mechanisms to arrest the gapand propel growth. But what are the suggestions

that will really work in the current scenario? Be

sure to catch up on the next issue of The Focusto find out the feasible solutions to the infrastruc-

ture deficit choking our economy!

its population out of poverty by powering plans

such as the NREGS scheme which provided em-

ployability options to the rural folk. However,this has indirectly lead to increasing pressure on

the infrastructure front.

India being an agriculture driven economywhere the unorganized sector forms up to 80% of

the trade, needs to have better connectivity tofacilitate trade from the rural areas. Appropriate

Storage methods are also the need of the hour.We need better managed inventories and trans-

parency to limit hoarding of agricultural pro-

duce. Being the second largest producers of fruitsand vegetables, were still at a loss when nearly

40% of the produce rots away due to inefficient

modes of storage. The government has estimated

that it would need an investment of nearly$500billion to meet the current infrastructuredeficit. This is the estimate drawn from 2007-2012. However, I reckon that this deficit must

have further widened up in recent times. These

estimates were penned when the Congress wasin the subsequent term and had introduced a

series of reforms with the backing of the UPA.We did experience a positive growth rate after

that, but it has recently been shrouded withscams. Rampant corruption has become the order

of the day. This has lowered the investor confi-dence and the general mood of the Junta. One of

the primary factors that could have helped India

IBS Hyderabad



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Guest Contributions

IBS Hyderabad



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13

exchange rate of INR against USD yesterday hy-

pothetically was 46.40/ 47.20 and today is 48.50/

49.30 then the INR is said to have depreciatedagainst the US dollars. Exact opposite to depre-ciation is the concept of appreciation wherelesser units of domestic currencies are required

to buy one unit of foreign currency. It is to beremembered always that it is not in the hand of a

government to controlthe currency as such.

Though there are ways

to do so but for now letsassume that it is only the

market forces that decidewhen a currency should

appreciate or depreciate.It is important to talkabout depreciation or

appreciation of a cur-

rency due to its implica-tions.

The following implica-tions that I am going to

talk about are not imme-diate i.e. it is not that all

this would happen on thesame day when the cur-rency depreciates. The

implications are due topersistent fall of the currency over a period of

time. Now lets see what happens:

INR depreciates against USD ->For people in USit is cheaper to buy INR goods -> Indias exportbecome competitive -> Exports to US rise -> Im-ports from US fall as it is expensive to buy goods

from there -> Trade Account improves ->Net

Exports rise ->Y (output) rises as

Before talking about depreciation of currency itis important to point out that there are two kindsof exchange rates that exist: A fixed exchange

rate and a flexible Exchange Rate. For example:

China follows a fixed exchange rate system whileIndia follows a flexible exchange rate system.

What is the main difference between the two sys-tems one might ask?

The main difference in the

two systems is that incase of fixed exchangerate system (as the namesuggests) the exchange

rate of the currency is

fixed and can be changedonly by the government

and not by market forces.A government if it

wishes, can either revalueor devalue its currency.

But in the case of flexible

exchange rate system thevalue of the currency is

determined externally viathe market forces i.e. by

the demand and the sup-

ply of the currency in the

market. Now i t is here the

concept of depreciation comes in.

A currency is said to depreciate when its value

declines or falls against another currency i.e.when more of domestic currency is required to

buy one unit of another foreign currency then thedomestic currency is said to have depreciated

against that foreign currency. For example: If the

IBS Hyderabad

Depreciation of Currency : A Boon

in disguise or An Evil ?-Rahul Mukerji

How does Depreciation really

affect the Economy? Does it help

us build on Capital Gains as a

Boon or would it just add on to

Hyper-inflatory Pressures? The

Dilemma is yet to be answered.



14/16

14

demand for INR in the currency market leads

INR to depreciate. This withdrawal of money

from the economy also to certain extent helps to

curb inflation.

This is one way how a currency may depreciate.

Now as seen above, the converse is also true asthe currency starts to depreciate ->exports be-

come more competitive -> exports rises and im-

ports fall -> there is a change in NX -> in case ofIS curve the NX lies in the autonomous compo-

nent of the equation -> Y = m(A0 br) where m =multiplier and A0 the autonomous component As

the A0 increases it causes in Y which is larger du ethe presence of the multiplier -> this is what is

causing a larger increase in Y in the figure

(Mundell- Fleming Model) -> IS curve shifts thusfrom IS to IS1 -> equilibrium shifts from E* to E2

-> Y increases from Y1 to Y2 -> increase in output

and thus GDP.

The automatic stabilization that I was talking

about before has been achieved through therightward shift of the IS curve. The interest rates

have been restored to the original level along

with which the output has increased.

Therefore it may seem like that the ultimate

benefits achieved from depreciation of a currencyare larger for the economy as there is a rise in the

output and lowering of inflation as well.

Y = C + I + G + NX -> increase in GDP

When the currency is cheap and interest rates are

high -> Investors willing to invest -> more FIIsand FDIs -> capital inflow -> money supply in-

crease -> LM curve shifts to the right -> output

increases

As we move further there is one reason why I

think the currency might depreciate, which is

external market forces. But the big question is ifthats the case it would imply that there is nocontrol and the economy should continue togrow infinitely. But this is not the case as there

are automatic stabilizers built in to the economy.To explain this I would need to take the help of

the IS-BP-LM model or the Mundell-Fleming

model for currency exchange in a floating ex-change rate system. Lets see how: (Of course as

always there are lots of assumptions that I am

making to simplify the model for understanding)

Let us say that initially we are at E1 with interest

rate at iw and output at Y1. Now the governmenthas introduce a new expansionary monetary pol-

icy for which the LM curve has shifted to theright from LM to LM1 -> equilibrium shifts to E*

-> interest rates fall to i* -> there is huge capital

outflow as investors see lower returns -> thisleads to lower demand for INR as the investors

sell INR and convert currency to USD -> lower

IBS Hyderabad


MUNDELL FLEMING MODEL


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15

economy can be disastrous as it may lead to

hyperinflation. As the currency continues to de-

preciate for longer period of time the value of thedomestic currency will fall which spells gloom

for the economy. On the other hand as the cur-rency persistently depreciates it will be muchexpensive for the country to import goods likecrude oil which is primarily traded in USD. This

would lead cost push inflation in the economy. Itmight happen that as inflation level raises unem-

ployment level also starts rising. Thus the econ-

omy would fall into a stagflation scenario. Thus acountry has to decide whether it is worth it to let

the currency depreciate for a long period of timeand enjoy short term benefits at the cost of long

term doom. This is exactly why no countrywishes to face this problem and does not deliber-

ately depreciate their currency. So here upon I

leave it upon you, Is depreciation really a Boon

in Disguise or an Evil to follow?

So through depreciation two birds can been

killed with one stone. But heres the big catch:

As we all remember: Money Supply = Money

multiplier * High Powered money

i.e. Ms = mm * H

But this H has two components: one is domestic

(Hd) and one is foreign (Hf) i.e.

Ms= mm * (Hf + Hd)

The central bank can control the Hd component

of the high powered money as it is domestic butthe Hf component is not in their control and is

determined primarily by the market forces. So, ifthe Hf component goes into a spiral then itwould really hard for the central bank to con-

trol the money supply in the economy. A fre-quent fluctuation of the money supply in the

IBS Hyderabad


FALL IN DEMAND FOR INR (leading to depreciation)

Government's view of the economy could be summed up in a few short

phrases: If it moves, Tax it. If it keeps moving, Regulate it. And if it stops mov-

ing, Subsidize it

- Ronald Reagan


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IBS Hyderabad

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