Review of Developments
a) Macroeconomic Overview
The performance of the Indian economy in 2004-05 so far has exceeded expectations formed at the beginning of the year. Buoyed by a rebound in the agriculture and allied sector, and strongly helped by improved performance in industry and services, the economy had registered a growth rate of 8.5 per cent in 2003-04, the highest ever except in 1975-76 and 1988-89. Normally, strong growth is expected after anaemic growth, and vice versa. Following the 'bumper' growth in 2003-04, initial growth projections for 2004-05 were placed in the range of 6.2 per cent to 7.4 per cent. Modest expectations were further pared down to around 6.1 per cent when rainfall, after remaining normal in June, 2004, became deficient in the crucial sowing month of July and the shortfall in the south-west monsoon turned out to be 13 per cent. Deterioration in the benign world inflation environment, particularly of petroleum, coal and steel, led to further apprehensions about growth and inflation.
1.2 In the event, according to the advance estimate of the Central Statistical Organisation (CSO) released on February 7, 2005 , the economy is likely to grow by 6.9 per cent in 2004-05. Year-on-year WPI-based inflation was 5 per cent on February 5, 2005 (Table 1.1). The economy has managed to maintain the growth momentum in spite of a deficient south-west monsoon, hardening international prices of oil and steel and, last but not the least, its first recorded experience of tsunami which caused extensive damage to life and property in Andaman & Nicobar islands, and 2,260 kms of coastline in Tamil Nadu, Kerala, Andhra Pradesh and Pondicherry.
1.3 After a drought-induced decline of 7.0 per cent in 2002-03, the growth rate in the agriculture and allied sector bounced back to 9.6 per cent in 2003-04. While industry maintained the higher growth of 6.6 per cent observed in 2002-03, the services sector improved its performance significantly from 7.9 per cent in 2002-03 to 9.1 per cent in 2003-04. Growth in the industry and services sectors in 2003-04 was broad-based with manufacturing, public utilities, the trade, hotels, transport and communication group, and community, social and personal services recording higher growth than that in the previous year.
1.4 The year 2004-05 began on a promising note with buoyant industrial growth, early onset of monsoon and forecast of a normal rainfall. But, in the event, the kharif (summer) crop suffered from a shortfall in the south-west monsoon, particularly in July. While the short-fall in kharif foodgrains output is likely to be partly offset by the prospects of a good rabi crop, overall foodgrains production in 2004-05 is estimated to decline by about 3 per cent (Figure 1.1). Yet, with a comfortable buffer of foodgrain stocks, pressure on food manage-ment is minimal. Furthermore, with buoyant performance of non-foodgrains agriculture (e.g. cotton, fruits and vegetables, and dairy), the agriculture and allied sector is expected to grow by 1.1 per cent in the current year (Table 1.2). Not only has the share of foodgrains in agriculture declined, but the share of agriculture in GDP has also gone down by as much as 3.5 percentage points since 2001-02.
1.5 Despite this setback in the kharif crop, the outlook for 2004-05 remains robust because of the persistence of the overall growth momentum observed in 2003-04 through the current year. With distinct signs of continuation of global recovery and world output growth estimated at 5.0 per cent in 2004, the highest in nearly three decades, the Indian economy is expected to do well in 2004-05.
1.6 GDP grew by 7.4 per cent in the first quarter and 6.6 per cent in the second quarter of the current year, compared with 5.3 per cent and 8.6 per cent in the corresponding quarters of the previous year. The deceleration of growth in the second quarter is on account of a negative growth of 0.8 per cent in agriculture and allied sector, a lower growth of 8.2 per cent in the services sector compared with 9.5 per cent in the first quarter, and a fall in the growth of community, social and personal services. The growth in industry accelerated from 6.9 per cent in the first quarter to 8.1 per cent in the second quarter. Within industry, growth in manufacturing accelerated from 8.0 per cent in the first quarter to 9.3 per cent in the second quarter, the highest in any quarter since 1997-98, when CSO started compiling quarterly estimates. Despite a lower growth in the second quarter, the overall growth in the first half of the current year at 7.0 per cent is marginally higher than the growth of 6.9 per cent achieved in the same period last year.
1.7 There was a sudden bout of inflation in the first half of 2004-05, caused by a combination of factors, some exogenous, like the sharp rise in global petroleum prices, deficient rainfall-induced inflationary expectations and monetary overhang from accretion of foreign exchange reserves. The year 2004-05, after starting with a point-to-point, annual inflation rate of 4.5 per cent on April 3, 2004 witnessed a peak level of inflation at 8.7 per cent on August 28, 2004 , the highest in the last four years. However, as a result of the quick monetary and fiscal measures taken by the Reserve Bank of India (RBI) and Government, coupled with a slight easing of global petroleum prices, inflation has been on a declining trend and stood at 5 per cent on February 5, 2005 compared to 6.1 per cent a year ago.
1.8 The 52-week average inflation rate at 6.4 per cent on February 5, 2005 was, however, higher than the 5.5 per cent registered last year. In the current year up to February 5, 2005 , both manufactured products and primary articles recorded lower year-on-year inflation rates at 4.5 per cent and 1.6 per cent, respectively, compared to 6.7 per cent and 3.4 per cent, respectively, last year. But there was acceleration in the inflation rate of the fuel, power, light and lubricant group from 7.6 per cent last year to 10.0 per cent this year due to a hardening of international prices of oil and minerals. The major groups witnessing high year-on-year inflation as on February 5, 2005 include minerals (135.5 per cent), coal (16.2 per cent), petroleum, oil and lubricants (POL) (14.6 per cent), sugar group (21.4 per cent), and basic metals and products (16.0 per cent). The contribution of these items with a combined weight of 21.5 per cent in the WPI was 88 per cent to the current inflation, compared to 52 per cent a year ago. The hardening of international prices of these commodities (except sugar) due to a surge in global demand shows that a major part of inflation is due to external factors.
1.9 Year-on-year inflation as measured by the Consumer Price Index (CPI) for industrial workers declined significantly from 5.1 per cent in April 2003 to 3.5 per cent in March 2004 and further to 2.2 per cent in April 2004. Thereafter, the CPI inflation rate started registering an increasing trend reaching 4.8 per cent in September 2004, as WPI inflation pushed up the consumer prices also. Partly in response to policy measures, and the subsequent easing of external pressure of oil imports, CPI declined to 4.6 per cent in October 2004 and further to 3.8 per cent in December 2004. The CPI inflation, which is considered a more appropriate indicator of general inflation, is also substantially lower than the average WPI inflation at 6.7 per cent in December 2004.
1.10 The lower inflation exhibited by the CPI than by the WPI was mainly because of the food group of commodities having lower than overall inflation and higher weight in CPI than in WPI. Thirty essential commodities for households, with a weight of 17.63 per cent in WPI, registered a 12-month point-to-point inflation of 4.5 per cent on February 5, 2005 , compared to 4.9 per cent a year ago, and accounted for 15.6 per cent of the overall inflation compared to 14.0 per cent a year ago. Out of the 30 items, 11 items registered declines in absolute prices over last year, while year-on-year inflation was less than five per cent for 8 items as on February 5, 2005. There was double-digit inflation for potato, tea, sugar, salt, bajra, gur, and coking coal, partly because absolute prices of these items (except sugar, gur and coking coal) had witnessed a decline in the previous year. Furthermore, food group inflation is lower in CPI than in WPI, suggesting that food prices in the wholesale market increased faster than in the retail markets.
1.11 In the second quarter of 2004-05, Government stepped in to keep inflation under check by reducing excise and customs duties on selected petroleum products; reducing customs duties on non-alloy steel; exempting melting scrap of iron and steel from customs duty; and reducing tariff values of many vegetable oils. The RBI hiked the Cash Reserve Ratio (CRR) in two stages, effective from September 18, 2004 , and October 2, 2004 , respectively, and the reverse-repo rate was hiked effective from October 27, 2004 , to check liquidity overhang in the system. These measures, coupled with the subsequent fall in international crude prices, helped to rein in inflation.
1.12 For the last two financial years, with widening fiscal and current account deficits in the United States (US), the rupee had been strengthening against the US dollar. This trend saw a brief spell of reversal during May-August 2004. With other major convertible currencies strengthening more than the rupee (vis-à-vis the US dollar), the rupee weakened against major non-dollar currencies. The rising expectations of higher US interest rates and buoyant growth contributed to moderate appreciation of the US dollar. This in turn led to the depreciation of the rupee against the dollar from May 2004. After April 2004, the rupee also depreciated against other major non-dollar global currencies (Euro, Pound Sterling and Yen) until August, 2004. May-July, 2004 also witnessed net portfolio outflows.
1.13 The exchange rate of the rupee has exhibited appropriate flexibility in response to market conditions in 2004-05. Furthermore, the international currency markets also saw large changes in cross-currency rates. Thus, particularly with resumption of capital inflows, the depreciating trend of the rupee vis-à-vis the US dollar and other non-dollar major currencies was reversed from September and August, 2004, respectively. With the Euro strengthening sharply against the US dollar, the rupee began weakening again from October 2004 against the major non-dollar currencies. In January 2005, in nominal terms, the rupee appreciated against all major currencies.
1.14 In real effective terms, the rupee appreciated in June, August and September, 2004. Despite strengthening nominally against the US dollar from September 2004 due mainly to renewed foreign institutional investors' (FII) inflows and US dollar's weakness against global currencies, the rupee started depreciating in real effective terms due to a softening of domestic inflation and a sharp fall against non-dollar currencies. This trend continued until end-2004.
1.15 The rising trend in India's foreign exchange reserves continued with such reserves (including gold, SDRs and reserve position in IMF) reaching an estimated level of US$128.91 billion on February 4, 2005 in excess of India's total external debt of US$114 billion at end-September, 2004. However, the accretion to reserves so far in this year at just over US$15.9 billion is small compared to that of more than US$31 billion during the corresponding period of the previous year, and an unprecedented US$36.9 billion in the full year 2003-04. The slowdown in reserves growth - not entirely an unwelcome development - is due to three main reasons. First is the emergence of a current account deficit during the first half of the year compared to a surplus in the corresponding period last year. Second, with adjustment of interest rates on such deposits, non-resident Indians' (NRI) deposits went down. Third, relative to 2003-04, when there were large valuation gains with the weakening of the US dollar, such gains during the current year are difficult to predict.
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