Question

My countries are India and China

1. Please, gather and briefly present data that would examine the theory of purchasing power parity (PPP) between the countries you are considering! Do you expect it to hold between your chosen countries – why or why not?

2. Please, find and gather data on the interest rates in the countries under consideration! If you examine trends/correlation between the interest rates (and their differentials) and exchange rate, what are the key conclusions you are observing?

3. Are there any relationships between these and other macroeconomic indicators? Please, provide a brief story about how/why any theories discussed in class apply (or do not apply)?

Answer 1

Indian Rupees 1= 10.21 Chinese Yuan

The following list contains the prices of goods in both countries in Indian rupees

Goods                                                 India                China

Milk (1 litre)                                                  52 Rs                      113 Rs

Chicken(1 kg)                                               242 Rs                     231 Rs

Burger at Mc Donalds                                   250 Rs                     306 Rs

Rice (1kg)                                                      56 Rs                       68 Rs

Eggs 1 dozen                                                 61 Rs                       124 rs

Pair of jeans (Levis 501)       2481 Rs    3961 Rs

Rent( 1 bedroom apartment) City               20,000 Rs                52,000 Rs

In the list above I have taken a few important items to make a comparison of the cost of living in both India( Mumbai) and China(beijing).

Most of the basic neccesities cost almost the same with China on the higher side. But apartments, clothes, schooling etc is way more expensive in China than in India. This is because China is a more developed nation. India in comparison to China undervalues its currency on the global market so as to make the cost of living low and therefore the cost of exports are lower in the global market. This is done in order to get a competitive advantage in pricing over China. The difference in prices despite the huge difference in the size of the economies of the two countries is not as high as it should be except for schooling and apartments in our list. India in comparison to China does not need so much income as the cost of living is cheaper. It will not hold for long as there is a price inflation in India that is around 5.8 % whereas in China it is only 1.8%. It will not be long before there is puchasing power parity between the two nations.

The benchmark interest rate in India is 6% while it is 4.4 % in China. The difference in interest rates is again because China being a larger economy has a lot of foreign exchange reserves and gold while India has relatively less. China being a large economy can afford to lend at lower interest rates and encourage circulation of money in the economy.

Comparing the interest rate trends between India and China one can observe the following.

In india the interest rates have steadily dropped from 8% in 2014 to 6% in 2018. In the case of China the interest rate has dropped from 6% in 2014 to 4.5% in 2018. The two economies are projecting a similar trend in the last 4 years with interest rates being steadily decreased to encourage more investment and economic growth. China, however, being the larger economy can afford interest rates as low as 4 % which India at the moment cannot afford. The same trend was observed in 2012 when China's interest rate was at 6% and India's interest rate was at 8.5%. The data reflects a similar pattern in both countries.

The graph below explains the relationship between investment, savings, interest rate, expected rate of return.

A country with low interest rates has more investment, more investment means more output(GDP) which is one of the key indicators of development. With population levels being similar in both countries it is the GDP that will be a key factor.