Assessment of Macroeconomic and Monetary Developments
Developments in the External Sector
28. Balance of payments data for 2005-06 released at end-June 2006 continue to indicate strength and resilience in the external sector. Merchandise exports maintained a high growth trajectory, rising by 27.5 per cent during the year. Exports of manufactures and, in particular, transport equipments, machinery and instruments, woollen yarn, fabrics and readymade garments, basic chemicals and pharmaceuticals and petroleum products underpinned the momentum of overall export growth. Merchandise import payments also rose sharply by 31.6 per cent, largely reflecting a growth of 47.3 per cent in petroleum, oil and lubricants (POL) imports on the back of a rise in the average price of the Indian basket of international crude by 42.4 per cent from US $ 38.9 per barrel in 2004-05 to US $ 55.4 per barrel in 2005-06. Non-oil import payments increased by 20.5 per cent with capital goods as key components, signifying the underlying strength of domestic industrial activity. Accordingly, on a payments basis, the merchandise trade deficit widened to US $ 51.6 billion (6.5 per cent of GDP) from US $ 36.6 billion (5.3 per cent) in the previous year.
29. During 2005-06, gross invisible receipts increased by 27.3 per cent, apace with merchandise exports. At US $ 91.5 billion, invisible receipts amounted to about 87 per cent of merchandise exports. The major components driving this expansion were software exports, remittances from Indians working overseas and a host of professional and business services. During 2005-06, invisible payments increased by 24.4 per cent, mainly on account of higher interest payments and imports of transportation, business and technology-related services. Nevertheless, the net invisible surplus rose to US $ 40.9 billion in 2005-06 from US $ 31.2 billion in the previous year. Accordingly, the current account deficit (CAD) amounted to US $ 10.6 billion during 2005-06 or 1.3 per cent of GDP, up from US $ 5.4 billion or 0.8 per cent of GDP in 2004-05.
30. In the capital account, net inflows under foreign direct investment (FDI), portfolio investment and non-resident Indian (NRI) deposits recorded increases in 2005-06 while other capital flows including external assistance and external commercial borrowings moderated in relation to their levels in the preceding year. Net FDI inflows to India picked up to US $ 5.7 billion in 2005-06 from US $ 3.2 billion in 2004-05 on sustained interest in India as an attractive investment destination, strong macroeconomic performance and corporate profitability. FDI inflows were mainly channelled into manufacturing, business and computer services. Net inflows under portfolio investment remained buoyant at US $ 12.5 billion in 2005-06, up from US $ 8.9 billion in 2004-05, extending an expansionary phase that began two years ago. American Depository Receipts/Global Depository Receipts (ADRs/GDRs) issuances also remained buoyant as corporates took advantage of external market conditions to issue equities abroad. NRI deposits showed a significant turnaround from net outflows of US $ 1.0 billion in the previous year to net inflows of US $ 2.8 billion in 2005-06. There was a one-off principal repayment of India Millennium Deposits (IMD) (US $ 5.5 billion) in the capital account and interest payments (US $ 1.6 billion) under the current account.
31. Reflecting the movements in current and capital accounts of the balance of payments, the accretion to foreign exchange reserves (excluding valuation) amounted to US $ 15.1 billion during 2005-06 on top of US $ 26.2 billion in 2004-05. At the end of March 2006, the foreign exchange reserves stood at US $ 151.6 billion.
32. India’s external debt increased marginally by US $ 2.0 billion during 2005-06 to US $ 125.2 billion at end-March, 2006. Among the various components of debt, NRI deposits, trade credit and multilateral debt registered increases which were moderated by the redemption of IMD in December 2005. The US dollar had a dominant share of 45.1 per cent in India’s external debt by currency whereas rupee-denominated debt had a share of 19.9 per cent in the external debt at end-March, 2006. The ratio of short-term debt to total debt increased marginally to 7.0 per cent at end-March, 2006 from 6.1 per cent a year ago.
33. According to the Directorate General of Commercial Intelligence and Statistics (DGCI&S), export growth in US dollar terms moderated to 16.9 per cent during April-June, 2006 from 35.4 per cent a year ago. Merchandise import also decelerated to 17.7 per cent from 45.4 per cent. While POL import growth rose sharply to 39.0 per cent from 31.0 per cent reflecting the steep rise in international crude oil prices, non-oil imports posted a relatively modest growth of 9.6 per cent as compared with 51.7 per cent a year ago. Accordingly, the trade deficit at US $ 12.6 billion during April-June, 2006 was higher than that of US $ 10.5 billion in the corresponding period last year. Net invisible earnings and capital flows have remained reasonably strong despite outflows by foreign institutional investors (FIIs) in May-June. Accordingly, India’s foreign exchange reserves increased by US $ 11.0 billion over their end-March, 2006 level to US $ 162.7 billion as on July 14, 2006.
34. The exchange rate of the rupee depreciated by 4.7 per cent against the US dollar, by 8.4 per cent against euro, by 10.2 per cent against pound sterling and by 5.1 per cent against Japanese yen during 2006-07 so far (up to July 21, 2006). Orderly conditions have prevailed in the domestic foreign exchange market during the period.
35. 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.