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Economic Survey 2004-2005
GENERAL REVIEW
Review of Developments
a) Macroeconomic Overview
1.16 The current account balance, after being in surplus for the three previous years in succession, turned into a deficit in the first half of the current year (April-September 2004-05). The surplus in the current account in the first quarter of the current year was not only reversed but more than offset by the deficit in the second quarter, resulting in an overall current account deficit of US$3.2 billion in the first half of 2004-05. The current account development can be attributed to two main reasons. First, there was a large merchandise trade deficit with a rise not only in the POL import bill because of high prices but also in non-bullion, non-POL imports, which overwhelmed the growth of exports in US dollar terms at over 23 per cent. Second, there was a relatively moderate growth of 23 per cent in net invisibles surplus in the first half of the current year as compared to 35 per cent in the corresponding previous period. While workers' remittances declined marginally, net non-factor services registered a robust year-on-year growth of 174 per cent, and software services exports remained buoyant with 28.7 per cent growth in the first half of 2004-05. Movements in the external merchandise trade account in the first ten months of the current year hold pointers to three emerging trends.
1.17 First, the buoyancy of merchandise export growth (25.6 per cent), in US dollar terms, after a continuous rise of more than 20 per cent in each of the previous two years, reflects a sustained rise in volume of exports with revival of growth in the manufacturing sector and increased export competitiveness. Commodity-wise export growth continued to be broad-based with the manufacturing sector in the lead. The main drivers of this high growth were the five major sectors of engineering goods, gems & jewellery, textiles, chemicals and related products, and petroleum products. However, despite the buoyancy of exports, among the top exporting countries of the world, India ranked 31st in 2003, down from 30th in the previous year. Government has fixed an ambitious target of US$150 billion for exports by the year 2008-09 to double India 's share in world exports to 1.5 per cent.
1.18 Second, the estimated strong growth in non-POL, non-bullion merchandise imports by 33.7 per cent in April-January 2004-05 reflects buoyant domestic demand including for investment, a mildly strengthening rupee in real terms, and greater import liberalization.
1.19 Third, the emergence of the ASEAN + 3 (China, Japan and Korea) countries as India's dominant trading partners accounting for 19.9 per cent of India's total merchandise trade, followed by the EU and North America with shares of 19.0 per cent and 12.9 per cent in 2003-04, respectively, points to a broadening of the trade horizons and a 'look-east' emphasis. To broaden its trade horizons further, besides active participation in WTO negotiations, India also engaged itself in a number of bilateral trade agreements.
1.20 The capital account surplus in April-September 2004 was also down by around US$1.5 billion from April-September 2003. Buoyant foreign investment inflows along with robust inflows of commercial borrowings sustained the capital account. The balance of payments surplus was around US$7 billion in the first half of 2004-05, roughly half of what it was in April-September 2003.
1.21 In 2003-04, capital account surplus doubled to over US$20 billion. There was a rise of 255 per cent in net foreign investment flows, mainly of the portfolio variety driven by the heavily bullish sentiments in the Indian stock markets. NRI deposits increased by US$3.6 billion in 2003-04, compared to the previous year's increase of US$3.0 billion. The capital account remained in surplus during the first half of the current year, but at a reduced level compared to April-September 2003, reflecting a sharp fall in portfolio and banking capital inflows. Portfolio flows declined by about US$3 billion from the corresponding period of the previous year to US$512 million. With a decline in the premium on their interest rates, NRI deposits-the dominant component of banking capital-declined by US$1.2 billion in April-September 2004, compared to an increase of US$2.2 billion in the corresponding period of the previous year. With a more liberalized regime and an improvement in the country's foreign currency ratings, there was a large increase of about US$2 billion in external commercial borrowings (ECB) in the first half of 2004-05 over the corresponding period of the previous year; but this increase was not sufficient to offset the decline in portfolio flows and banking capital.
1.22 The decline in net portfolio flows in the first half of the current year was particularly pronounced in the first quarter with volatility in the Indian stock market in mid-2004, and reassessment of risk-return payoffs by FIIs in the wake of a rise in US interest rates. Recent data indicate that with resumption of bullish trends in the Indian stock market from July 2004, portfolio inflows have gathered momentum. Similarly, the upward revision of interest rate ceilings on NRI deposits from November 2004 appears to have contributed to a reversal of the declining trend in such deposits in the first half.
1.23 Improvement in India's external debt position continued in 2003-04. Apart from continuing with its extant prudent external debt policy, some initiatives such as prepayment of costly external debt and rationalization of interest rates as well as structure of NRI deposits contributed to an improvement in the debt-sustainability indicators during 2003-04. For example, external debt as a proportion of GDP went down from 20.2 per cent at end-March 2003 to 17.8 per cent at end-March 2004. Similarly, the share of short-term debt in total external debt declined from 4.8 per cent at end-March 2003 to 4.3 per cent at end-March 2004. In the first half of the current year, such indicators have shown a marginal deterioration, but within prudent limits, and for legitimate reasons such as an increase in short-term trade-credit reflecting larger import demand.
1.24 Compared to its stock at the beginning of the year, the growth in reserve money, which had accelerated from 9.2 per cent during 2002-03 to a high of 18.3 per cent during 2003-04, declined to 6.4 per cent in the current year up to January 28, 2005 . The corresponding growth in reserve money a year ago was 7.8 per cent. The lower growth of reserve money in the current year was on account of lower growth of 15.9 per cent in net foreign exchange assets (NFA) of the RBI compared with 32.8 per cent in the corresponding period last year. The sharp decline in net RBI credit to Government observed in 2003-04 (62.8 per cent in the full year) continued in the current year with a further fall of 69.9 per cent upto January 28, 2005, and resulted in NFA constituting 120.9 per cent of reserve money as of that date. Despite a lower growth of reserve money in the current year, liquidity management remained a major concern. This was because, after a sharp increase in reserve money in the previous year, there was a liquidity overhang of over Rs.81,000 crore in the form of outstanding reverse repos under the Liquidity Adjustment Facility (LAF), Government surplus balances and excess reserves of banks from the previous year. This overhang posed a nascent problem in liquidity management. The Government raised the limit under MSS from Rs.60,000 crore to Rs. 80,000 crore on August 26, 2004 , after the threshold limit of Rs.50,000 crore was crossed. Measures taken by the RBI include discontinuation of the auction of 7-day and 14-day reverse repo and its substitution by an overnight fixed rate reverse repo, and raising the cash reserve ratio by 50 basis points to 5 per cent.
1.25 Compared to its stock at the beginning of the year, broad money (M3) grew by 9.5 per cent (net of conversion) in the current year up to January 21, 2005 , compared with the high of 16.6 per cent in the whole of the previous year, and 12.1 per cent in the same period last year. The money multiplier-the ratio of M3 to reserve money-which increased from 4.43 at end-March 2002 to 4.65 at end-March 2003 declined to 4.59 at end-March 2004. As on January 21, 2005, this ratio stood at 4.72.
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