We had an awesome 4.5 hour lecture by Prof Dholakia from IIM A yesterday on the basics of macro economics, in the Indian context, as part of our Arjuna training program.
Here are my notes from the lecture... an exciting journey into the basics of economics, and a peek into what goes behind running a country. While I will not even pretend to be a shade as effective as Prof Dholakia, this is a sincere attempt at giving you a brain dump of what I tried to soak in yesterday!
Introduction to Economics
While management can be called the art of making decisions, economics is the science of decision making, the only social science to have a Nobel Prize. Economics is all about managing (and minimizing) "Opportunity Cost" - the cost of your decisions, the value of the best alternative you have forgone because of your decision.
Government policies can be sectoral or macro. Sectoral policies are for lawyers, they are specific to certain sectors, and its all about the language of specifics of how and what. Macro policies, on the other hand, have a much wider, all-pervasive impact, and it is necessary for managers to be aware of these policies and their implications.
Macro Policies - Fiscal and Monetary
Fiscal Policies are those that directly impact government expenditures or revenues. These policies are not restricted to the central government only. In India, only 50-55% of total revenue collected is by the central government. The state has another 40-45%, while the remaining 5-10% goes to the local government.
The Budget is a comprehensive statement of the government's fiscal policy. The budget is a process. In India, the budget process lasts around 6 months, starting in Oct-Nov, when the Ministry of Finance starts meetings with various stakeholders including industry, academicians, NGOs, customer groups, banks and politicians. At the same time, the government conducts an internal appraisal of the economy, through the Chief Economic Advisor, and this apprisal is presented to parliament 2 days before the presentation of the budget as the Economic Survey. The Economic Survey is really representative of the inside thinking and direction sought to be taken by the government in terms of the budget and the fiscal policy.
The MoF may not always implement the recommendations of the Economic Survey right away, but he is constrained to justify any decisions taken contrary to the recommendations. The MoF typically uses roll-back as a political tool to drive acceptance for other tough decisions that may be taken by the government in the budget.
In India, the "inside lag" - the time taken for identification, recognition, decision making - for fiscal policy is enormous, unlike in China, where opinions and debates do not matter. This inside lag is really the cost of democracy, and the price we pay for the freedom to have and to be able to express our opinions! However, once the fiscal policy is announced (through the budget) the "outside lag" - time for implementation and the effect to register - is minimal or non-existent. Changes are implemented right away, without any delay (change in tax structure, for example).
Remember, fiscal policies come through political process, and they mean nothing without political stability.
Monetary Policies are those that direct influence quantity and cost of liquidity in the system. Liquidity is the ability to settle transactions - any medium of exchange, unit of account, store of value - the money supply. Here, quantity represents the total money in the system, while the cost is represented by the Interest rates.
Democracy has no role to play in the monetary policies of India - this is handled independent of Parliament by the RBI. After 1998, the government of India freed the RBI from the MoF, which now has no executive powers over it, but only advisory powers. And unlike fiscal policies which take a long time to come out with, monetary policies may be changed rapidly, sometimes even a couple of times a day! Formally, there are two credit policy announcements a year - April (busy season) and October (slack season).
Interest rates and exchange rates are now no longer dictated by the RBI - these are now dependent on the market. However, as a player, the RBI can influence these heavily. When the RBI sells its bonds in the market, it sucks out liquidity, and when it buys bonds, it infuses fresh cash into the system. As you can see, the "inside lag" for monetary policy is much lower, while the "outside lag" is much higher - the effects of these decisions, like changing interest rates, have a long term effect, and do not really make any difference in the short term (you will still buy that house you were in the process of buying).
(In the next post - the GDP, and the exciting story of India's growth)
Here are my notes from the lecture... an exciting journey into the basics of economics, and a peek into what goes behind running a country. While I will not even pretend to be a shade as effective as Prof Dholakia, this is a sincere attempt at giving you a brain dump of what I tried to soak in yesterday!
Introduction to Economics
While management can be called the art of making decisions, economics is the science of decision making, the only social science to have a Nobel Prize. Economics is all about managing (and minimizing) "Opportunity Cost" - the cost of your decisions, the value of the best alternative you have forgone because of your decision.
Government policies can be sectoral or macro. Sectoral policies are for lawyers, they are specific to certain sectors, and its all about the language of specifics of how and what. Macro policies, on the other hand, have a much wider, all-pervasive impact, and it is necessary for managers to be aware of these policies and their implications.
Macro Policies - Fiscal and Monetary
Fiscal Policies are those that directly impact government expenditures or revenues. These policies are not restricted to the central government only. In India, only 50-55% of total revenue collected is by the central government. The state has another 40-45%, while the remaining 5-10% goes to the local government.
The Budget is a comprehensive statement of the government's fiscal policy. The budget is a process. In India, the budget process lasts around 6 months, starting in Oct-Nov, when the Ministry of Finance starts meetings with various stakeholders including industry, academicians, NGOs, customer groups, banks and politicians. At the same time, the government conducts an internal appraisal of the economy, through the Chief Economic Advisor, and this apprisal is presented to parliament 2 days before the presentation of the budget as the Economic Survey. The Economic Survey is really representative of the inside thinking and direction sought to be taken by the government in terms of the budget and the fiscal policy.
The MoF may not always implement the recommendations of the Economic Survey right away, but he is constrained to justify any decisions taken contrary to the recommendations. The MoF typically uses roll-back as a political tool to drive acceptance for other tough decisions that may be taken by the government in the budget.
In India, the "inside lag" - the time taken for identification, recognition, decision making - for fiscal policy is enormous, unlike in China, where opinions and debates do not matter. This inside lag is really the cost of democracy, and the price we pay for the freedom to have and to be able to express our opinions! However, once the fiscal policy is announced (through the budget) the "outside lag" - time for implementation and the effect to register - is minimal or non-existent. Changes are implemented right away, without any delay (change in tax structure, for example).
Remember, fiscal policies come through political process, and they mean nothing without political stability.
Monetary Policies are those that direct influence quantity and cost of liquidity in the system. Liquidity is the ability to settle transactions - any medium of exchange, unit of account, store of value - the money supply. Here, quantity represents the total money in the system, while the cost is represented by the Interest rates.
Democracy has no role to play in the monetary policies of India - this is handled independent of Parliament by the RBI. After 1998, the government of India freed the RBI from the MoF, which now has no executive powers over it, but only advisory powers. And unlike fiscal policies which take a long time to come out with, monetary policies may be changed rapidly, sometimes even a couple of times a day! Formally, there are two credit policy announcements a year - April (busy season) and October (slack season).
Interest rates and exchange rates are now no longer dictated by the RBI - these are now dependent on the market. However, as a player, the RBI can influence these heavily. When the RBI sells its bonds in the market, it sucks out liquidity, and when it buys bonds, it infuses fresh cash into the system. As you can see, the "inside lag" for monetary policy is much lower, while the "outside lag" is much higher - the effects of these decisions, like changing interest rates, have a long term effect, and do not really make any difference in the short term (you will still buy that house you were in the process of buying).
(In the next post - the GDP, and the exciting story of India's growth)
2 comments:
I'm not very clear about the difference between the meetings organized by the MoF and the internal appraisal conducted by the goverment. I would've assumed that it is the MoF that conducts an economic survey as well as comes up with new policies and the Budget. So of course that blurs out the next paragraph about MoF's compliance with the Survey.
I know practically nothing about the financial side of things, but my guess is that it is the Monetary Policies that affect the interest rates on home loans. Would that be right? Not sure of the kind of parameters that would come under Fiscal Policies.
Lemme Google a bit :)
The budget is a (forward) planning exercise, which is largely driven by political compulsions, and led by the Finance Minister and his team. It is compliant and aligned with the economic survey, which is conducted by an independent body, the Economic Advisory Committee, formed largely of economists and professionals.
Monetary policies affect interest rates, availability of cash, credit etc - and yes, that is what influences home loan rates too. Fiscal policies are long term, and include taxation and duties - the incomes and expenditures of the government.
Makes sense?
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