Purchasing power parity

Its economy may be in the grips of a slowdown, its polity paralysed and markets morose, but all this hasn’t prevented India from overtaking Japan to become the world’s third-largest economy in purchasing power terms. Data just released by the International Monetary Fund (IMF) shows that India’s gross domestic product in purchasing power parity (PPP) terms stood at $4.46 trillion in 2011, marginally higher than Japan’s $4.44 trillion, making it the third-biggest economy after the United States and China. India’s share in world GDP in terms of PPP, a measure of relative consumer prices across countries, stood at 5.65% in 2011 against Japan’s 5.63%, with the gap expected to widen significantly by 2017. In five years, the IMF estimates the share of India’s GDP in PPP terms would grow to 8.09% compared with 4.8% for Japan. Economists said India’s move up the league table was a reminder of the boundless potential the country offered, despite the prevailing mood of pessimism. The PPP system allows GDP comparisons to be made by asking how much money would be needed to purchase the same goods and services in two countries and using that to calculate an implicit foreign exchange rate. Under this method, a dollar should be able to buy the same amount of goods anywhere in the world and exchange rates should adjust accordingly. It also strips away distortions that come with market exchange rates, which are often volatile, affected by political and financial factors that do not lead to immediate changes in income and tend to understate the standard of living in poor countries. The Economist magazine’s proprietary Big Mac Index, which takes the price of a McDonald burger across 120 countries to calculate the ‘real’ price of their currencies, is another crude way to measure PPP. India was included in the index recently. It showed that the Indian rupee was undervalued by 62% against the US dollar in January. PPP methods help adjust income to prices for a meaningful comparison on quality of life in countries with widely different prices and incomes. India, according to the IMF’s calculations, was able to overtake Japan in 2011 because its economy grew 7.24% whereas in the case of Japan, it shrank 0.75%,hit by a tsunami that ravaged the country and exacerbated the adverse impact of global economic slowdown. While India may have beaten Japan under this particular system of calculation, under more conventional methods of measurement, it has to travel a long distance to catch up. Under the regular method of GDP calculation, India’s economy is well behind Japan. Even assuming an average economic growth rate of 7.5% over the next five years, the Indian economy will be only $2.9 trillion compared with Japan’s $6.69 trillion. For the fiscal year to end-March 2013, official forecasts are for GDP growth of around 7%, slightly higher than the 6.9% expected in the previous year and much lower than 8.4% the year before. Economists reckon that India will continue to lag behind when it comes to matching living standards of its population with more developed western and Asian economies. Yet, with its demographic advantage and prospects of sustainable high growth over the next five years, the country is expected to consistently improve its global economic standing.

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