Submitted by: Group-7

Using differential data for constructing an index which is leading indicator of economy. Decoding the economic data to predict economic health.
Leading Indicators of Economic Growth
Indian Perspective

1. Introduction
Leading Indicator approach is helpful in predicting the health of economy and take corrective fiscal or monetary policy in anticipation.

2. Economic Indicators
Leading, Lagging and Coincident indicators confirm what is happening in our economy. Leading Indicator: Predict what the economy will do in the future. Example: hours worked per employee. If the hours are rising, firms should increase hiring.
Lagging indicators: confirm what leading indicators predict. Lagging numbers change a few months after the economy does. Example: unemployment rate. It will fall after a few months of economic growth. If the leading indicator of hours worked is increasing, after a few months the lagging indicator of unemployment should fall.
Coincident indicators: mirror what the data is saying. It is generally what is happening right now, for example, the jobs report. If a leading indicator is predicting future job gains, a lagging indicator is saying unemployment is falling, a coincident indicator will tell you the current employment number.

3. Business Cycles
3.1 Definition
Fluctuations found in the aggregate economic activity. It is cyclical, consisting of expansions followed by recessions, contractions and revivals which merge into the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic.
3.2 Selection & Quality of LI
Quality of the indicators is essential for performance of forecast. Selection of a LI is justified using five rationales: production time, ease of adaptation, market expectations, prime movers, and change versus level.
National Bureau of Economic Research (NBER) approach applied the following six criteria to a series: Economic significance, statistical adequacy, timing, conformity, smoothness, and timelines.
The appropriateness of an indicator may also be assessed, through its turning points and reference series. For assessing the appropriateness of a Leading Indicator (LI), the point-to-point lead periods may be estimated. The standard deviation of these point-to-point leads will give the extent to which the estimated lead period of the LI is reliable.
The efficiency of a LI also depends upon its success in indicating the turning points of the target series in advance. A good indicator should predict each of the turning points in advance devoid of any false signals. A measure of the efficiency is defined as:
1/)*(T/N)*(T/H)
where  = measure of efficiency,  = standard deviation of all leads of the LI with respect to the reference series, T = number of points in which indicator leads nearest turning point in reference series, N = number of turning points identified in reference series, H = number of turning points identified in indicator.
4. LI- Indian Economy
4.1 RTBCI
Real Time Business Conditions Index (RTBCI) is a composite index of some of the important indicators, released at different frequencies. The purpose of the index is to accurately estimate the economic trend by appropriate combination of individual indicators releasing at weekly, fortnightly, monthly and quarterly levels. Accounting the changes at different time intervals allows for an accurate and early detection of signals coming out of economy. The main indicators included in RTBCI are: * Real Non-Agricultural GDP, Quarterly data * Index of Industrial Production (IIP), Monthly data * Narrow money (M1), Fortnightly data * Yield Curve Term Premium (difference between 10 yrs Govt Bond and 91 days Treasury Yield), Daily data
4.2 PMI
Purchasing Managers Index (PMI) is a composite index of sub-indicators extracted through surveys. Surveys include around 400 purchasing managers at different influential positions. Responses are recorded as worse(0), neutral(50) and better(100). Resultant PMI numbers indicate the future prediction of how economy will be going forward. A reading of 50 indicates neither contraction nor expansion. Less than 50 indicates contraction while PMI less than 42 (number arrived by past happenings) indicates an imminent recession in economy. Constituents of PMI * Production level (.25) * New orders (from customers) (.30) * Supplier deliveries - (are they coming faster or slower?) (.15) * Inventories (.10) * Employment level (.20)
4.3 Stock Market Index
Rising Nifty or Sensex reflects improving business climate and higher growth expectations. It is believed that since investors are putting the hard money in markets, so they would have done a fair bit of research about the businesses of companies that they invest in. A broader buying in market would thus indicate improving earnings of companies reflecting good health of economy. Also, rising markets facilitates capital formation easily at a reasonable rate helping the economy further.

5. Yield Spread
Analysis using the long-horizon regression, which has been standard tool for judging predictive ability of the term spread. High-yield spread has a high predictive content. Second possibility is that term spread also reflects movements in current rate of inflation. If rise in current inflation leads to a rise in short-term interest rates, hence, a flattening of the yield curve and if inflation and real activity are negatively correlated, fall in term spread will predict slower future real activity. Example, reductions in real output brought about by shifts in aggregate supply will be accompanied by a rise in prices and inflation as economy moves along aggregate demand schedule. If we introduce nominal wage inertia and long-run vertical supply curve into such a framework, then aggregate demand shifts may also lead to negative correlation between inflation and growth since, while short-run effect of a positive demand shock will be to raise output, prices will initially be largely unaffected because of nominal inertia.

6. WG Recommendations * Selection of reference series as the non-agricultural GDP at quarterly frequency. Agricultural output is dependent on natural factors and market forces play a low role in determination of its level. On the other hand, movement in the cyclical components of major output variables in the non-agricultural sector are closely related and, among such indicators of economic output, non-agricultural GDP has the maximum coverage. * Estimates of major aggregates relating to overall economic activity(IIP, employment, Agricultural/Non-Agricultural GDP, Private consumption) also addition of available information into consideration (automobile sales, new loan equipment sales, housing statistics) * Strengthening the database on inventories is suggested. Department of Company Affairs (DCA) may be requested to initiate immediate action to make manufacturing inventory stock data (providing aggregates for work-in-progress, finished goods stocks as well as raw material and spares) as part of the quarterly financial reporting * Compiling regular information on capacity utilization. Suggestion that he RBI puts in place a system for estimating the series on capacity utilization in major industries preferably on a quarterly basis * Improving the industrial outlook survey and resolving issues of low response rate and lag * Providing an institutional framework for organized work on dating of business cycles in India and compilation of the index of leading indicators on a regular basis. Research in business cycles mostly empirical. Theoretical research should be given due consideration. The theoretical and empirical work in conjunction could throw light on the relative importance of various causal factors, including role of productivity shocks