Aggregate Versus Sectoral Shocks : A Missing Link In India’s Macroeconomic Story

The comovement among different sectors of the Indian economy is found to be low which suggests an important role for sector-level disturbances vis-à-vis aggregate shocks in explaining economic fluctuations. Accordingly, the paper adopts a multisectoral framework that accounts for aggregate as well as sectoral shocks to offer a new take on the Indian economy. Using a dynamic factor model to decompose GDP, the paper finds that around 48 per cent of the variation in GDP in the long-run is explained by sectoral shocks, with their contribution increasing to 98 per cent in the short-run. Thus, short-run economic fluctuations or the business cycle is almost entirely driven by sectoral shocks. Among sectoral shocks, those associated with public administration followed by manufacturing and agriculture are found to contribute most to the GDP movement in the short run. A historical decomposition analysis shows that sectoral shocks emanating in the manufacturing sector have been consistently unfavourable, highlighting that the sector has been unable to keep pace with the rest of the economy. Further, it is found that most of the sectoral shocks move GDP and inflation in the opposite direction thereby generating an impact similar to a supply shock