2013 NYJC H1 Econs Q2 Suggested Answers

1 2013 H1 Prelim CSQ 2 Suggested Answers Extract 4: Slowing down of the BRIC Brazil, Russia, India and China, was acronymed into the BRIC in 2001 by Jim O’Neill, an investment banker from Goldman Sachs. In 2007 China’s economy expanded by an eye- popping 14.2%. India managed 10.1% growth, Russia 8.5%, and Brazil 6.1%. The IMF now reckons China will grow by just 7.8% in 2013, India by 5.6%, and Russia and Brazil by 2.5%. So, what is ailing the BRIC and other emerging markets? Firstly, the idea that emerging-market economies could fully decouple from economic weakness in advanced economies was far-fetched: recession in the eurozone, near- recession in the United Kingdom and Japan in 2011-2012, and slow economic growth in the United States were always likely to affect emerging-market performance negatively – via trade, financial links, and investor confidence. Secondly, and most recent, factor is the US Federal Reserve's signals that it might end its policy of quantitative easing earlier than expected, and its hints of an eventual exit from zero interest rates. The era of cheap or zero-interest money that led to a wall of liquidity chasing high yields and assets – equities, bonds, currencies, and commodities – in emerging markets is drawing to a close. These countries share other weaknesses as well: excessive fiscal deficits, external deficits, above-target inflation, and stability risk (reflected not only in the recent political turmoil in Brazil but also in India's political and electoral uncertainties). Thus, emerging economies with large twin deficits and other macroeconomic fragilities may experience further downward pressure on their growth rates. Adapted from various sources Indicator – (%) Brazil Russia India China Real GDP Growth 2.7 4.3 7.2 9.2 Inflation 6.6 8.4 8.6 5.4 Unemployment 6.0 6.5 9.8 4.0 Investment/GDP 20.6 23.2 34.4 48.3 Saving/GDP 18.4 28.6 31.6 51.0 Current Account/GDP -2.1 5.5 -2.8 2.8 Budget Balance /GDP -2.6 1.6 -8.7 -1.2 Table 1: BRIC’s in 2011 Source: The Economist, 29th September 2012

2 Extract 5: Rupee fall may have triggered inflation, but it also offers a way out of industrial decline Every dark cloud has a silver lining. Nowhere is this saying more apt than in the case of the falling rupee. It has raised fears of a spike in already high inflation rates and decline in foreign investment flows. But it has simultaneously opened up new possibilities of boosting exports, making India's economy more competitive and aiding a manufacturing revolution. The opportunity offered by the rupee depreciation can be substantial, given that labour costs in China have risen sharply. Current trends have already made India the cheapest source of auto components. Important industries that can leverage these trends include automobiles, IT, engineering, metals, pharmaceuticals, chemicals, textiles, leather and sports goods. Sustained growth of labour- intensive manufactured products offer great potential for absorbing the growing numbers of workers added to the labour force each year. The rupee, which has been hurt by a record current-account deficit, has sunk 7.4 percent against the dollar in 2013. In July 2013, India stepped up efforts to help the rupee after its plunge to a record low. The RBI (Reserved Bank of India, India’s Central Bank) raised bank rates by 2 percentage points, and plans to drain 120 billion rupees ($2 billion) through open market sales of government bonds. These actions of the RBI will lead to an increase in interest rates. Finance Minister, Palaniappan Chidambaram, told reporters that “these measures in no way affect our commitment to growth. Measures are taken to quell excessive speculation and reduce volatility and stabilize the rupee.” Prasanna Ananthasubramanian, an economist at ICICI Securities Primary Dealership Ltd. in Mumbai exclaimed that “it’s quite surprising that the central bank has used these measures to support the rupee at a time when the economy is in such a bad state.” India’s economy expanded 5 percent in the fiscal year ended March, the slowest since 2003, hurt by moderating investment, easing domestic demand and subdued exports. Source: India Times, Aug 2013 Figure 1: The BRIC Growth and Inflation rate in March 2013 BRICS: India worst off on Industrial Growth and Inflation Adapted from The Economist and The Guardian 2012   0 2 4 6 8 10 India China Russia Brazil Percenatage Industrial  Producti on Consumer  Price s

3 Extract 6: FDI no panacea for ailing economy In a bid to shore up India’s flagging economy, the government on Tuesday announced opening up foreign direct investment (FDI) in 13 sectors, including petrol and natural gas, insurance, defence production and telecom. The truth is that FDI easing only makes it easier for foreign investors to put their money in India. It doesn’t change the fundamentals that determine if they should put their money in India. A liberal FDI regime can yield results only if domestic economy is revived. The investors, including Indian firms that have been growing in India for decades, are reluctant to risk money due to uncertainties of doing business in India. That Korean steel giant Posco walked out of the biggest FDI deal in Karnataka the day the government announced liberalization of FDI rules is a grim reflection of ground realities. To create an enabling investment atmosphere, the government must remove bureaucratic hurdles, adopt stable fiscal policies and a transparent tax regime. It should allow level playing field for Indian industry and fix a lock-in period for FDI so that money doesn’t flow back easily. Source: The New Indian Express, 18th July 2013 (a) Using Table 1, summarise the economic performance of India compared to that of China in 2011. [2] (b) (i) Using a diagram, explain why the Indian Rupee appreciated after the Indian government raise the interest rates. [2] (ii) Explain how this rise in t he Indian rupee might a ffect prices of goods and services in India. [2] (c) (i) Explain what is meant by the term ‘slower growth’. [2] (ii) Using AS/AD analysis, expl ain two evidences contained in the data that cause growth rate of BR IC to slow down in the near future. [6] (d) With reference to the data where appropriate, assess whether on balance the Indian economy would be nefit from its ‘liberal FDI regime’. [8] (e) The finance minister of India stated that raising bank rates and having open market sales have ‘no way affect our commitment to growth’. Discuss the validity of this statement. [8]

4 a Using Table 1, summarise the economic performa nce of India compared to that of China in 2011 2m In 2011, both India’s and China’s real GDP growth was positive but China’s GDP was growing at a higher rate than that of India. India’s une mployment rate was at 8.6% which was more than twice the rate of China’s unemployment rate at 4%. [1m] Note: Use of other indicators such as the inflation rate or the current balance is acceptable. China performed better than India in both aspects (real GDP and unemployment rate). [1m] bi Using a diagram, explain why the Indian ru pee appreciated after the Indian government raise the interest rates. 2m India govt Raise i/r  Hot money flows into India to get a better return DD for Indian rupee rises (as shown in the figure below)  Indian Rupee appreciated [1m] Explanation indicating a fall in supply of Indian Rupee is also accepted. With rising interest rates in India, Indians would cut down their demand for foreign curr ency (reducing supply of Indian rupee) to take advantage of the relative