The mystery of India’s purchasing power parity

Buying the world with a rupee!
By Anjan Roy

In the midst of India’s current slow down in growth, India is said to be the third largest economy in the world. This is what the OECD has put out in its latest review of the global economy. Third largest, mind you, in purchasing power parity terms only.

By nominal exchange rate, the US economy is by far the biggest at close to $15 trillion, China is a far behind second at just above $4 trillion and Japan is now the third largest. In nominal terms, the economy is only above $2 trillion.

Yet story would have been radically different if we were doing such comparison in 1917. At that time one Indian rupee, was equal to 13 US dollars. Today, what a difference: $1 is exchanged for Rs 57!

But purchasing power parity comparison is routinely done to estimate what is believed to be the true size of the economy.

This is an invention of the economists and not a bad invention. In terms of the nominal exchange rate, that is the rate at which the Indian rupee is exchanged with the US dollar or the euro, Indian economy is the tenth largest in the world. It is the third largest in Asia after China and Japan.

However, economists have devised another formula for converting the worth of an economy in terms of the purchasing power of the local currency compared with the purchasing power of the US dollar in USA. This is a much better way of comparison of the GDP of different countries, because the GDP is after all the total income of a nation.

The well-known financial magazine, The Economist of London, for example, has a rough and ready guide to this. The Economist considers the price of a McDonald’s burger in United States as a benchmark and then tries to find out how much a similar McDonald burger will cost in different countries. If the local price say in India is Rs50 and the US price is $5, then on purchasing power parity basis $1 will be equivalent to Rs10. But against that, the nominal value of the Rupee in the market for foreign exchange is $1 selling for Rs 57 (at current exchange rate).

Thus, what the purchasing power parity computations do is to value a nation’s GDP at the local purchasing power of the currency. It thus inflates the GDP, say in our imaginary case by five times. Their actual calculation of the purchasing power parity is of course much more complicated, though the underlying sense is the same.

Consider once again a very interesting study done by the Deutsche Bank recently. The Bank has gathered the price of five products in seven countries and compared these with the prices of the same products in the USA. Then taking the US price at the benchmark, it has estimated how much are the local prices in percentage terms in comparison with the US price.

The table makes for interesting reading. In Australia, a beer bottle of pint size costs 137% of the US price, a taxi ride is 110% of the US cost of a cab ride, a litre of petrol in Australia costs 117% of US price, among other things.

Now look at India. A pint of beer in India costs only 29% of the US price, a cab ride costs only 10% of a similar taxi ride in USA, a litre of petrol in India costs 139% of USA and medicine for common cold for six days costs 19% of what it costs in the USA. The price comparisons are all in nominal exchange rate conversion.

Purchasing power parity comparison would involve taking a sample basket of goods and services and then comparing their prices and coming to an average of the these prices between the two countries to be compared in arriving at a purchasing power parity exchange rate.

It clearly brings out the fact that any comparison of the GDP of different countries in terms of nominal exchange rates is like comparing apples with oranges. The Indian rupee can buy much more goods and services in India than the US dollar in the USA.

Even without getting into such technical details, one can surmise that India’s is a large economy and as a matter of fact one of the largest.

This is because India has two economies, one the formal and official economy, which is captured in the official figures. But there is a second economy which in informal and unorganized and that is only imperfectly captured by the official figures.

Quite often described as the black economy, its size is a matter of conjecture. The formal and the informal economies are, moreover, intimately interwoven. Many of the essential service providers are basically informal and the payments for these services are not accounted as any other service providers’ incomes are reported, nor is the payment for the service recorded.

Thus, the value addition provided by all these economic agents are not captured in the official transactions as much as these should. The statistical arm of the government will say that they are captured and the NSSO surveys bring in these activities within some accounts. However, even if these are captured, they come in partially.

OECD says that India’s economy would surpass China after a while. Sure, it will. Think of the 300-400 million people who today are reckoned to be below poverty line. Development process, if uninhibited, will lift them above the poverty line in another two decades. Their demands, their consumption, their augmented economic activity will lift the size far beyond the computations currently on.

Finally, it is not the size that matters. It is how the average level goes up. There will be, for all times to come, discrepancies in incomes. But the average must rise – that will mean more Indians will get more income and a better standard of life. [IPA]

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