Macroeconomics:

A practical guide
The economy: In a nutshell

5.)
External
sector

4.) Fiscal
position 1.)
Growth

Economy

2.) Price
3.) trends—
Monetary Inflation/
policy deflation

2
The real economy
What is GDP growth?
GDP growth:
• Is the final value of goods and services produced within the geographic
boundaries of a country, during a specified period of time, typically for a quarter
or an annual basis
• It is also considered as the sum of values, added at every stage of production
• It is calculated as a percentage increase over the period (YoY, QoQ)

Income method

Three methods of
Expenditure method
calculating GDP growth

Output method

4
The three methods of calculating GDP:
• It is the sum of all goods and services purchased by the households, the Private Sector
and the government.
Expenditure • GDP = C+I+G+(N-X)
method

• The sum of all incomes earned by the household of a country, excluding the transfer
income.
Income • GDP = Wages + Rent + Profits + Interest Income + (Taxes – Subsidies)
method

• It measures the value of goods and services produced.

• GVA = Industry-wise gross output – Intermediate inputs
Output • GDP = GVA + (Taxes –subsidies)
method (GVA)

In India, the output method is considered the most robust and looked at closely.
5
Structure of the Indian economy: service sector and consumption driven

6
Source: MOSPI, ICICI Bank Research
Growth: Important factors to consider
Potential rate of output:
• Is the level of output that is consistent with a full employment level—takes into
account all the factors of production in an economy
• Not static, but can change over a period of time.

Output gap: Refers to actual growth minus the potential rate of growth:
• A negative number implies that the economy is growing below potential
• A positive number implies that the economy is above the potential rate.

What is an economic (business) cycle? An economic cycle refers to the pattern of

growth that an economy undergoes, over a period of time (can be from one year to
10 years).
• Expansion—Situation in which the pace of growth is increasing, relatively
• Contraction—Situation in which either the pace of growth slows or the output
contracts.

7
Decoding business cycles: Indian economy and the global economy
(%YoY) India GDP Growth
(%YoY) Global GDP
12
6
10 Global reflation Policy stimulus
5
Dot-com boom
8
4
6
3
4 Trade-war
2
Financial crisis
2 1
BoP Crisis Global Financial Crisis
0 0
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019

1980

1984
1986

1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
1982

1988
-1

Both the Indian economy and the global economy, have been through several
‘economic cycles’ over the last twenty years, with periods of economic expansion
and economic contraction.

8
Source: IMF, ICICI Bank Research
Economy: Labour markets and GDP per capita (1/2)….
Unemployment rate: The number of unemployed persons divided by the total
working population.

GDP per-capita: GDP per person—a measure of income or wealth in a nation.

Why they are important?:

• Labour market trends are important from a policy perspective, to understand the
state of aggregate demand in the economy
• GDP per capita provides some aspect of the distribution of wealth in a nation and
living standards in the country.

9
….economy: Labour markets and GDP per capita (2/2)

(%YoY) GDP per capita (USD) GDP per capita

16.0
12000.0
14.0
12.0 10000.0
10.0 8000.0
8.0
6.0 6000.0
4.0 4000.0
2.0
0.0 2000.0
-2.0 0.0
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013

2017
2019
2015

1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
China India India China

• Per-capita income in India has increased since the reform process of 1991 but has
slowed down over the last three years
• India’s per capita GDP growth lags China’s.

10
Source: IMF, ICICI Bank Research
High frequency indicators are used as a guide to predict GDP
Does the market respond to GDP growth?:
Leading indicators: Some examples No, investors are people who are forward
looking and want to know the future. GDP
PMI manufacturing
growth does not help, as it is released with
Survey indicators PMI services a lag.
Consumer confidence
Industrial production Importance of high frequency indicators:
Cement production To understand the future, investors use
Leading indicators
Steel production high frequency indicators that correlate
Auto sales/production well with GDP growth, to predict what
might happen.
Exports/Imports
Foreign tourist arrivals
Coincident indicators
Airport, port & cargo traffic
High frequency indicators are of various
Rail freight traffic types—Survey, Leading and Coincident are
used to asses the state of GDP
growth/demand.

11
Price trends
Price pressures: Inflation/Deflation: The basics
Inflation Deflation

Increase in prices over a period of time Decrease in prices over a period of

can be caused by: time can be caused by:

Increase in aggregate demand, caused by Decrease in aggregate demand, caused by

strong domestic growth (expansionary cycle) falling domestic growth (contractionary cycle)

Expansionary policy environment Restrictive policy environment

Exchange rate depreciation

Exchange rate appreciation

13
Inflation: What is CPI?

CPI measures the change in price levels for both goods and services, over a period of
time that are purchased by consumers. It is typically calculated on a YoY or MoM basis

Composition of CPI in India has been constructed to take into account the consumption
patterns of Indian households—both rural and urban

An index is constructed by calculating price changes on a monthly basis, of all the items
of goods by taking into account the change in prices, with respect to a base-year

The Indian CPI index uses a base-year of 2012-13. The base-year gets revised on a regular
basis, to reflect changes in the economy.

14
Composition of CPI
Core CPI: components as % of total
Pan/tobacco & intoxicants 2.4
Clothing & footwear 6.5
Housing 10.1
Household goods & services 3.8
Health 6.8
Transport & communication 7.6
Recreation & amusement 1.4
Education 3.5
Personal care & effects 4.3

Food, beverages and tobacco tend to be volatile components of CPI inflation

CPI core is a measure of sustainable price increases, as it removes the volatile

components.

15
Source: MOSPI, ICICI Bank Research
 16
Source: MOSPI, ICICI Bank Research
WPI inflation
Composition of WPI (%)

15.26 4.12

13.2
64.2

Primary food articles Primary non-food articles

Fuel & Power Manufactured products

Unlike CPI inflation, WPI inflation measures the changes in the prices of goods sold and
traded in bulk, by wholesale businesses to other businesses

Composition of WPI is different than CPI, with manufactured products contributing a

substantial part

For policy purposes, WPI inflation is not given that much importance but provides
indications of pricing power in the Corporate Sector.

17
Source: MOSPI, ICICI Bank Research
Historically, both WPI and CPI have diverged considerably
(%YoY) Inflation indicators
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0

Oct-14

Oct-15

Oct-17

Oct-18

Oct-19
Oct-16
Apr-15

Apr-16

Apr-17

Apr-18

Apr-20
Apr-14

Apr-19
Jul-15
Jul-14

Jul-16

Jul-17

Jul-18

Jul-19

Jul-20
Jan-18
Jan-15

Jan-16

Jan-17

Jan-19

Jan-20
CPI WPI

Both WPI and CPI have diverged considerably, historically, reflecting a difference in
composition

From a policy perspective, RBI has an official mandate to target CPI inflation. Hence, WPI
inflation is given less importance.

18
Source: MOSPI, ICICI Bank Research
Monetary Policy
The link between money supply and inflation

Formula: Money Supply(M)*Velocity of money (V) = Average Price Level(P)*No. of

transactions in an economy(T)
M*V = P*T

The velocity of money in India’s case is estimated to be 1.3 and is estimated: GDP/money
supply

P*T is often considered to be a proxy for nominal GDP growth

Hence, changes in money supply tend to have a direct impact on aggregate price levels.

20
What is money supply?
There are different forms of money supply:
• Reserve Money = Currency in circulation + Bank Deposits with RBI + Other Deposits
• Reserve money forms the basis at which money is created by the RBI, through liquidity
programmes and intervention in the Foreign Exchange market

• Broad Money Supply = Reserve Money + Deposits in the banking sector

• Money multiplier= Broad Money supply/Reserve Money

• It measures the quantum of credit that is created from the base money supplied by the
Central Bank
• For e.g.) Person X deposits INR 1,000, banks park the CRR worth INR 30 with the RBI,
and the remainder (INR 970) is lent out to Person Y. Y takes this loan and buys goods
from company XYZ that deposits its money with the bank. The Bank uses this money,
takes the CRR and lends it out again to someone else.

21
RBI: An introduction (1/2)…..

In India, the RBI operates ‘independently’, based on the mandate that has been provided
by the government, as per the RBI Act of 1934

In May 2016, the RBI Act of 1934 was amended to implement a flexible inflation targeting
framework

The government in consultation with the RBI, sets the inflation targeting, that is reviewed
every five years

The current inflation target is set at 4% YoY CPI, with an upper tolerance of 6% and a
lower tolerance of 2% for the period of Aug 2016 to Mar 2021.

22
…RBI: An introduction (2/2)

What happens if the CPI inflation deviates from the target?

• RBI needs to write a letter to the government, explaining why that has happened and
what action it plans to take.

How is a Monetary Policy set?

• A Monetary Policy Committee (MPC) has been set up to evaluate and take decisions on
monetary policies
• The MPC comprises of 6 members—3 members from the RBI and 3 external members
nominated by the government
• Decisions are taken by a majority vote, with the Governor casting the deciding vote in
case of a tie
• The MPC meets every six weeks.

23
RBI decision making: Key aspects
• The MPC makes an assessment of the state of the economy and whether it is close to
achieving its inflation mandate. Decisions are made accordingly

• The MPC can choose to resort to tightening/restrictive stance if it feels that inflation is
rising and could exceed its target level

• The MPC can choose to resort to an accommodative/easing stance if it feels that

inflation is falling and could undershoot its target level

• To execute its actions, the RBI then implements actions by hiking/cutting policy rates
and adjusting liquidity conditions in the market and by sending a guidance on the
direction in which the future policy will move towards

• Guidance can be hawkish, neutral or dovish.

24
How does a Monetary Policy function?

(a) Policy rates/Price of

money supply
RBI conducts a
monetary policy via:
(b) Quantum of Money
Supply in the system

• The RBI has several instruments in both categories that it uses to ensure that money
supply and policy rates move in sync with its objective
• It can use either policy rates or quantum of money supply in the system or both
together, if required.

25
Policy instruments that are used by the RBI (1/2)
Policy rates

• Repo - The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks
against the collateral of eligible securities under the LAF

• Reverse Repo - The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an overnight
basis, from banks against the collateral of eligible securities under the LAF

• Marginal Standing Facility (MSF) - A facility under which scheduled commercial banks can borrow
additional amount of overnight money from the Reserve Bank, up to a limit at a penal rate of
interest

• Term repo/reverse repos—This is a window in which liquidity is offered for more than one day. The
rate can vary, according to demand/supply.
Instruments to manage durable Liquidity
• Open Market Operations (OMO) - These include both, outright purchase and sale of government
securities, for injection and absorption of durable liquidity, respectively

• FX Swap Auctions - a USD/INR Buy/Sell Swap Auction increases the supply of Rupees in the market
by purchasing Dollar from the banks.
26
Policy instruments used by the RBI (2/2)

Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets,
such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of
resources in the banking system for lending to the Private Sector

Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank,
as a share of such per cent of its Net Demand and Time Liabilities (NDTL) that the Reserve Bank may notify from
time to time

Long Term Repo Operations (LTROs)/Targeted Long Term Repos Operation (TLTROs): Long term lending
for banks at the repo rate, to improve monetary transmission

Special Liquidity windows/Refinancing facilities: If certain sectors are facing stress, the RBI introduces a
special liquidity window to address the build-up of that stress.

7
The operating variable: Overnight call rate
Net Liquidity infusion by RBI: An example (%) Weight Average Call rate Repo Reverese repo
Net injection via Standing Net OMO 9

In INR cr LAF window MSF Facilities purchases Total

8
30 August 2020 25 0 0 0 25
29 August 2020 16122 0 0 0 16122 7
28 August 2020 674095 300 1025 0 674820
27 August 2020 644363 0 0 0 644363 6

26 August 2020 632916 4 -30.17 0 632882

5
25 August 2020 634837 1 -1355 0 633481
24 August 2020 614757 202 -30 0 614525 4
23 August 2020 871 0 0 0 871
22 August 2020 933 0 0 0 933 3

Sep 15
Dec 15

Sep 16

Sep 18
Sep 17

Sep 19
Dec 16

Dec 17

Dec 18

Dec 19
Mar 16

Mar 17

Mar 18

Mar 19

Mar 20
Jun 17

Jun 18

Jun 19
Jun 15

Jun 16

Jun 20
21 August 2020 636574 0 -34 0 636540
20 August 2020 648114 0 0 0 648114

• The idea is for the RBI to use the policy rate and liquidity operations to guide the
overnight rates and the cost of funds in the banking system to be lower
• The net impact is seen in influencing the lending rates and deposit rates,
simultaneously.

7
Source: RBII, ICICI Bank Research
Fiscal Policy
Fiscal Balances: The Government’s account

• Like a private agent, the government also has its own expenditure and revenue account

• Government budget balances (fiscal position) = Revenues – Expenditure

Government’s decision to increase spending, depends on its assessment of the economy:

• If it is concerned about growth, as the private demand slows down, it will increase
spending
• If it is confident about a strong private demand, it will reduce spending.

30
Government Receipts
Revenue Capital
Receipts receipts

Recoveries of
Tax - Non tax
loans

Dividends Disinvestment
Income tax Corporate tax
from RBI/PSU

Customs Excise • Revenues are composed of tax and non-tax components

• Tax revenues consist of direct (income and corporate) and
indirect (customs, excise, GST) sources
• Non tax revenues are primarily dividends and surpluses
GST
received from RBI and PSUs
• Capital receipts consist of disinvestment of PSUs.
30
Government Expenditure

Revenue Capital
Expenditure expenditure  Expenditure consists of revenue and
capital
 Revenue expenditure is largely committed
Repayment Acquisition to spending, like salaries, pensions,
Salary Pensions
of Loans of valuables subsidies, etc.
 Revenue expenditure is ~85-90% of the
Interest total expenditure
Subsidies
Payments  Of revex, ~65% is committed to
expenditure like salaries, pensions, defense
payments, interest payments, which
Food Fuel cannot be delayed
 Quality of expenditure refers to the
composition of expenditure; higher capex
Fertilizer implies better quality of expenditure
 Government capex expenditure has been a
key growth driver, given high multiplier
effects of the same.
The Government’s Fiscal position: Summing it up
Government's summary statement
1.) Revenue Receipts:
--Tax Revenue (Net to Centre) (a) Revenue
--Non Tax Revenue
2.) Capital Receipts: (excluding borrowings)
items
--Recovery of Loans
--Other Receipts Government (b) Expenditure
Total Receipts (1+2)
Total Expenditure (3+4)
fiscal statement items
3.) Revenue expenditure
4.) Capital expenditure
Fiscal Deficit Deficit ratios
Revenue Deficit
Primary Deficit

33
Historically, public debt levels have remained high
(% of GDP) Deficit ratios (%) Total Public Debt to GDP ratios
10.00 100
8.00 80
6.00 60
4.00
40
2.00
20
0.00
0
-2.00

2014-15
2010-11
2012-13

2016-17
2018-19
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11

2012-13

2014-15

2016-17

2018-19
1990-91

1992-93

1994-95

1996-97

1998-99

2000-01

2002-03

2004-05

2006-07

2008-09
Fiscal deficit Primary deficit Revenue deficit Center Center + States

• Fiscal deficit = Revenue – expenditure

• Primary deficit = Fiscal deficit – interest payments
• Revenue deficit = Revenue receipts – Revenue Expenditure
• Total public debt is the outstanding quantum of government debt in an economy.

34
Source: RBII, ICICI Bank Research
Financing the fiscal deficit

Revenues

Disinvestment
The problem with running very high fiscal
deficits are: Market
• Concerns about sovereign position borrowings

• Increase in market borrowings on bond Government

NSSF
market borrowing
• ‘Crowding out’ of private resources. External
assistance

Provident fund

Cash
drawdown

35
The External Sector
Balance of Payments: Sum of all foreign exchange transactions
Balance of Payments (BoP) = (X-M) + [(CI+FI) – (Co-Fo)] +FXB
X is the exports of all goods and services
M is the imports of all goods and services
(X-M) is the Current Account
CI and FI are capital inflows and financial inflows
Co and Fo are Capital outflows and financial outflows
[(CI+FI)- (Co+Fo)] is the Capital Account
FXB is the change in official monetary reserves.

It is a snapshot measure of all foreign transactions, undertaken over a period of time

that provides some guidance on the extent of the net demand for the local currency
(INR).

37
The current account: historically been in a deficit

Current Main components of the current account

Account Trade balance Net services
Remittance flows Income
(USD mn)
Merchandise Invisibles 200000
Trade 100000
0
Transfer
Services -100000
payments
Exports Imports -200000
-300000
Primary

2010-11
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10

2011-12
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
2018-19
Income

38
Source: RBI, ICICI Bank Research
The Capital Account:

FDI Key components of the capital account

FDI FPI
Loans Banking Capital
(USD mn)
Other capital Total capital account
120000
FPI 100000
80000
Capital Account: 60000
Main components 40000
20000
External Loans 0
-20000
-40000

2002-03

2005-06

2008-09

2011-12

2018-19
2000-01
2001-02

2003-04
2004-05

2006-07
2007-08

2009-10
2010-11

2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
Banking Capital

39
Source: RBI, ICICI Bank Research
BoP position correlates well with direction in INR
BoP (LHS) USD/INR (Reverse scale)
(USD mn) (%YoY)
100000 15

80000 10

60000 5

40000 0

20000 -5

0 -10

1996-97
1994-95

1998-99
2000-01
2002-03
2004-05
2006-07
2008-09
2010-11
2012-13
2014-15
2016-17
2018-19
-20000 -15

-40000 -20

• BoP surplus implies relatively higher demand for local currency over foreign currency,
resulting in appreciation bias
• BoP deficit implies relatively lower demand for local currency over foreign currency,
resulting in depreciation bias.

40
Source: RBI, ICICI Bank Research
RBI plays an important role in driving the exchange rate
(USD bn) Net purchases of foreign currency by the RBI
(USD mn) Foreign Exchange Reserves
15,000
600000
500000 10,000
400000 5,000
300000
200000 0

100000 -5,000
0
-10,000

2020-21
2006-07
1990-91
1992-93
1994-95
1996-97
1998-99
2000-01
2002-03
2004-05

2008-09
2010-11
2012-13
2014-15
2016-17
2018-19

Oct-13

Oct-18
Mar-14

Mar-19
Sep-11

Sep-16
Nov-15
Apr-16
Aug-14

Aug-19
Feb-12

Feb-17
Jun-15

Jun-20
May-13

May-18
Jul-12

Jul-17
Dec-12

Dec-17
Jan-15

Jan-20
RBI plays an important role in the FX market through direct intervention for:
• Precautionary purposes to build-up FX reserves, to guard against external shocks
• To provide a boost to exports.

41
Source: RBI, ICICI Bank Research
India’s external balances remain comfortable

(USD bn) (%)

600000 30.0 India’s external debt (both private and
public) has picked up over the last twenty
500000 25.0 years
400000 20.0

300000 15.0

200000 10.0 But there are no problems in terms of

servicing this debt, given the size of the
100000 5.0 economy and foreign exchange reserves
0 0.0
2001
2002
2003
2004
2005
2006

2008
2009
2010
2011
2012
2013

2015
2016
2017
2018
2019
2007

2014

External debt to GDP (RHS) External Debt Short-term external debt can be fairly
easily financed through foreign exchange
reserves, in case of a shock.

42
Source: RBI, ICICI Bank Research
Disclaimer
This presentation has been prepared by ICICI Bank Limited (“ICICI”) for educational and information purposes only. This presentation may
contain information relating to the Indian economy and may be amended, superseded or replaced by subsequent presentations.

ICICI has based this presentation on information obtained from sources it believes to be reliable but which it has not independently verified.
ICICI has relied upon and assumed the accuracy and completeness of all information available from public sources. ICICI makes no
representation or warranty as to the accuracy, completeness or reliability of any information contained in the presentation or otherwise
provided and shall not be held responsible for any inaccuracies or omissions or for any claims, losses or damages arising in any way from
or in connection with errors or omissions in the information contained in the presentation. Neither ICICI (including its officers, directors,
associates, connected parties, and/or employees) nor does any of its agents accept any liability for any direct, indirect or consequential
losses, loss of profits and/or damages that may arise from use or reliance on the information contained in the presentation.

The information contained in this presentation should not be construed as an offer, invitation, solicitation, solution or advice of any kind to
buy, sell or otherwise invest or deal in any securities, financial products/instruments or services offered by ICICI or any other entity/person.
ICICI group or its officers, employees, personnel, directors may be associated in a commercial or personal capacity or may have a
commercial interest in or with the issues or matters as contained in this presentation and such commercial capacity or interest shall not
make or render the ICICI Group liable in any manner whatsoever.

Persons distributing/sharing this presentation must satisfy themselves that it is lawful to do so.

43
Thank you