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.