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Economic Survey 2004-2005
GENERAL REVIEW
Review of Developments
a) Macroeconomic Overview
1.26 Despite lower growth of money supply in the current year, there was an impressive growth in gross bank credit by scheduled commercial banks (SCBs). Gross bank credit, net of conversion, increased by 19.9 per cent up to January 21, 2005 compared to 9.3 per cent in the corresponding previous period. Growth was observed in both food and non-food credit, more so in the case of the latter. Food credit grew by 15.2 per cent in the current year up to January 21, 2005 compared to a decline of 25.9 per cent last year, while non-food credit grew at an impressive 20.1 per cent compared to 11.9 per cent in the same period last year, the highest growth registered since 1996-97. Priority sector advances by public sector banks (PSBs) reached 44.0 per cent of net bank credit (NBC) in 2003-04, exceeding the target of 40 per cent. There were, however, shortfalls in meeting the sub-target under agriculture.
1.27 The Government announced a comprehensive policy envisaging a 30 per cent increase in agriculture credit in the current year and doubling the credit flow to the sector in three years.
1.28 There was an improvement in the performance of SCBs in 2003-04. While the ratio of net profits to total assets of SCBs improved marginally from 1.0 per cent in 2002-03 to 1.1 per cent in 2003-04, the ratio of operating profits to total assets improved from 2.4 per cent to 2.7 per cent in the same period. The profitability of SCBs showed a declining trend in the first half of the current year on account of a decline in treasury income. The annualized ratio of net profit to total assets was 1.1 per cent in the first half of 2004-05 compared to 1.3 per cent in the same period last year. There was a significant decline in the non-performing assets (NPAs) of SCBs. Gross NPAs of SCBs as a proportion of total assets declined from 4.0 per cent in 2002-03 to 3.3 per cent in 2003-04. The decline in the corresponding ratio of net NPAs was from 1.9 per cent to 1.2 per cent. The capital to risk weighted assets ratio (CRAR) of SCBs improved from 12.7 per cent in 2002-03 to 12.9 per cent in 2003-04.
1.29 In the current year, there was a marginal northward movement in deposit rates of five major banks by 25 basis points. Interest rates on housing loans witnessed a marginal firming up as well. Call money rates moved up in the second half of the year, reflecting higher growth of bank credit. Nevertheless, interest rates continue to be moderate. The benchmark prime lending rates of five major banks were lower by 25 to 50 basis points in December, 2004 compared to the rates prevailing a year ago.
1.30 Fiscal consolidation, after a promising beginning in the early 1990s, started faltering from 1997-98. Fiscal deficit of the Central Government as a proportion of GDP, after its decline from 6.6 per cent in 1990-91 to 4.1 per cent in 1996-97, rose every year to reach 6.2 per cent in 2001-02. Progress in fiscal consolidation resumed in 2002-03. According to provisional data, in 2003-04, the ratio at 4.6 per cent was lower than the budget estimate of 5.6 per cent. A further improvement in this ratio to 4.4 per cent was budgeted for 2004-05.
1.31 After witnessing a trend similar to that in fiscal deficit until 1996-97, the deterioration in revenue deficit was much sharper in subsequent years. The rise in revenue deficit continued till 2001-02, when it reached 4.4 per cent of GDP. Revenue deficit declined to 3.6 per cent of GDP in 2003-04 (Prov.), but even at this level, it was higher than the level of 3.3 per cent of GDP observed in the pre-reform year of 1990-91. The increasing share of revenue deficit in fiscal deficit distinctly reveals the deterioration in the composition of the fiscal deficit and in the quality of expenditure. The share of revenue deficit in fiscal deficit had risen from 49.4 per cent in 1990-91 to 78.0 per cent in 2003-04, which was sought to be reversed in 2004-05 by targeting a lower revenue deficit of 2.5 per cent of GDP in the budget estimates (BE).
1.32 The current year 2004-05 is the first year when the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 is in operation. With the notification of the Rules in July 2004, Central finances are subject to the discipline of the FRBM Act. Accordingly, the Government targeted a front-loaded fiscal adjustment in the Budget for 2004-05, going beyond the stipulated minimum reductions in the revenue and fiscal deficits. The budgeted reductions in fiscal and revenue deficits as proportions of GDP are 0.4 and 0.9 percentage points over revised estimates, respectively, as compared with the minimum reductions of 0.3 and 0.5 percentage points, respectively, mandated under the FRBM rules.
1.33 During the first nine months of the current year, the performance of Central finances was not very encouraging. As proportions of BE, fiscal and revenue deficits at 65.7 and 82.7 per cent, respectively, were higher than 60.2 and 65.0 per cent, respectively, observed in the corresponding previous period. A vigorous drive to collect tax arrears, mobilization of minimum dividend payment on Government equity, 10 per cent cut in the budgetary allocations under non-plan and non-salary expenditure, and restricting expenditure in the last quarter of the year to no more than 33 per cent of BE are expected to result in improved performance of Central finances in the last quarter of 2004-05.
1.34 Efforts at improving the fiscal health of the States are continuing. The consolidated fiscal deficit of the Centre and the States is budgeted to come down from 9.4 per cent of GDP in 2003-04 (RE) to 7.9 per cent of GDP in 2004-05. For the States, between 1990-91 and 2003-04(RE), as proportions of GDP, revenue and fiscal deficits had increased from 0.9 per cent and 3.3 per cent to 2.6 per cent and 5.1 per cent, respectively. In 2004-05, revenue and fiscal deficits are budgeted to be brought down to 1.4 per cent of GDP and 3.6 per cent of GDP, respectively. The Centre has been playing a proactive role in furthering the cause of fiscal reforms at the State level. Under the debt swap scheme, States swapped their high cost borrowings from the Centre amounting to Rs. 34,085 crore in the current year up to December, 2004, with additional market borrowings and loans from the National Small Savings Fund (NSSF). The cumulative high cost loans swapped by States amounted to Rs. 92,444 crore at end-December, 2004. The decision of States to introduce VAT from April 1, 2005 marks the culmination of efforts that began more than a decade ago at reforming domestic trade taxes.
1.35 State level reforms are likely to receive an impetus with the recommendations of the Twelfth Finance Commission (TFC) coming into force from 2005-06. The roadmap for reforms intended to put the State finances on a sustainable path unveiled by the TFC include: raising the share of States in the net proceeds of shareable Central taxes from 29.5 per cent to 30.5 per cent; and consolidation and rescheduling of Central loans contracted till March, 2004 and outstanding on March 31, 2005 (Rs. 1,28,795 crore) for a fresh term of 20 years at a rate of interest of 7.5 per cent, subject to the enactment of fiscal responsibility legislation by the State. The fiscal responsibility legislation as recommended by the TFC should prescribe annual targets with a view to eliminating revenue deficit by 2008-09 and reducing fiscal deficit based on a path for reduction of borrowings and guarantees. The Commission also recommended a debt write-off scheme linked to reduction of revenue deficit of States.
1.36 The equity markets continued to boom in 2003-04 and in the current year so far. The top 50 stocks (Nifty) generated returns of 11 per cent in 2004, following returns of 72 per cent in 2003. The second rung of smaller stocks (Nifty Junior) generated returns of 31 per cent in 2004, following returns of 141 per cent in 2003. These strong returns largely reflected growth in profits of corporations, and not changes in expectations. Strong equity index returns in calendar 2003 led to a revival of the primary market in 2004. Overall public issues grew by roughly five times to Rs. 35,859 crore in 2004. The growth was concentrated in equity issues and particularly in equity initial public offerings (IPOs).
1.37 Securities markets in India grew strongly in terms of turnover. In 2004, the turnover on the equity spot and derivatives markets and on the spot market for government bonds was Rs.43 lakh crore and Rs.11 lakh crore, respectively. Turnover on commodity futures was Rs.1.7 lakh crore in the half year, April-September 2004. The equity spot and derivatives markets had experienced major reforms in recent years, and these reforms yielded results in terms of improved liquidity and robustness. Impact cost, by measuring the price impact of a large trade, reveals the liquidity and depth of the market. The impact cost of the top 50 stocks dropped in 2004 to a level which was one-third of that found as recently as in 2001.
1.38 Direct household participation in the securities markets, which had stagnated in 2002, grew strongly in 2003 and 2004 to a level of 6 million accounts at the National Securities Depository Limited (NSDL). Diverse participation is a major source of strength for equity markets. FIIs also showed greater interest in the equity market by increasing their share to 5.8 per cent of the total market turnover. In the latest two years, the top 50 stocks (Nifty) had a correlation of 0.33 against the U.S. S&P 500 index. The next 50 stocks (Nifty Junior) had a correlation of just 0.20. These low correlations imply that Indian equities continue to be highly attractive as a tool for diversification of global portfolios.
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