Wow, this escalated a lot while I was gone.
What does nominal GDP 2.4 TR USD against 9.5 TR USD PPP GDP mean? can you please explain the difference (Logically and not reeducation camp economics way)
This means that IF PPP holds, our GDP stands at $9.5 trillion. But PPP DOES NOT hold in international trade, which is governed by nominal exchange rates (Real Effective Exchange Rate to be exact).
What do I mean by "if PPP holds"?
Well, if maize in India costs Rs 50/kg, while in USA maize costs $ 5/kg, we say that 10 Rupee should be equal to 1 $. This would be the market rate if PPP holds. But it does not. And $1 is worth 65 USD.
Another example would be cost of a Japanese comic (called manga) in India is, say Rs 150 while in Japan it is 1500 Yen. PPP dictates the exchange rate should be at 10 Yen for 1 Rupee. But the RER is roughly 2 Yen for 1 Rupee. Why? Beacuase the manga came from Japan, and its transportation costs were added. Also, manga sales are not common in India, so economies of scale do not work.
Now real PPP calculations look at a basket of goods (and not a single product, as I used in the oversimplified examples above). Still, PPP can not account for some of the reasons for difference in price of goods. For example, medicine produced in Europe would cost you a fortune, while the same medicine produced in India is comparatively very cheap. Why? Royalties on IPRs. They pay, but we do not always pay. Does PPP account for these factors? No.
Similarly, PPP does not account for the barriers to arbitrage, such as trade barriers, liquidity constraints, transportation costs, etc.
PPP also does not account for some other things like base effect, FII and FPI and other things like technological innovations and frugal constraints that can force a change in the price levels of certain services (like space launch and heart surgeries in India vis-a-vis the West).
Note that nominal exchange rates do not shed light on the Purchasing Power of a currency, and so the closest thing we have, to measure that, is the PPP.
So we are using PPP in the absence of a better alternative.
Therefore GDP at PPP (which is GDP calculated at PPP exchange rates) is a heavily distorted figure.
What
@no smoking smoking said about PPP being a measure of only quantity and with no emphasis on quality is only half correct, but that is an academic debate that extends the uncertainty into the very marrow of economic thinking.
All this is part of the larger, ongoing debate of economics which questions the very reasoning that we use to label a country as developed, developing or underdeveloped. Until this debate reaches its logical consensual conclusion, we have no choice but to continue on with the current system. As far as current system is concerned, we compare countries based on GDP measured at nominal rates, and we compare quality of life using GDP PPP per capita.
Nobody said so either.
But the gap between Nominal & PPP GDP is damn high. Means there's an inflationary potential left between which can patched up for a bigger economy in MER.
Rest, get the example of East Asia.
By the term “inflationary potential”, do you mean to say that ideally, the nominal exchange rate should be equal to the PPP level exchange rate which is INR 17 to 1$?
About the East Asian crisis of 1997, AFAIK, it was due to a meltdown of banks due to heavy (over?) spending which did not translate into heavy returns as a result of which banks were saddled with Non-performing Assets. The Japanese bought a trillion dollars in FOREX and were barely able to arrest a Yen slide. I can't relate it to our current situation
Every development in economy will have multiple effect and implication. If it is 100 inr vs 1 usd, our export will further increase. Can we afford it?
It is always be at a correct level which is your economic power or strength. Our economy is big and our nominal value is 4 time lower than our purchase power is unacceptable and it has a negative overall impact on our economy and so any appreciation up to 50 INR VS 1 USD is well come. We can think subsequently whether it is good or not good. At this level, there is no question of rethinking on INR appreciation.
Any under or overvaluation of a currency is supposed to be self-correcting. How? Arbitrage. But there are a lot of enemies that arbitrage has, and so arbitrage never really works at 100% efficiency.
You seem to be celebrating the fact that the Rupee is appreciating. So let us assume that you are made the supreme authority in this country with the absolute control over both fiscal and monetary policies, as well as absolute control over all of the state governments.
You choose to raise RER to INR 50 to 1 $. How would you go about doing this? The only ways I can think of are:-
- Increasing the demand of the INR in international markets. But how?
- Decreasing the supply of cash in the economy. Prudent?
Also, what would be a higher priority for you - Inflation control or Rupee appreciation or GDP growth?
- Currency appreciation needs more exports.
- While a healthy economy for "safe currency appreciation" needs high manufacturing growth rate.
Now,
- India has a high trade deficit but it has world's largest Greenfield FDI which patches the deficit up and saves our currency from falling dangerously.
- It's manufacturing growth rate is now close to double digit & exports are rising faster than imports.
So, the currency who is already backed up by FDI is obvious to go up with depleting trade deficit.
FDI temporarily raises demand for Rupee in international market, and when we start exporting goods produced as a direct result of this FDI, we will again see an increase in the demand for Rupee as they will have to convert their currency to Rupee before buying Made in India goods. All this is likely to raise the REER of Rupee. But the parameter the government seems most interested to control is inflation. No Indian government can disregard inflation. However, FPI and FII also play an increasingly important role in driving the demand for Rupee in the international market. Infact, the recent hike in Rupee is due to increased FII in India (due to Modi's win in UP and the subsequent market expectation for more big-ticket reforms.)
BTW, another thrust area of the RBI has been to control Rupee fluctuation. That seems to be bearing fruit. (Although there are indeed a number of factors at work here in RBI's favour)
What should be interesting over the long term is if the government will indeed allow Rupee to appreciate. If we succeed in making ourselves an export-led economy, I do not see any incentive for the government to cause an increase in the REER of Rupee. They'll most likely try to keep it low.
Most projections place the Rupee between 75 to 80 to a Dollar in 2020.
Oh, wait. One reason for the RBI to allow this appreciation to continue in the short run could be to allow us to shore up our FOREX reserves. 2017-18 is likely to be turbulent. I know that the RBI is preparing ahead of times by shoring up its Forex. So this is why the Rupee is being allowed to rise.
Anyhow, I think this is a temporary phenomenon.
