Macroeconomic
Overview
Vigorous
growth with strong macroeconomic fundamentals has characterized developments
in the Indian economy in 2006-07 so far. However, there are some genuine
concerns on the inflation front. Growth of 9.0 per cent and 9.2 per
cent in 2005-06 and 2006-07, respectively, by most accounts, surpassed
expectations (Table 1.1). While the up-and-down pattern in agriculture
continued with growth estimated at 6.0 per cent and 2.7 per cent in
the two recent years, and services maintained its vigorous growth
performance, there were distinct signs of sustained improvements on
the industrial front (Table 1.2). Entrenchment of the higher growth
trends, particularly in manufacturing, has boosted sentiments, both
within the country and abroad. The overall macroeconomic fundamentals
are robust, particularly with tangible progress towards fiscal consolidation
and a strong balance of payments position. With an upsurge in investment,
the outlook is distinctly upbeat.
1.2 The
advance estimates (AE) of gross domestic product (GDP) for 2006-07,
released by the Central Statistical Organisation (CSO) on February
7, 2007, places the growth of GDP at factor cost at constant (1999-2000)
prices in the current year at 9.2 per cent. Growth in 2005-06, initially
estimated by the CSO at the AE stage at 8.1 per cent in February 2006,
was revised upwards to 8.4 per cent at the revised estimate stage
in May 2006 and further to 9.0 per cent in the quick estimates released
by the CSO on January 31, 2007.
1.3 The
ratcheting up of growth observed in recent years is reflected in the
Eleventh Five Year Plan target of an average annual growth of 9 per
cent relative to 8 per cent targeted by the Tenth Plan (2002-03 to
2006-07). The shortfall in the annual average growth of 7.6 per cent
from the target of 8 per cent in the five years of the Tenth Plan
is attributable to the disappointing 3.8 per cent growth in the first
year of the Plan and its subsequent surge to 8.6 per cent, on average,
in the last four years.
1.4 Services
contributed as much as 68.6 per cent of the overall average growth
in GDP in the last five years between 2002-03 and 2006-07. Practically,
the entire residual contribution came from industry. As a result,
in 2006-07, while the share of agriculture in GDP declined to 18.5
per cent, the share of industry and services improved to 26.4 per
cent and 55.1 per cent, respectively.
1.5 The
lower contribution of industry to GDP growth relative to services
in recent years is partly because of its lower share in GDP, and does
not adequately capture the signs of industrial resurgence. First,
growth of industrial sector, from a low of 2.7 per cent in 2001-02,
revived to 7.1 per cent and 7.4 per cent in 2002-03 and 2003-04, respectively,
and after accelerating to over 9.5 per cent in the next two years,
touched 10.0 per cent in 2006-07. Second, growth of industry, as a
proportion of the corresponding growth in services, which was 78.9
per cent on an average between 1991-92 and 1999-2000, improved to
88.7 per cent in the last seven years. Third, within industry, the
growth impulses in the sector seem to have spread to manufacturing.
Industrial growth would have been even higher, had it not been for
a relatively disappointing performance of the other two sub-sectors,
namely, mining and quarrying; and electricity, gas and water supply.
Fourth, since 1951-52, industry has never consistently grown at over
seven per cent per year for more than three years in a row before
2004-05. Fifth, year-on-year, manufacturing, according to the monthly
Index of Industrial Production (IIP) available until December 2006,
has been growing at double digit rates every month since March 2006,
with the solitary exception of the festive month of October.
1.6 A
notable feature of the current growth phase is the sharp rise in the
rate of investment in the economy. Investment, in general being a
forward looking variable, reflects a high degree of business optimism.
The revival in gross domestic capital formation (GDCF) that commenced
in 2002-03 has been followed by a sharp rise in the rate of investment
in the economy for four consecutive years. The earlier estimates of
GDCF for 2004-05 of 30.1 per cent, released by CSO in their advance
estimates, now stand upgraded to 31.5 percent in the quick estimates.
The rate of GDCF for 2005-06 as per the quick estimates released by
CSO is 33.8 per cent. This sharp increase in the investment rate has
sustained the industrial performance and reinforces the outlook for
growth.
1.7 Services
sector growth has continued to be broad-based. Among the three sub-sectors
of services, ‘trade, hotels, transport and communication services’
has continued to boost the sector by growing at double-digit rates
for the fourth successive year (Table 1.2). Impressive progress in
information technology (IT) and IT-enabled services, both rail and
road traffic, and fast addition to existing stock of telephone connections,
particularly mobiles, played a key role in such growth. Growth in
financial services (comprising banking, insurance, real estate and
business services), after dipping to 5.6 percent in 2003-04 bounced
back to 8.7 percent in 2004-05 and 10.9 per cent in 2005-06. The momentum
has been maintained with a growth of 11.1 per cent in 2006-07.
1.8 After
an annual average of 3.0 per cent in the first five years of the new
millennium starting 2001-02, growth of agriculture at only 2.7 per
cent in 2006-07, on a base of 6.0 per cent growth in the previous
year, is a cause of concern. Low investment, imbalance in fertilizer
use, low seeds replacement rate, a distorted incentive system and
low post-harvest value addition continued to be a drag on the sector’s
performance. Given its low share, a mechanical calculation of the
adverse impact of low growth in agriculture on overall GDP can be
misleading. With more than half the population directly depending
on this sector, low agricultural growth has serious implications for
the ‘inclusiveness’ of growth. Furthermore, poor agricultural
performance, as the current year has demonstrated, can complicate
maintenance of price stability with supply-side problems in essential
commodities of day-to-day consumption. The recent spurt of activity
in food processing and integration of the supply chain from the farm
gate to the consumer’s plate has the potential of redressing
some of the root causes such as low investment, poor quality seeds,
and little post-harvest processing.
1.9 With
a shortfall in domestic production vis-à-vis domestic demand
and hardening of international prices, prices of primary commodities,
mainly food, have been on the rise in 2006-07 so far. Wheat, pulses,
edible oils, fruits and vegetables, and condiments and spices have
been the major contributors to the higher inflation rate of primary
articles. As much as 39.4 per cent of the overall inflation in WPI
on February 3, 2007 came from the primary group of commodities. Within
the primary group, the mineral subgroup recorded the highest year-on-year
inflation at 18.2 per cent, followed by food articles at 12.2 per
cent and non-food articles at 12.0 per cent. Food articles have a
high weight of 15.4 per cent in the WPI basket. Including manufactured
products such as sugar and edible oils, food articles contributed
as much as 27.2 per cent to overall inflation of 6.7 per cent on February
3, 2007.
1.10
Starting with a rate of 3.98 per cent, the inflation rate in 2006-07
has been on a general upward trend with intermittent decreases. However,
average inflation in the 52 weeks ending on February 3, 2007 remained
at 5 per cent. A spurt in inflation like in the current year has been
observed in the recent past in 1997-98, 2000-01, 2003-04 and 2004-05.
1.11
The international annual average price of the Indian basket of crude
(about 60 per cent of Oman/Dubai and 40 per cent of Brent), after
remaining more or less stable in 2002-04 at around US$27-28 per barrel,
increased by over 40 per cent annually in the next two years to reach
US$75.2 per barrel on August 8, 2006. To stop the hemorrhaging of
public sector oil companies’ finances, there was an unavoidable
upward revision of retail selling prices of petro-products on June
6, 2006. The pass-through to consumers was restricted to just 12.5
per cent in a three-way burden sharing arrangement among consumers,
Government and oil marketing companies. With the softening of international
petroleum prices, domestic prices of petrol (motor spirit) and high-speed
diesel were reduced by Rs. 2 and Re.1, respectively with effect from
November 30, 2006, and again by the same amounts with effect from
February 16, 2007.
1.12
Government closely monitored prices every week and initiated measures
to enhance domestic availability of wheat, pulses, sugar and edible
oils by a combination of enhanced imports, export restrictions and
fiscal concessions. In wheat, State Trading Corporation, the parastatal,
tendered overseas for 55 lakh tonnes of wheat; private trade was permitted
to import wheat at zero duty from September 9, 2006; and exports were
banned from February 9, 2007. The minimum support price (MSP) of wheat
was raised by Rs. 50 per quintal and announced well in advance of
the sowing season to bring additional acreage under wheat. In pulses,
imports were allowed at zero duty from June 8, 2006; export was banned
from June 22, 2006; and National Agricultural Cooperative Marketing
Federation (NAFED) purchased urad and moong overseas. Regulation of
commodity futures markets was strengthened for wheat, sugar and pulses;
and as a matter of abundant precaution, futures trading was banned
in urad and tur from January 24, 2007. Duty on palm group of oils,
which meets more than a half of the domestic demand-supply shortfall
in edible oils, was reduced by 20-22.5 percentage points in a phased
sequence, first in August 2006 and later in January 2007. Further,
tariff values of these oils for import duty assessment were frozen.
On January 22, 2007, further duty cuts were announced for portland
cement, various metals and machinery items. With a firming up of international
prices, the impact of duty-free import of wheat and pulses in rolling
the domestic prices back was limited. But such imports improved domestic
market discipline.
1.13
Inflation, with its roots in supply-side factors, was accompanied
by buoyant growth of money and credit in 2005-06 and 2006-07 so far.
While GDP growth accelerated from 7.5 per cent to 9.0 per cent between
2004-05 and 2005-06, the corresponding acceleration in growth of broad
money (M3) was from 12.3 per cent to 17.0 per cent. Year-on-year,
M3 grew by 21.1 per cent on January 19, 2007. The industrial resurgence
and upswing in investment was reflected in, and sustained by, growth
of gross bank credit (as per data covering 90 per cent of credit by
scheduled commercial banks), for example, to industry (medium and
large) at 31.6 per cent and for housing loans at 38.0 per cent in
2005-06. It was also observed in year-on-year growth of gross bank
credit at 32.0 per cent in September 2006, albeit marginally down
from 37.1 per cent in 2005-06. Reconciling the twin needs of facilitating
credit for growth on the one hand and containing liquidity to tame
inflation on the other remained a challenge. RBI put a restraint on
the rapid growth of personal loans, capital market exposures, residential
housing beyond Rs. 20 lakh and commercial real estate loans by more
than doubling the provisioning requirements for standard advances
under these categories from 0.40 per cent to 1.0 per cent in April
2006. Simultaneously, it increased the risk weight on exposures to
commercial real estate from 125 per cent to 150 per cent.
1.14
Liquidity conditions remained fairly comfortable up to early September
2006 with the unwinding of the Central Government surplus balances
with the RBI and continued intervention in the foreign exchange market
to maintain orderly conditions. During 2006-07, up to September 8,
2006, RBI had not received any bid for repo under Liquidity Adjustment
Facility (LAF) and the continuous flow of funds under reverse-repo
indicated a comfortable liquidity position. In 2005-06, the reverse
repo rate had been raised by 25 basis points each time on April 29
and October 26, 2005, and on January 24, 2006 to reach 5.50 per cent.
In 2006-07, it was raised again by 25 basis points each time on June
9 and July 25, 2006. There was some tightness with the onset of the
festival season and due to high credit expansion and outflows on account
of advance tax payment. From mid-September through October, 2006,
while RBI had to provide accommodation to some banks through repo
facility, with reverse repo operations simultaneously, in net terms,
RBI absorbed liquidity from the system.
1.15
With year-on-year inflation stubbornly above 5 per cent from early-August
2006, on October 31, 2006, the RBI announced more measures to stem
inflationary expectations and also to contain the credit off-take
at the desired growth rate of 20.0 per cent. Unlike the previous four
times, when both the repo and the reverse repo rates were raised by
the same 25 basis points, thereby keeping their spread constant at
100 basis points, on October 31, 2006, only the repo rate was raised
by 25 basis points. With a repeat of this policy move on January 31,
2007, the repo rate reached 7.50 per cent with a spread of 150 basis
points over the reverse repo rate. Since deposits are growing at a
lower rate than credit, the higher repo rate signaled to the banks
the higher price of accommodation they would have to pay in case of
credit overextension.
1.16
The cash reserve ratio (CRR) was hiked by 25 basis points each time
on December 23, 2006 (5.25 per cent) and January 6, 2007 (5.50 per
cent). While a further increase of CRR of 25 basis points was effected
on February 17, another similar increase of 25 basis points will follow
on March 3, 2007.
1.17
Sustained faster growth of M3 relative to that of reserve money (M0)
observed in recent years continued in 2005-06 and 2006-07 so far with
the money multiplier () steadily increasing from 4.43 at end-March
2002 to 4.60 at end-March 2005, 4.76 at end-March 2006 and further
to 4.79 on January 19, 2007. The increase in money-multiplier coincided
with fast growth of M0 at 17.2 per cent during 2005-06 and year-on-year
at 20.0 per cent on January 19, 2007 and resulted in the rapid growth
of M3.
1.18
Driving the fast growth of reserve money was net foreign assets (NFA)
of the RBI. Even with the redemption of the India Millennium Deposits,
NFA of the RBI grew by Rs. 60,193 crore and contributed 12.3 percentage
points to the 17.2 per cent growth in M0 during 2005-06. The corresponding
growth of NFA between end-March 2006 and January 19, 2007 was Rs.
114,338 crore. Liquidity in the system continued to be addressed by
Market Stabilisation Scheme (MSS) operations. Outstanding balance
under MSS, after increasing from Rs. 29,062 crore (1.0 per cent of
M3) on March 31, 2006 to a high of Rs. 42,364 crore (1.5 per cent
of M3) on August 25, 2006, started declining thereafter to reach Rs.
40,491 crore (1.3 per cent of M3) on January 19, 2007.
1.19
The change in the liquidity and inflation environment is reflected
in the continuous hardening of interest rates in 2005-06 and in 2006-07
so far. With the high demand for credit not adequately matched by
deposit growth, there was steady increase in the credit-deposit ratio
and hardening of int up by 84 basis points during 2005-06 to 7.53
per cent at end-March 2006, hardened further to 8.08 erest rates.
For example, the yield on 10-year residual maturity Government securities,
which had goneper cent on February 14, 2007. Movements in the call
money rates also reveal a similar picture. The hardening of rates
was more pronounced at the shorter end of the yield curve, suggesting
concerns about inflation only in the short run.
1.20
The rapid growth in NFA of the RBI was a reflection of the buoyant
flows of foreign exchange reserves through the balance of payments.
Reserve accretion through the balance of payments was US$15.1 billion
in 2005-06 and US$8.6 billion in the first six months of 2006-07.
While the appreciation of the US dollar vis-à-vis other major
currencies resulted in a valuation loss of US$5.0 billion in 2005-06,
in the first half of the current year, the weakening US dollar resulted
in valuation gain of a similar amount. Inclusive of gold, IMF reserve
tranche position and valuation changes, foreign exchange reserves
grew from US$141.5 at end-March 2005 to US$151.6 billion at end-March
2006, and to US$165.3 at end-September, 2006. Such reserves were US$185.1
billion on February 9, 2007.
1.21
In the balance of payments, in 2005-06 and in the first half of 2006-07,
capital flows more than made up for the current account deficits of
US$9.2 billion and US$11.7 billion, respectively, and resulted in
reserve accretion. The current account deficit reflected the large
and growing trade deficit in the last two years. Exports grew fast,
but imports grew even faster, reflecting in part the ongoing investment
boom and the high international petroleum price. In 2005-06, imports
(in US dollar terms and customs basis) had grown by 33.8 per cent.
In the first nine months of the current year, imports grew by 36.3
per cent. While petroleum imports continued to grow rapidly, non-oil
import growth decelerated to a moderate 18.7 per cent in the first
nine months of the current year, primarily because of high bullion
prices leading to a decline in import of gold and silver in the first
few months of the year. The non-POL trade balance, after remaining
in surplus till 2003-04, has turned negative since 2004-05.
1.22
India’s exports (in US dollar terms and customs basis) have
been growing at a high rate of more than 20 per cent since 2002-03.
During 2005-06, with growth of 23.4 per cent, India’s exports
crossed the US$100 billion mark. During 2006-07, after a slow start,
exports gained momentum to grow by an estimated 36.3 per cent in the
first nine months to reach US$89.5 billion. Buoyancy of exports was
driven by the resurgence in the manufacturing sector and sustained
demand from major trading partners.
1.23
Overall, the external environment remained supportive with the invisible
account remaining strong and stable capital flows seamlessly financing
the moderate levels of current account deficit caused primarily by
the rise in international oil prices. The trend in invisibles (net),
comprising of non-factor services (like travel, transportation, software
services and business services), investment income, and transfers,
compensating to a large extent the trade deficit continued in 2005-06
and through the first half of 2006-07, and resulted in a moderate
current account deficit of 1.1 per cent of GDP in 2005-06.
1.24
As a proportion of GDP, invisibles (receipts) at 11.5 per cent of
GDP in 2005-06 exhibited steady growth from a modest level of 2.4
per cent of GDP in 1990-91. The most recent two years have shown acceleration,
particularly in software and business services. Simultaneously, invisible
payments at 6.2 per cent of GDP in 2005-06 have grown, albeit at lower
levels and somewhat unevenly, again with acceleration being noticed
in the last two years. Under receipts, tourism earnings are estimated
to have crossed the US$6.6 billion in 2006. The UN World Tourism Organisation,
in January 2007, has noted the ‘emergence’ of South Asia
as a tourist destination, with remarkable growth of 10 per cent in
tourist arrivals in 2006 which was more than double the global growth.
Furthermore, it noted that growth of toursim in South Asia was ‘boosted
by India, the destination responsible for half the arrivals to the
sub-region.’
1.25
Capital flows into India remained strong. The composition of flows,
however, fluctuated from year to year. In the three-year period, 2002-05,
there were large ‘other flows’ (delayed export receipts
and others) accounting for a sizeable proportion of net capital flows.
After being outflows in the previous two years, external assistance
and external commercial borrowing (ECBs) — two major debt-creating
flows — picked up in 2004-05. These debt flows, as a proportion
of total capital flows, were 25 per cent in 2004-05 and 18 per cent
in 2005-06. Foreign investment, as a proportion of capital flows,
has remained in the range of 39.1 per cent to 79.3 per cent in the
last four years ending in 2005-06. There was strong growth in foreign
direct investment (FDI) flows (net), with three-quarters of such flows
in the form of equity. The growth rate was 27.4 per cent in 2005-06
followed by 98.4 per cent in April-September 2006. This was even after
gross outflows under FDI with domestic corporate entities seeking
a global presence to harness scale, technology and market access advantages
through acquisitions overseas. FII flows, the dominant variety of
portfolio flows, after remaining buoyant until 2005-06, turned into
net outflows in the first half of 2006-07. FII flows are reported
to have turned positive again in the second half of the current year.
1.26
The buoyancy of foreign investment flows through the balance of payments,
in part, reflected the bullish sentiments in the domestic capital
markets. The BSE Sensex, the bell-weather stock-index of the Bombay
Stock Exchange (BSE), rallied from a low of 8,929 on June 14, 2006
to an all-time intra-day high of 14,724 on February 9, 2007. The rally
from the 13,000 mark to the 14,000 mark in only 26 trading sessions
was the fastest ever climb of 1,000 points. India with a market capitalization
of 91.5 per cent of GDP on January 12, 2007 compared favourably not
only with emerging market economies but also with Japan (96 per cent)
and South Korea (94.1 per cent). The strength of the market micro-structure
from large retail participation continued.
1.27
The positive sentiments were manifest also in most indicators such
as resource mobilized through the primary market. Aggregate mobilization,
especially through private placements and Initial Public Offerings
(IPOs), grew by 30.5 per cent to Rs. 161,769 crore in calendar year
2006, with about 6 IPOs every month, on average. Net mobilisation
of resources by mutual funds increased by more than four-fold from
Rs. 25,454 crore in 2005 to Rs. 1,04,950 crore in 2006. The sharp
rise in mobilisation by mutual funds was due to buoyant inflows under
both income/debt oriented schemes and growth/equity oriented schemes.
The negative inflows in 2004 turned positive for the public sector
mutual funds in 2005 and accelerated in 2006. Other indicators of
market sentiments, such as equity returns and price/earnings ratio
also continued to be strong and supportive of growth.
1.28
The upbeat mood of the capital markets, reflecting the improved growth
prospects of the economy, was partly also a result of steady progress
made on the infrastructure front. Overall index of six core industries
— electricity, coal, steel, crude oil, petroleum refinery products,
and cement, with a weight of 27 per cent in IIP — registered
a growth of 8.3 per cent in April-December 2006 compared to 5.5 per
cent in April-December 2005. On the transport and communications front,
railways maintained its nearly double-digit growth in the first nine
months of the current year. There was, however, a growth deceleration
in cargo handled at major maritime ports (both exports and imports)
and airports (exports). The news of gas discoveries in the Krishna
Godavari (KG) basin under New Exploration and Licensing Policy (NELP)
in recent months was an encouraging development in the country’s
pursuit of reduced import-dependence in hydrocarbons.
1.29
Investment requirements for infrastructure during the Eleventh Five
Year plan are estimated to be around US$ 320 billion. While nearly
60 per cent of these resources would come from the public sector,
the balance would need to come either from the private sector and/or
through public-private partnership (PPP). The potential benefits expected
from PPP are: cost-effectiveness, higher productivity, accelerated
delivery, clear customer focus, enhanced social service, and recovery
of user charges. Further, the additionality of resources that PPP
would bring, along with the ‘value for money’, continues
to remain critical. Based on the number of projects that have been
approved or are under consideration, it is estimated that a leveraging
of nearly six times could be achieved through this route.
1.30
The ability of Government and the public sector to invest additional
resources for developing the much-needed infrastructure critically
depends on the creation of fiscal space. The notification of the Fiscal
Responsibility and Budget Management Act (FRBMA) 2003, with effect
from July 5, 2004, the culmination of the policy resolve to place
the process of fiscal consolidation in an institutional framework,
has yielded rich dividends in terms of creating such fiscal space.
The fiscal deficit declined to 4.1 per cent of GDP in 2005-06 and
was budgeted at 3.8 per cent of GDP in 2006-07. With the implementation
of the award of the Twelfth Finance Commission (TFC), which was calibrated
to restructure public finances of both the Centre and States, the
process gained momentum. In the current year, as a proportion of GDP,
the budgeted fiscal deficit of the States has declined to less than
the mandated 3 per cent two years ahead of schedule, and only a marginal
revenue deficit remains to be eliminated. The decline in the deficit
indicators of the Centre has been relatively slower with demands on
its resources, inter alia, on account of the implementation of the
TFC award and a ‘pause’ in fiscal consolidation in 2005-06.
The resumption of the fiscal consolidation process in 2006-07, without
compromising the National Common Minimum Programme (NCMP) objectives,
indicates the commitment towards meeting the FRBMA targets.
1.31
The fiscal consolidation process underway in India, unlike the expenditure
compression strategy in most other countries, has been essentially
revenue-led and has involved reprioritisation of expenditure with
a focus on outcomes. The tax-GDP ratio of the Centre has steadily
risen from 8.8 per cent in 2002-03 to 10.3 per cent in 2005-06 and
was budgeted at 11.2 per cent in 2006-07. After growing by 20.3 per
cent and 22.7 per cent, respectively in 2005-06, corporate income
tax and personal income tax have grown by 55.2 per cent and 30.3 per
cent, respectively in April-December 2006 over April-December 2005.
Buoyant growth in direct taxes revenue has helped take its share in
total revenue to 47.6 per cent in 2006-07 (BE). In the reduction of
revenue and fiscal deficits, buoyant revenue growth has been complemented
by a discernible shift in the composition of expenditure. While as
a proportion of GDP, total expenditure of the Centre declined from
16.8 per cent in 2002-03 to 14.1 per cent in 2005-06, gross budgetary
support to the Plan increased on a like-to-like basis from Rs. 111,470
crore to (including disintermediated loans to States) to Rs.172,500
crore. The balance from current revenues, which had remained negative
till 2003-04, turned positive in 2004-05 and has strengthened to Rs.
22,332 crore in 2005-06. With non-Plan expenditure as a proportion
of total expenditure declining from 73.0 per cent in 2002-03 to 69.4
per cent in 2006-07 (BE), there have been distinct signs of reprioritisation
of expenditure. With lower levels of borrowings of Government, the
public sector draft on private savings has come down.