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Business News/ Opinion / Online-views/  Market values are better growth cues
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Market values are better growth cues

Market values are better growth cues

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How fast is the global economy growing? The answer depends on how the growth rate is calculated—by model or by market values.

The International Monetary Fund (IMF) uses a model.

Rather than relying on shifting market exchange rates, it determines values for each currency based on the cost of a common basket of goods—so-called purchasing power parity (PPP). Haircuts in China and the US are much the same, but the Chinese variety costs a lot less in dollars. PPP tries to measure the haircuts, not the prices.

With PPP adjustments, IMF calculates that global gross domestic product (GDP) has been increasing by about 5% annually since 2004. For 2007, it expects 5.2% growth. These four years are set to be the strongest in decades. China has played a big part in the expansion. In IMF model, its 2006 GDP—adjusted for PPP came in at $10 trillion (Rs393 trillion)—equivalent to 15% of the world output.

But is China’s GDP really 76% as large as that of the US? The Chinese government calculated its 2006 GDP at 21 trillion renminbi—a little less than $3 trillion, or 21% of the GDP of the US at the current exchange rate. The renminbi is undervalued, but not by a factor of three.

Investors should be suspicious. For them, IMF models have two huge problems. First, the PPP adjustments are based on old studies. New estimates from the Asian Development Bank suggest that China’s PPP-adjusted GDP in 2006 was $4.4 trillion—a relatively modest 65% higher than the reported number. IMF is expected to adopt these numbers next year.

Second, investors shouldn’t really pay much attention to PPP adjustments. The Shanghai haircut stays firmly in Shanghai. What matters for global markets is the market economy, in particular exports and imports, which are priced at market exchange rates. At those rates, the world looks much less investor-friendly. The fast growing developing world’s share of 2006 GDP shrinks from a PPP-adjusted 49% to a mere 25%, according to Deutsche Bank AG.

What’s more, at market prices, recent world growth has been 3.5%-4%—slower than in the mid-1980s. In 2006, it was 3.8%. It’s not just in mortgages that markets can be harsher than models.

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Published: 15 Nov 2007, 11:18 PM IST
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