Mid-Term Review of the Annual Policy Statement for 2007-08, RBI Credit Policy, Reserve Bank of India: Banknet India

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Part I. Mid-term Review of Annual Statement on Monetary Policy for the Year 2007-08

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Developments in the External Sector

32. Balance of payments data for the first quarter of 2007-08 released by the Reserve Bank at the end of September 2007 indicate a widening of the merchandise trade deficit on a year-on-year basis, sustained buoyancy in invisibles and sizeable net capital inflows which comfortably met the external financing requirement for April-June 2007 and also enabled a build-up of international reserves, fortifying the stability and strength of India’s external sector. In US dollar terms, merchandise export growth was 17.8 per cent during April-June 2007 as against 23.7 per cent in the first quarter of the previous year. Commodity-wise data available from the Directorate General of Commercial Intelligence and Statistics (DGCI&S) for April-May 2007 indicate that exports of petroleum products, engineering goods and gems and jewellery together contributed 69 per cent of overall export growth as compared with 66 per cent in April-May 2006. The growth of exports of primary products moderated to 7.1 per cent, mainly due to the deceleration in the exports of agriculture and allied products; exports of ores and minerals, however, showed a turnaround during April-May 2007. Exports of manufactures registered a growth of 12.7 per cent in April-May 2007 as against 12.2 per cent a year ago. While growth of exports of chemicals and related products moderated to 7.9 per cent as compared with 12.1 per cent, export of textiles and related products declined by 7.7 per cent as against an increase of 11.6 per cent. Merchandise import payments rose by 21.3 per cent during the first quarter of the 2007-08 as compared with 22.9 per cent a year ago. While crude oil import growth at 8.0 per cent moderated from 45.2 per cent, non-oil import payments increased by 47.4 per cent, reflecting the underlying strength of domestic demand. The main drivers of non-oil import growth in 2007-08 so far (April-May) were capital goods, iron and steel, gold and silver, pearls, precious and semi-precious stones, chemicals and metalliferrous ores and metal scrap. China remained the major source of imports in April-May 2007 accounting for 10 per cent of total imports and 14.8 per cent of non-oil imports. On a payments basis, the merchandise trade deficit widened to US $ 21.6 billion in the first quarter of 2007-08 from US $ 16.9 billion a year ago.

33. During the first quarter of 2007-08, gross invisible receipts comprising services, current transfers and income at US $ 31.4 billion amounted to nearly 90 per cent of merchandise exports, recording a year-on-year increase of 27.5 per cent. Software exports, travel earnings, other professional and business services and remittances from overseas Indians underpinned the strength of invisible receipts. On the other hand, invisible payments increased by 18.6 per cent, mainly on account of a surge in payments related to travel, business and management consultancy, engineering and technical services and dividend and profit payouts. On a net basis, the invisible account recorded a surplus of US $ 16.9 billion during the first quarter of 2007-08 as against US $ 12.4 billion in the corresponding quarter of the previous year. The current account deficit (CAD) amounted to US $ 4.7 billion, broadly the same as in the first quarter of 2006-07.

34. Net capital flows surged to US $ 15.3 billion during the first quarter of 2007-08 from US $ 10.6 billion a year ago. Net external commercial borrowings (ECB) inflows at US $ 7.0 billion were sizeable and accounted for 45.8 per cent of total net capital flows as compared with nearly US $ 4.0 billion or 37.5 per cent of net capital flows in the first quarter of the previous year. The growing appetite of Indian companies for global expansion was mirrored in outward foreign direct investment (FDI) from India which showed a significant increase to US $ 5.4 billion in the first quarter of 2007-08 as compared to US $ 1.1 billion a year ago. Net portfolio investment by foreign institutional investors (FIIs) turned around with inflows of US $ 7.1 billion during the first quarter of 2007-08 as against an outflow of US $ 1.8 billion a year ago. The impact of the reduction in ceiling on interest rates during January and April 2007 resulted in non-resident Indians (NRI) deposits recording a net outflow of US $ 0.4 billion in the first quarter of 2007-08, a turnaround from net inflows of US $ 1.2 billion in the first quarter of 2006-07. Inflows under American Depository Receipts/Global Depository Receipts (ADRs/GDRs) amounted to US $ 308 million in April-June 2007.

35. Reflecting the movements in current and capital accounts of the balance of payments, the accretion to foreign exchange reserves (excluding valuation) amounted to US $ 11.2 billion during the first quarter of 2007-08 as against US $ 6.4 billion a year ago. Taking into account the valuation gain of US $ 3.0 billion, the level of foreign exchange reserves amounted to US $ 213.4 billion at the end of June 2007.

36. India’s external debt increased by US $ 8.7 billion during April-June 2007 and amounted to US $ 165.4 billion at end-June 2007. While multilateral debt registered a moderate increase of US $ 317 million, there was a marginal decline of US $ 417 million in bilateral debt. ECB increased by US $ 5.5 billion while there was an increase of US $ 1.0 billion in short-term trade credits. Valuation gains on account of the appreciation of the US dollar vis-à-vis other major international currencies added US $ 1.2 billion to the stock of external debt. The US dollar had a dominant share of 50.4 per cent in India’s external debt whereas rupee-denominated debt had a share of 18.0 per cent. The ratio of short-term debt to total debt increased marginally to 7.9 per cent at end-June 2007 from 7.6 per cent at end-March 2007. The ratio of foreign exchange reserves to external debt was 129.0 per cent at the end of June 2007 as compared with 127.1 per cent at end-March 2007.

37. These developments appear to have gained ground in the second quarter of 2007-08. According to the DGCI&S, merchandise exports rose by 18.2 per cent in US dollar terms during April-August 2007 as compared with 27.1 per cent in the corresponding period of the previous year. Import growth was higher at 31.0 per cent as compared with 20.6 per cent in the previous year. Non-oil imports rose by as much as 44.3 per cent (10.9 per cent a year ago); oil imports, however, slowed down to 6.0 per cent (44.5 per cent), mainly on account of moderation in the price of the Indian basket of crude oil by 0.5 per cent during April-August 2007 (US $ 68.0 per barrel) as against an increase of 30.2 per cent during April-August 2006 (US $ 68.4 per barrel). On the other hand, oil import in volume terms increased by 18 per cent during April-May 2007 as compared with 13 per cent in April-May 2006. As a result, the merchandise trade deficit widened to US $ 32.5 billion during April-August 2007 from US $ 19.9 billion in April-August 2006. There are also indications of a substantial increase in remittances received from Indians working abroad as well as sustained resilience and growth in exports of software and IT enabled services.

38. Available information points to a scaling up of various elements of net capital flows in relation to their levels a year ago and even in the preceding quarter. Portfolio flows have picked up strongly on account of FIIs, amounting to US $ 21.2 billion during 2007-08 (up to October 19) as compared to an inflow of US $ 0.9 billion in the corresponding period of 2006-07. Gross FDI inflows during April-July 2007 were placed at US $ 6.6 billion as compared with US $ 3.7 billion a year ago. Approvals for ECBs amounted to US $ 8.7 billion during April-June 2007 as compared with US $ 4.4 billion in the corresponding period last year. On the other hand, there were net outflows under NRI deposits of US $ 148 million in April-July 2007 as compared with inflows of US $ 1,585 million during April-July 2006. ADR/GDR issues by Indian companies amounted to US $ 2.3 billion during April-July 2007 as against an inflow of US $ 1.5 billion in the corresponding period in the previous year. The foreign exchange reserves increased by US $ 62.0 billion and stood at US $ 261.1 billion on October 19, 2007.

39. The exchange rate of the rupee against the US dollar, which was Rs.43.59 at end-March 2007, appreciated thereafter to reach Rs.41.24 at end-August 2007 and strengthened further to Rs.39.51 per US dollar as on October 26, 2007. The rupee appreciated by 10.3 per cent against the US dollar, by 2.4 per cent against the euro, by 5.4 per cent against the pound sterling and 7.1 per cent against the Japanese yen during the current financial year up to October 26, 2007.

40. The exchange rate policy in recent years has been guided by the broad principles of careful monitoring and management of exchange rates with flexibility, without a fixed target or a pre-announced target or a band, coupled with the ability to intervene, if and when necessary. The overall approach to the management of India’s foreign exchange reserves takes into account the changing composition of the balance of payments and endeavours to reflect the ‘liquidity risks’ associated with different types of flows and other requirements.

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