Macroeconomic
Overview
In
a robust demonstration of its nascent strengths, the Indian economy,
after growing at 8.5 per cent and 7.5 per cent in the two previous
years, is projected to grow at 8.1 per cent in the current year 2005-06.
Growth of Gross Domestic Product (GDP) at constant prices in excess
of 8.0 per cent has been achieved by the economy in only five years
of recorded history, and two out of these five are in the last three
years. After dipping below 1.0 per cent in 2004-05, mostly on account
of erratic rainfall, agricultural and allied sector’s growth in 2005-06
is projected at 2.3 per cent. With a good kharif and bright rabi prospects,
foodgrain production is expected to increase by 5 million tonnes (MT)
in 2005-06. Some significant dimensions of the dynamic growth in recent
years are: a new industrial resurgence; a pick up in investment; modest
inflation in spite of spiraling global crude prices; rapid growth
in exports and imports with a widening of the current account deficit;
laying of some institutional foundations for faster development of
physical infrastructure; progress in fiscal consolidation; and the
launching of the National Rural Employment Guarantee (NREG) Scheme
for inclusive growth and social security.
1.2 According
to the national income data released by the Central Statistical Organisation
(CSO) on February 7, 2006, the advance estimate (AE) for growth of
GDP at factor cost at constant (1999-2000) prices in 2005-06 at 8.1
per cent was up 0.6 percentage points over the 7.5 per cent growth
recorded in 2004-05 (Table 1.1).
The CSO has changed the base year for calculation of national income
aggregates at constant prices from 1993-94 to 1999-2000 (Box
1.1). The revised growth rate with base 1999-2000
is the same as or less than the rate with base 1993-94 for each of
the four earlier years ending in 2003-04. For 2004-05, with the availability
of detailed data at the sectoral level rather than some indicators
that were available at the time when the advance estimate was made,
growth of GDP at factor cost at 1999-2000 prices is 7.5 per cent (according
to the quick estimate), up from the 6.9 per cent for GDP at factor
cost estimated on February 7, and June 30, 2005.
1.3 Against
the annual average growth rate of 8.0 per cent envisaged in the Tenth
Five Year Plan (2002-03 to 2006-07), the average rate is estimated
to have been 7.0 per cent in the first four years ending in 2005-06.
Excluding the first year of the Plan (with a much lower growth of
3.8 per cent) results in an average growth rate of 8.0 per cent in
the remaining three of the first four years. Maintenance of growth
at or above 8 per cent in 2006-07 will yield a plan period annual
average growth rate of at least 7.2 per cent.
1.4 The
growth trend for the last three years appears to indicate the beginning
of a new phase of cyclical upswing in the economy from 2003-04. The
initial momentum to this new phase of expansion, in 2003-04, was provided
by agriculture. After a somewhat subdued impetus from the farm sector
in 2004-05, there is a moderate recovery in agricultural growth in
2005-06 (Table 1.2). This is partly
because of a change in the rainfall pattern from erratic to a near-normal
distribution.
1.5 In
contrast to the sharp fluctuations in agriculture, industry and services
have continued to expand steadily. Indeed, since the beginning of
the Tenth Plan in 2002-03, with annual growth of 7.0 per cent or more
(Table 1.2), industry and services
have acted as the twin engines propelling overall growth of the economy.
Over a somewhat longer horizon, in the six years between 2000-01 and
2005-06 (AE), on average, services with a share of 52.0 per cent of
GDP, contributed 65.0 per cent of GDP growth, and increased its share
in GDP from 49.8 per cent to 54.1 per cent. During the same reference
period, on average, with a share of 25.8 per cent of GDP, industry,
by contributing 28.0 per cent of GDP growth, increased its share in
GDP from 25.9 per cent to 26.2 per cent.
1.6 Overall
industrial recovery that commenced from the second quarter of 2002-03
continues. After an acceleration of growth of industrial GDP at factor
cost at constant 1999-2000 prices from 7.0 per cent in 2002-03 to
7.6 per cent and 8.6 per cent in the next two years, the industrial
resurgence is manifest in the projected step up in its growth to 9.0
per cent in the current year. In the current year, industrial growth
is driven by robust performances from manufacturing and construction
sectors (Table 1.2). Within industry,
while manufacturing growth has accelerated steadily from 7.1 per cent
in 2003-04 to 9.4 per cent in 2005-06, construction growth has been
in double digits in each of the last three years. Substantive commercial
bank credit flows to the housing and real estate and retail sectors
continue to provide support to the boom in construction and consumer
durables. On the negative side, a deceleration in the growth of mining
and quarrying, partly due to a fall in the levels of crude oil production
as a result of a fire accident in July 2005 at Mumbai High North Platform,
has had a dampening impact on overall industrial growth.
1.7 Services
sector growth continued to be broad-based. Among the three sub-sectors
of services, ‘trade, hotels, transport and communication services’
continued to lead by growing at double-digit rates for the third successive
year (Table 1.2). Impressive progress
in expanding railway passenger network and production of commercial
vehicles, and fast addition to existing stock of telephone connections,
particularly mobiles, played key roles in such growth. Growth in
financial services (comprising banking, insurance and real estate
services), which after dipping in 2003-04 had bounced back in the
following year, maintained the momentum with progressive maturing
of Indian financial markets and the ongoing construction boom. However,
community, social and personal services, which include public administration
and defence, reflecting the process of fiscal consolidation and increasing
efficiency of fiscal expenditure management, experienced a growth
deceleration of more than a percentage point (Table
1.2).
1.8 A
pick-up in investment, reflecting the high business optimism, not
only strengthened industrial performance but also reinforced the growth
outlook itself. The rally in gross domestic capital formation (GDCF)
that had commenced in 2002-03 continues. GDCF, as a proportion of
GDP at current market prices, had declined from 26.0 per cent in 1999-2000
to 23.0 per cent in 2001-02 before the commencement of the industrial
recovery in 2002-03. Climbing back to 25.3 per cent and 27.2 per
cent in the two subsequent years, the ratio reached a high of 30.1
per cent in 2004-05.
1.9 Stock
market index returns of 11 per cent in 2004 followed by 36 per cent
in 2005 provide a good measure of investor sentiments. The bell-weather
BSE Sensex crossed the 10,000 mark on February 6, 2006. In 2005,
Rs. 30,325 crore of resources were raised on the primary market for
equity. The number of initial public offerings (IPOs) per year, on
the rise since 2002, increased from 26 to 55 between 2004 and 2005.
In line with the rally in investment, bank credit to the commercial
sector increased by 22.8 per cent during 2004-05 and by a further
21.2 per cent between end-March 2005 and January 20, 2006.
1.10 Robust
growth of the industrial sector and Government’s conscious decision
to increase credit to the agriculture sector led to rapid increases
in bank credit. Non-food credit by Scheduled Commercial Banks (SCBs)
expanded by Rs. 2,21,802 crore in 2004-05, substantially up from the
increase of Rs. 1,25,088 crore in 2003-04. During the period (ending
on January 20, 2006) of 2005-06, non-food credit expanded further
by Rs.2,66,857 crore, up 25.2 per cent from Rs. 1,68,188 crore in
the corresponding period of the previous year. Food credit by SCBs,
after expanding by Rs. 5,159 crore in 2004-05 compared to a decline
of Rs. 13,517 crore in the previous year, declined again by Rs. 2,778
crore during 2005-06 up to January 20, 2006 because of lower procurement
and lower stocks of Food Corporation of India (FCI) after a lean agricultural
year.
1.11 Bank
credit disbursal during 2004-05 was well diversified across different
sectors of the economy, with flows to housing and retail sector particularly
strong and a substantial pick up in flows to agriculture. Strong industrial
recovery was accompanied by much higher credit growth of 17.4 per
cent to industry (medium and large) in 2004-05 compared to only 5.1
per cent in the previous year. During 2005-06, at end-October, 2005,
the year-on-year growth (over end-October 2004) of credit to industry
(medium and large) accelerated further by 45.7 per cent.
1.12 After
growing by 24.7 per cent during the previous year, lending by SCBs
to priority sectors increased sharply by 31.0 per cent during 2004-05.
Total outstanding credit to priority sectors on March 31, 2005 was
Rs. 3, 45,627 crore. In 2005-06, at end-October, 2005, SCBs’ credit
to priority sectors expanded by Rs. 1,43,407 crore over the level
on the corresponding date of the previous year representing an increase
of 49.4 per cent. Credit flow to priority sectors was driven mainly
by agriculture and ‘other priority sectors’. Outstanding credit balances
to agriculture had more than doubled in the last three years from
Rs. 60,761 crore at end-March 2002 to Rs. 1,22,370 crore at end-March
2005; at end-October, 2005, such outstanding credit balances were
Rs. 1,41,612 crore.
1.13 TAs
per the ‘farm credit package’ announced by Government of India on
June 18, 2004, that the flow of credit to agriculture would be doubled
in the ensuing three years, the target for institutional credit for
agriculture by all agencies was fixed at Rs.1, 05,000 crore for the
year 2004-05, ensuring 30 per cent growth over the previous year’s
achievement. During 2004-05, with an aggregate disbursement of Rs.1,25,309
crore to the agricultural sector, the target of Rs. 1,05,000 crore
was exceeded by 19.3 per cent and was 44.1 per cent higher than previous
years’ level. During 2005-06, as against the target of Rs. 1,41,000
crore for the full year, the flow of institutional credit to agriculture
up to end-December 2005, was Rs. 1,17,899 crore, representing 84 per
cent of the annual target. Credit to small-scale industries, after
increasing from Rs. 57,199 crore at end-March 2002 to Rs. 76,114 crore
at end-March 2005, increased further to Rs. 78,780 crore at end-October,
2005.
1.14 The
5,39,365 new self-help groups (SHGs) credit-linked during 2004-05
represented an increase of 49 per cent over the previous year. As
on March 31, 2005, the total of 16.18 lakh SHGs credit-linked by banks
covered an estimated 242 lakh poor families, with an average loan
disbursement per family of Rs.3, 044. Refinance support extended by
NABARD amounted to Rs. 3,082 crore. A highlight of the programme was
that about 90 per cent of the groups linked with banks were exclusively
women groups. As against the target of linking 3 lakh SHGs for the
whole year 2005-06, 2.11 lakh new SHGs were linked by December 2005.
1.15 From
1993-94 to 2003-04, net capital stock in industries (comprising mining,
manufacturing and electricity sectors, and at constant prices), which
proxies capacity addition, increased at an average rate of 6.66 per
cent per annum. Going by the use-based classification of industries,
the growth rate in the capital goods sector in April-December 2005
at 15.7 per cent indicated a substantial improvement over the growth
of 13.8 per cent during the same period last year. Buoyant growth
of imports of capital goods at 21 per cent in 2004-05, on top of the
40 per cent growth in 2003-04, reflected the higher domestic investment.
Non-electrical machinery, transport equipment, manufacture of metals
and machine tools were the main contributors of the rise in capital
goods imports.
1.16 Inflation,
in most parts of the world, showed a rising tendency on account of rising
global crude oil prices. The sharp and spiraling increase in international
oil prices from late 2003, combined with considerable week-to-week and
even day-to-day volatility, posed considerable challenge in the maintenance
of macroeconomic stability. Average headline world price of Indian basket
of crude petroleum increased by 44.5 per cent, from US$37.3 per barrel
in April-November 2004 to US$53.9 per barrel in April-November 2005,
and was US$58.10 per barrel on February 13, 2005. Nevertheless, the
virtuous expansion in the current phase of economic upturn has been
maintained without an undue escalation of domestic prices. In India,
inflation, measured by a point-to-point increase in the Wholesale Price
Index (WPI) declined from 5.7 per cent on April 2, 2005, to a low of
3.3 per cent on August 27, 2005. Despite increasing thereafter, prices
have remained at comfortable levels with the WPI-inflation at 4.1 per
cent on February 4, 2006 vis-à-vis 5.0 per cent on February 5, 2005.
1.17 Like
in the previous year, the fuel, power, light, and lubricants group,
having a weight of 14.2 per cent in the WPI basket, contributed the
most to price rises in the economy. As on February 4, 2006, the fuel
group, with an inflation rate of 7.6 per cent, contributed 40.5 per
cent to the overall inflation, which was marginally lower than 42.8
per cent a year ago. Much of the inflation in the fuel group is attributable
to the ‘pass through’ effected in June and September 2005, in the
form of enhanced retail prices of petrol and diesel, precipitated
by the flare-up in global oil prices. While retail prices of kerosene
canalised through the public distribution system (PDS), and domestic
LPG were kept unchanged for softening the burden on consumers, the
incomplete pass through, however, entailed adverse implications both
for the finances of domestic oil marketing companies and for the exchequer
because of the issue of ‘oil bonds’ to such companies.
1.18 The
decelerating trend in inflation relating to manufactured products
group observed since the last quarter of 2004-05 continued as the
inflation rate for this group dropped from 4.5 per cent a year ago
to 2.4 per cent on February 4, 2006. This deceleration in both wholesale
and retail prices, in the aftermath of the introduction of value added
tax (VAT) in most of the States with effect from April 1, 2005, helped
to mobilise popular support behind a fundamental reform of State-level
sales taxes – a reform termed by some as the most important tax reform
in post-independent India. Inflation in manufactured products was
under tight control with heightened competition in increasingly liberalised
markets for such products.
1.19 Simultaneously,
however, the low inflation in primary articles observed in the previous
two years came to an end as the point-to-point inflation rate for
this group increased from 1.2 per cent to 5.0 per cent between February
5, 2005 and February 4, 2006. This contrasting development in primary
products reflected supply shortfalls in some commodities such as onions
and potatoes, and a firming up of demand all over the world for minerals.
Primary items with a weight of 22.0 per cent in WPI basket, contributed
26.3 per cent to overall inflation on February 4, 2006 significantly
higher than 5.2 per cent a year ago. Among primary food items, apart
from potatoes and onions, urad, gram, moong and fish-inland experienced
higher inflation during the current year. Higher prices for some of
the crops can be partly explained by output disruptions brought on
by excessive rainfall in different parts of the country. Raw cotton
prices, in line with international trends, recovered somewhat from
the lows experienced in the previous year. Improved crop prospects
succeeded in keeping oilseed prices at moderate levels.
1.20 Manufactures,
as a group, had a lower contribution of 33.1 per cent to overall inflation
of 4.1 per cent on February 4, 2006, compared to 51.6 per cent a year
ago. Among manufactures, ‘other non-ferrous metals’ experienced the
highest price rise (34.1 per cent), followed by wood and wood products
(15.5 per cent) and rubber and plastic products (6.3 per cent).In
the manufactured segment, domestic sugar prices remained firm on account
of depleting stocks and a rise in world prices. With domestic producers
frequently adjusting inventory levels in response to changes in international
market conditions, domestic steel prices continued to reflect international
prices. Increase in steel prices in the current year so far has been
moderate compared to that in the previous year. The sharp rebound
in construction activity resulted in cement prices increasing by 7.1
per cent during the year so far.
1.21 In
April 2005, inflation, year on year, in terms of consumer price index
for agricultural labourers (CPI-AL) and of consumer price index for
industrial workers (CPI-IW) was 3 per cent and 5 per cent, respectively.
Data available for CPI-AL for the first nine months of 2005-06, indicated
that inflation in CPI-AL remained below that in CPI-IW for each of
the months of the current financial year including December 2005.
Furthermore, with inflation rate for food group (with a higher weight
in CPI than in WPI) lower than that of overall inflation, CPI inflation
(measured in terms of both CPI-AL and CPI-IW) remained below WPI-inflation
until October 2005. Inflation in both CPI-AL and CPI-IW, after declining
to 3.2 per cent and 3.4 per cent respectively – with some minor
fluctuations – between April and August, 2005, revealed an upward
trend. In December, 2005, inflation in CPI-IW was 5.6 per cent. The
upward trend in consumer prices was primarily on account of hardening
of retail prices of vegetables and pulses.
1.22 Maintaining
price stability continued to be one of the main objectives of monetary
policy. For achieving this, along with the other objective of providing
an enabling environment for higher investment and growth, the policy
variables were recalibrated appropriately. While the Bank Rate and
the cash reserve ratio (CRR) were kept unchanged during the current
year at 6.0 per cent and 5.0 per cent, respectively, the fixed reverse
repo rate under the Liquidity Adjustment Facility (LAF) of the Reserve
Bank of India (RBI) was raised three times, by 25 basis points each,
to reach 5.50 per cent on January 24, 2006. With the given spread
of 100 basis points vis-à-vis the reverse repo rate, the repo rate
is pegged at 6.50 per cent since January 24, 2006. RBI’s policy response
was in line with the cautious approach in many other countries of
moving policy interest rates in a measured way in the face of the
threat of inflationary expectations firming up with high crude oil
prices.
1.23 Growth
in broad money (M3) of 12.2 per cent at end-March 2005
was lower than both the 14.0 per cent projected by the RBI in its
Annual Policy Statement for 2004-05 and 16.7 per cent observed at
end-March 2004. Furthermore, during 2004-05, relative to the previous
year, growth in sources of M3 displayed some diversity
with net domestic credit growing faster (13.3 per cent compared to
11.7 per cent during 2003-04) and net foreign exchange assets (NFA)
of the banking sector growing slower (23.3 per cent compared to 33.7
per cent during 2003-04). Much of the net domestic credit expansion
in 2004-05 was from growth in bank credit to the commercial sector
(22.8 per cent) while net bank credit to government increased by only
0.4 per cent. Relative to end-March 2005, on January 20, 2006, M3
was up by 13.2 per cent compared to 9.2 per cent observed in the corresponding
period of the previous year. The year-on-year growth of M3
at 16.4 per cent on January 20, 2006 was not only higher than
the projected 14.5 per cent in RBI’s Annual Policy Statement for
2005-06, but also higher than the rate observed a year ago. Price
stability despite a rapid increase in money supply during the current
year testified to the investment-driven nature of the credit growth
and stability of inflation expectations based on confidence in the
appropriate stance of monetary and fiscal policies.
1.24 The
money-multiplier (the ratio of M3 to reserve money, M0)
rose steadily from 4.59 at end-March 2004 to 4.61 at end-March 2005
and further to 4.77 on January 20, 2006. This reflected a decline
in the reserve-deposit ratio — for example, from 0.064 to 0.061 between
January 21, 2005 and January 20, 2006. Consequently, growth in reserve
money (M0) was slightly slower than that of M3.
Furthermore, M0 growth had also decelerated from 18.3 per
cent at end-March 2004 to 12.1 per cent at end-March 2005. Continuing
the deceleration observed in the previous year, in the current financial
year, on January 20, 2006, M0 growth was 14.9 per cent
compared to 15.3 per cent observed on the corresponding date of the
previous year. The growth of NFA of the RBI dominated the evolution
of M0 in 2004-05.
1.25 In
2004-05, a part of this growth in NFA had to be sterilised by recourse
to the Market Stabilisation Scheme (MSS) and Liquidity Adjustment
Facility (LAF) and a resultant decline in net domestic assets (NDA)
of the RBI. The relative importance of NFA vis-à-vis NDA of the RBI
has changed sharply from 2004-05 to the current year so far. Between
end-March and January 21/20, while NFA had grown by Rs. 75,930 crore
in 2004-05, the corresponding increase was only Rs. 2,043 crore in
2005-06. With their extensive use to absorb liquidity and contain
the impact of reserve inflows through the balance of payments in 2004-05,
the outstanding balance under MSS and LAF (reverse repo) was Rs. 83,500
crore (3.7 per cent of M3) on March 31, 2005.
1.26 With
the decline in reserves in foreign currency terms, there was a diminution
of NFA flows in rupee terms in 2005-06 up to January 20, 2006, in
spite of the nominal depreciation of the currency. From mid-December
2005, signs of liquidity tightening were observed, partly on account
of redemption of India Millennium Deposits (IMD) of the State Bank
of India on December 29, 2005. Total outgo under IMD redemption was
about Rs. 32,000 crore, and in anticipation of the liquidity tightening,
on December 16, 2005, RBI had injected Rs. 1,085 crore under repo
(LAF), and followed it up by further liquidity injections in the four
days between December 27 and 30, 2005 of Rs. 21,415 crore, Rs. 26,685
crore, Rs. 30,110 crore and Rs. 29,795 crore, respectively. Between
January 2, 2006 and January 13, 2006, RBI had injected, on an average
Rs. 16,527 crore per day under repo (LAF). Nevertheless, unwinding
of a part of the liquidity impounded through MSS and LAF through the
year resulted in a decline in their outstanding balances to Rs. 40,178
crore (1.6 per cent of M3) on January 20, 2006.
1.27 The
call money rates followed an upward trend to reach 4.94 per cent on
April 30, 2005, when the fixed reverse-repo rate was raised by 25
basis points to 5.0 per cent. Thereafter, call money rates remained
benign for a considerable period, before starting to pick up again,
especially after the 25 basis point increase in the reverse repo rate
by the RBI in October 2005. For the first time in the current financial
year, call money rates crossed the 6 per cent barrier to reach 6.10
per cent on November 9, 2005 and further increased to 6.65 per cent
on November 11, 2005. After remaining below the fixed reverse-repo
rate (5.25 per cent) on December 2-3, 2005, call rates started to
rise sharply, under pressure of advance tax payments and the ensuing
IMD redemption, to reach 7.15 per cent on the redemption date of December
29, 2005. Call rates remained under pressure thereafter to reach 7.71
per cent on January 27, 2006, but moderated to 6.88 per cent on February
16, 2006.
1.28 In
2004-05, rising interest rates had an adverse effect on bond prices
and reduced treasury profits of banks. SCBs’ total income during
2004-05 grew at a slower rate of 1.5 per cent (net of conversion)
than 6.7 per cent observed in 2003-04. Furthermore, with credit growing
faster than deposits, recourse to funding sources like borrowing increased.
Operating expenses in 2004-05, as a proportion of net income, rose
to 49.1 per cent from 45.4 per cent in 2003-04; and as a proportion
of total assets, declined marginally to 2.16 per cent from 2.21 per
cent in the previous year. A significant improvement in recovery
of NPAs combined with a significant increase in gross loans and advances
by SCBs led to a sharp decline in the ratio of gross NPAs to gross
advances to 5.2 per cent at end-March 2005 from 7.2 per cent at end-March
2004. The overall capital-to-risk-weighted assets ratio (CRAR) of
SCBs at 12.8 per cent at end-March 2005 was marginally lower than
the previous year’s level (12.9 per cent).
1.29 In
a marked departure from the trend observed in recent years, the pace
of accretion to foreign exchange reserves has slowed sharply during
the current year so far. Following accretion of US$28.5 billion during
2004-05, in the current year until February 10, 2006, there was a
reduction of US$1.1 billion from the end-March 2005 level of US$141.5
billion of foreign exchange reserves. Three key factors were instrumental
behind this turnaround: an outgo of US$7.1 billion on IMD redemption;
valuation losses from a weakened dollar vis-à-vis other major currencies;
and a widening deficit in the current account of the balance of payments
(BOP).
1.30 The
weakening of the US dollar vis-à-vis other major global currencies,
which resulted in valuation losses of US$5.0 billion in reserves in
the first half of 2005-06, also got reflected in the movements of
the Rupee vis-à-vis the US dollar. During 2004-05, the Rupee had
appreciated against the US dollar (2.2 per cent) in nominal terms,
while depreciating against the Euro (-4.5 per cent), Pound (-6.3 per
cent), and the Japanese Yen (-2.6 per cent). However, in the first
ten months of 2005-06, on average, the Rupee has strengthened against
all major currencies. The appreciation was the strongest vis-à-vis
the Japanese Yen (6.4 per cent) followed by Pound (4.5 per cent),
the Euro (4.3 per cent), and the US dollar (2.1 per cent). In 2005-06,
in 5-country export-weighted nominal effective exchange rate (NEER)
terms (base year 2000), the Rupee appreciated in all months until
July 2005, and depreciated in subsequent months until December 2005.
In 5-country export-weighted real effective exchange rate (REER) terms
(base year 2000), the same pattern was observed, with the exception
of November 2005, which witnessed a mild appreciation.
1.31 The
embryonic deficit in the current account of the BOP, which emerged
in 2004-05 after three consecutive years of surpluses, has assumed
much larger dimensions during the current year. During April-September
2005-06, the current account deficit enlarged to around US$13.0 billion,
which was more than twice the deficit (US$5.4 billion) in the whole
of 2004-05. While net invisibles continued to rise, it was not enough
to neutralize the rapidly expanding trade deficit, which at US$31.6
billion during April-September 2005-06 was only around US$5.0 billion
less than that recorded in twelve months of 2004-05.
1.32 The
sharp rise in current account deficit reflects the burgeoning trade
deficit during the current year so far. Net invisibles increased,
but was not enough to neutralize the expanding trade deficit. While
the surge ahead in merchandise exports observed since 2002-03 continued,
such growth was surpassed by an even faster rise in merchandise imports.
Merchandise imports have been rising more rapidly than exports since
2003-04, reflecting perhaps the overall industrial recovery that commenced
from the second quarter of 2002-03. Growth of GDP at factor cost
at constant prices crossed 7.0 per cent in 2003-04 and has remained
in excess of that rate ever since. The heavy demand for imports arising
from increasing buoyancy and robustness of Indian industry may have
led to a sustained rise in growth of merchandise imports.
1.33 India’s
merchandise exports (in US dollar terms and customs basis) have been
recording annual growth rates of more than 20 per cent since 2002-03.
In 2004-05, such exports grew by 26.2 per cent – the highest annual
growth rate in the last three decades – to cross US$80 billion. Five
major sectors – gems & jewellery, engineering goods, petroleum
products, ores & minerals, and chemicals and related products
– were the key drivers. Despite recording a somewhat lower rate of
growth of 18.9 per cent, exports during April-January 2005-06 have
already reached $74.9 billion and are well on their way to achieve
the US$92 billion target set for 2005-06.
1.34 In
2004-05, merchandise imports (in US dollar terms and customs basis)
had grown by 39.7 per cent – the highest growth in two and a half
decades. On a decelerating mode in the current year, such imports
grew by 26.7 per cent during April-January, 2005-06. The increase
in imports has been driven, inter alia, by the sharp rise in
global crude prices, which resulted in petroleum, oil and lubricants
(POL) imports increasing by 46.9 per cent in April-January, 2005-06.
Non-oil, non-bullion imports, increased by 30.8 per cent during April-October,
2005 – on top of a 29.9 per cent rise during the corresponding period
of the previous year
1.35 After
growing by US$10.8 billion to US$27.8 billion in 2003-04, the increase
in net invisibles, was limited to only US$3.4 billion in 2004-05,
primarily on account of a drop of US$1.4 billion in private transfers.
However, services exports – captured by net non-factor services, and
including software and IT-enabled services – have continued to perform
satisfactorily with unfailing regularity. Such exports (in US dollar
terms), after growing by 71.3 per cent in 2004-05, increased further
by 75.3 per cent in the first half of 2005-06. In addition to software
and IT-enabled services, of late, business services, including professional
services, have come to play a key role in enlarging services exports.
1.36 With
robust inflows, during 2004-05, the surplus of US$31.6 billion recorded
in the capital account more than compensated the current account deficit
and resulted in an addition of more than US$26 billion, on BOP basis,
to the existing stock of foreign exchange reserves. In April-September
2005, while the capital account surplus at US$19.5 billion remained
higher than the current account deficit of US$13.0 billion, there
was a slowdown in reserve accretion on BOP basis. The dominance of
non-debt creating flows in the capital account continued. During
April-September 2005, foreign investment flows at US$7.4 billion were
nearly US$5.0 billion higher than such flows of US$2.5 billion in
the first half of 2004-05. Within foreign investment, portfolio flows,
comprising mainly foreign institutional investor (FII) investment,
were the dominant variety. At US$4.2 billion during April-September
2005, FII flows (net) were higher than not only the FDI flows of US$2.3
billion, but also the FII flows of US$339 million in April-September
2004. FDI flows (net) during April-September 2005 were US$2.3 billion
— up by only US$0.3 billion from such flows of US$2.0 billion in the
first half of 2004-05.
1.37 Notwithstanding
the dominance of non-debt creating flows in the capital account, the
importance of debt flows appears to have increased with the emergence
of a current account deficit since 2004-05. Both external assistance
and external commercial borrowings (ECBs), which were net outflows
during 2002-03 and 2003-04, became net inflows of US$1.9 billion and
US$5.0 billion, respectively, during 2004-05. These flows continued
to be positive in the first half of the current year. ECBs, in particular,
increased from US$1.5 billion to US$2.7 billion between the first
half of 2004-05 and the first half of 2005-06. Also, non-resident
deposits, which had turned into outflows after rationalisation of
interest rate premia on such deposits, turned into net inflows during
the first half of the current year. At end-September 2005, India’s
external debt at US$124.3 billion was up by US$1.0 billion from its
end-March 2005 level. The increase was primarily on account of a rise
in short term external debt, like ECBs and trade credits availed by
importers. The expected moderation in overall external debt from the
redemption of IMDs will be captured in the data being compiled for
December, 2005.
1.38 Infrastructural
inadequacies continued to constrain the full potential for industrial
resurgence, pick up in investment and buoyant exports. The growth
of power generation in April-December 2005 at 4.7 per cent, for example,
was lower than not only the annual target but also the 6.5 per cent
achieved in the same period of the previous year. In the first three
quarters of the current financial year, the overall index of six core
industries – coal, electricity, crude petroleum, refinery throughput,
steel, and cement – having a direct bearing on infrastructure, registered
a growth of 4.5 per cent, which was lower than the 6.4 per cent registered
during April-December, 2004. In the first half of 2005-06, crude oil
production registered a decline, and there was deceleration in growth
of coal, electricity and steel sectors. Growth of cement production,
however, accelerated during this period.
1.39 While
progress continued in attracting private investment into the infrastructure
sectors of telecommunications, ports, and airports, there was a step
up in budgetary outlays on roads financed through the enhanced road
cess on motor spirit and high speed diesel. Nevertheless, overall
investment in infrastructure continued to remain far below the requirement,
and net capital stock, for example, in electricity, gas and water
supply grew at a compound annual rate of 3.7 per cent between 1993-94
and 2003-04. The recently introduced public-private partnership (PPP)
model had limited success in the area of electricity and mining, and
the dominance of the public sector continued.
1.40 The
pick up in investment reflected partly the progress in fiscal consolidation
in the recent past, particularly since 2003-04, the year in which
Fiscal Responsibility and Budget Management Act (FRBMA) was enacted.
Reduction in preemption of credit by Government helped to maintain
a benign interest rate regime and stimulate capital formation. The
Rules under FRBMA mandate an annual minimum reduction of 0.3 per cent
of GDP in fiscal deficit and 0.5 per cent of GDP in revenue deficit.
From 2002-03, in the two subsequent years, there has been an annual
average reduction of 0.9 per cent of GDP in each of the two indicators
of fiscal health. This rapid front-loaded fiscal adjustment, noteworthy
though, restored the status-quo-ante of the mid-nineties. The process
of fiscal consolidation had to be paused in the Budget for 2005-06
consequent to the implementation of the Twelfth Finance Commission
(TFC) award. However, a clear picture will emerge only after the
RE for 2005-06 is revealed.
1.41 Indications
are that the slower progress in fiscal consolidation at the Centre
in the current year may be made up by faster progress on this front
by the State Governments and result in an overall improvement in the
financial health of the General Government, that is the Centre and
the States combined. Up to February 2, 2006, 18 States
had enacted fiscal responsibility legislations, and more were initiating
action to follow suit. Most States had adopted the VAT, a non-cascading,
self-enforcing, and harmonized commodity taxation regime, from April
1, 2005. Buoyant revenues in the States and significant improvement
in the combined fiscal position of States in 2004-05 (RE) indicate
that the process of deepening of the fiscal reforms and restructuring
of public finances as envisaged by the TFC have had a head start.
The revenue deficit of States declined to 1.4 per cent of GDP and
fiscal deficit to 3.8 per cent of GDP in 2004-05 (RE). This has been
carried forward in BE 2005-06 with targets of revenue deficit of 0.7
per cent of GDP and fiscal deficit of 3.1 per cent of GDP. These were
very close to the target for 2008-09 set by the TFC and their achievement
in the first year of the award itself indicates a significant front
loading.
1.42 Maintaining
its increasing trend since 1990-91, except in 1998-99, the share of
direct taxes in central tax revenues increased from 19.1 per cent
in 1990-91 to 43.3 per cent in 2004-05 (RE) and further to 47.9 per
cent 2005-06 (BE). The Union Budget for 2005-06 has continued the
process of raising revenues through reduction in rates, wider base
and better compliance. Significant across the board reduction in personal
income tax and a 5 percentage point reduction in basic corporate income
tax are pointers to this. The peak rate of customs duty on non-agricultural
items was reduced from 20 per cent to 15 per cent. Furthermore, customs
duty on petroleum products and crude were reduced, and part of the
excise duties on petroleum products were converted from ad valorem
to specific to mitigate the cascading effect of rising world prices
of petroleum on Indian consumers. A major announcement in the Union
Budget for 2005-06 was the enabling provision assumed by the Central
Government to partly remedy the anomalous situation of State levies
applying only to domestic products and not on imports by end-users.
This additional duty of customs is not to exceed 4 per cent.