Third Quarter Review of Annual Statement on Monetary Policy for 2006-07, RBI Credit Policy

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Third Quarter Review of Annual Statement on Monetary Policy for 2006-07 click here

Third Quarter Review of Annual Statement on Monetary Policy for 2006-07

I. Assessment of Macroeconomic and Monetary Developments

Developments in the External Sector

30. Balance of payments data for the second quarter of 2006-07 released at the end of December 2006 indicate underlying shifts in the external sector of the economy. Merchandise export growth in Us dollar terms decelerated to 22.9 per cent in April-September 2006 from 34.2 per cent in the first half of 2005-06, mainly in some segments such as chemicals and related products, textile and related products, leather and manufactures and a decline in exports of handicrafts and gems and jewellery. Merchandise import growth also decelerated to 25.3 per cent from 48.2 per cent a year ago, mainly due to lower growth of non-oil imports at 11.5 per cent as against 47.9 per cent a year ago. The merchandise trade deficit increased to US $ 35.1 billion during April-September, 2006 from US $ 27.1 billion in the first half of 2005-06. Buoyant exports of software, transportation services, the continuing strength of remittances from Indians working overseas and the growing net exports of various professional and business services resulted in an increase of US $ 23.5 billion in net invisible earnings from US $ 19.9 billion a year ago. The increase in invisible payments by 39.8 per cent, in conjunction with the wider trade deficit, resulted in a current account deficit (CAD) of US $ 11.7 billion which was higher than the CAD of US $ 7.2 billion a year ago.

31. Net capital inflows during April-September, 2006 at US $ 19.3 billion were composed of both debt and non-debt inflows. While portfolio investment slowed down markedly from US $ 5.4 billion in April-September, 2005 to US $ 1.6 billion mainly due to stock market turbulence in May-June, 2006 foreign direct investment (FDI) doubled to US $ 4.2 billion from US $ 2.1 billion. Debt flows (net) in the form of external assistance, external commercial borrowings (ECBs), non-resident Indian (NRI) deposits and short-term credit put together increased substantially to US $ 9.4 billion in April-September, 2006 from US $ 4.5 billion a year ago.

32. Net accretion to foreign exchange reserves, excluding valuation changes, amounted to US $ 8.6 billion during April-September, 2006. Valuation gains, reflecting the appreciation of major currencies against the US dollar, accounted for a rise of US $ 5.1 billion in total reserves as against a valuation loss of US $ 5.0 billion in the corresponding period last year. The foreign exchange reserves, including valuation changes, thus recorded an increase of US $ 13.7 billion during this period as against a modest increase of US $ 1.5 billion a year ago.

33. According to the provisional data released by the Directorate General of Commercial Intelligence and Statistics (DGCI&S), exports recorded a growth of 22.0 per cent during April-December 2006 as compared with 29.9 per cent in the corresponding period of 2005. Exports of petroleum, oil and lubricants (POL) increased by 64.6 per cent to US $ 8.2 billion. Imports rose by 24.8 per cent during April-December 2006 as compared with 37.8 per cent a year ago. While POL imports rose by 39.2 per cent during April-December, 2006 (46.9 per cent a year ago), non-oil import growth decelerated to 18.7 per cent during April-December 2006 from 34.3 per cent a year ago. Imports of gold and silver, which declined by 3.6 per cent during April-September, 2006 against an increase of 58.5 per cent a year ago, picked up substantially in October and November, according to information received from authorised banks. Among other non-oil imports, pearls, precious and semi-precious stones declined by 32.8 per cent as against an increase of 37.5 per cent a year ago. On the other hand, non-oil non-bullion imports decelerated to 19.2 per cent from 47.0 per cent in April-September, 2006. Imports of capital goods maintained strong growth (38.8 per cent during April-September 2006 as compared with 47.8 per cent a year ago) in consonance with the sustained investment demand in the economy. Reflecting the higher order of expansion in imports, the trade deficit, based on DGCI&S data, increased from US $ 31.7 billion during April-December 2005 to US $ 41.6 billion during April-December, 2006.

34. Capital flows to India remained sizeable during 2006-07 so far, taking the form of foreign direct investment (FDI), capital issues under Amercian Depository Receipts (ADRs)/Global Depository Receipts (GDRs) and net accretions to NRI deposits. FDI inflows at US $ 8.6 billion during April-November 2006 were higher by 91.7 per cent than in the corresponding period of the previous year. Source-wise, Mauritius, the US and Singapore remain the dominant sources of FDI to India. Foreign institutional investors (FIIs) were net sellers during May-July 2006 against the backdrop of weakness in domestic equity markets in consonance with the trends in international markets. During August-November, 2006 FIIs made large purchases in the Indian stock markets. Since December 2006, however, FIIs registered outflows against the backdrop of volatility in Asian equity markets subsequent to the tightening of capital controls by Thailand. The net cumulative FII inflows during 2006-07 so far (up to January 19, 2007) amounted to US $ 2.4 billion as against US $ 5.7 billion during the corresponding period last year. Amounts mobilised by corporates through ADRs/GDRs were also higher during April-November 2006. NRI deposits recorded inflows of the order of US $ 2.7 billion during April-November 2006 as compared with inflows of US $ 0.5 billion registered during the corresponding period of 2005, partly reflecting higher interest rates offered by banks on such deposits. The foreign exchange reserves rose to US $ 178.1 billion by January 19, 2007 from US $ 151.6 billion at the end of March, 2006.

35. The Indian foreign exchange market has generally witnessed orderly conditions during the current financial year so far with the exchange rate exhibiting two-way movements. The exchange rate of the rupee against the US dollar, which was Rs.44.61 at end-March, 2006 depreciated to Rs.46.95 by July 19, 2006 but appreciated thereafter to Rs.44.24 by January 25, 2007. Similarly, the rupee-euro exchange rate depreciated from Rs.54.20 at end-March, 2006 to Rs.59.90 by August 22, 2006 before appreciating to Rs.57.33 by January 25, 2007. Overall, the rupee appreciated by 0.8 per cent against the US dollar, and by 3.4 per cent against the Japanese yen but depreciated against the euro by 5.5 per cent and against the pound sterling by 10.5 per cent during the current financial year so far (up to January 25, 2007).

36. 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.