macro economic overview 2003-07

7/25/2019 Macro Economic Overview 2003-07

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INDIAN ECONOMY

2003-2007

Period of Growth and Investment

Submitted by Group 4


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MACRO-ECONOMIC OVERVIEW OF INDIA

2003-2007

Assignment - Macro-economics

REPORT SUBMITTED BY GROUP 4

Malay Nigam

Lavanya Murthy

Saurav MohantyPrabhpreet Kaur

Shilpam Rajput

Narendra Kulkarni

Submitted to

Dr. Vikas Prakash Singh

Director

PGPME Programme

Great Lakes Institute of Management, Gurgaon


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Acknowledgement

We would like to express our gratitude towards our teacher Dr Vikas Prakash

Singh for providing us with such an opportunity to study in detail the economic

developments of the county. The project made us read extensively, research

new topics and broaden our knowledge and thinking. This project was possible

only because of the encouragement and mentoring provide by the faculty.


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Table of Content

1 Introduction 52 The 10thFive Year Plan 6

3 Year 2003-2004 7

4 Year 2004-2005 13

5 Year 2005-2006 23

6 Year 2006-2007 30

7 Review and Analysis 37

8 Reference 41


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Introduction

The period of 2003-04 to 2006-07

This period witnessed some of the highest growth rate in the Indian Economy peaking

at 9.2. During this period the efforts of the NDA government (1999-2003) started

showing the effects of the groundwork done. This followed the INDIA SHINING period,

but the NDA Government failed to align itself with the public opinion and lost to UPA

in the 14the general elections held in 2004.

With the new government at place and high expectations from the much learned

Prime Minister Mr. Manmohan Singh the economic outlook was upbeat. The

government introduced a multitude of schemes which further helped the country

achieve some of the highest growth rates in Indian context. The period although

witnessed the ever increasing international crude oil prices but for most part of the

year stayed aloof with a fairly stable inflation.

This period also saw the growth of the service sector and industrial sector in a fashion

unheard of. The two sectors were called as the Twin Engine of Growth aptly.

This followed by the policy of fiscal consolidation created confidence in the investors

resulting in higher FII inflows than ever. The confidence in the NDA government also

created an environment of financial investment in multiple sectors including services,

industrial, agricultural and infrastructure.

This period also saw the implementation of VAT, with the aim to simplify the taxation

system and further improve investments and economic growth in total.

Towards the end the signs of global recession started to appear.

Overall this growth in the period surpassed all expectations and the indicators will

serve for long as benchmarks for Indian economy.


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The 10ThFive Year Plan

The National Development Council (NDC), headed by Prime Minister Atal BehariVajpayee, approved unanimously in December 2002 the Tenth Five-year Plan,

envisaging an 8 percent annual GDP growth.

The NDC decided to constitute four sub-committees to remove trade and investmentbarriers and improve governance. One to deal with governance reforms as the best

policies and programmes can flounder on the rocks of poor governance andimplementation; the second to consider all barriers to internal trade on merits and to

decide what would be the most appropriate steps that could be taken; the third to look

into the wide range of controls and restriction from the past which hindered the

creation of an investor-friendly climate and work out ways to dismantle such barriers,

and the fourth to look into problems faced in transferring functions and resources tothe Panchayati raj institutions. The NDC also accepted the proposal of Prime Minister

to formulate a priority agenda for action is the coming years.

The 10th Five Year Plan (2002-2007) targets at a Gross Domestic Product (GDP) growthrate of 8% per annum. Taking note of the inabilities of the earlier Five Years Plans,

especially that of the 9th Five Year Plan, the Tenth Five Year Plan decides to take up a

resolution for immediate implementation of all the policies formulated in the past.

This amounts to making appeals to the higher government authorities, for successful

completion of their campaigns associated with the rapid implementation of all past

policies.

The primary aim of the 10th Five Year Plan is to renovate the nation extensively,making it competent enough with some of the fastest growing economies across the

globe. It also intends to initiate an Economic growth of 10% on an annual basis. In fact,

this decision was taken only after the nation recorded a consistent 7% GDP growth,throughout the past decade.

The 7% growth in the Indian GDP is considered to be considerably higher that the

average growth rate of GDP in the world. This enabled the Planning Commission ofIndia to extend the GDP limit further and set goals, which will drive India to become

one of the best industrial countries in the world, to be clubbed and recognized withthe worlds best industrialized nations.


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Macro-economic overview 2003-2004

The economy appeared to be in a resilient mode in terms of growth, inflation and

balance of payments, a combination that offers large scope for consolidation of the

growth momentum with continued macroeconomic stability. GDP is estimated to havegrown by a sharp 8.2 per cent in the year to March 2004, beating government

forecasts as the country recovered from the impact of a severe drought to join the

ranks of the world's fastest growing economies.

The achievement was possible due to one of the most bountiful monsoons in years in

India, where two-thirds of the billion-plus population work in agriculture.

A benign world economic environment provided conducive backdrop to the robust

performance of the Indian economy in 2003-04. World output growth is estimated to

have accelerated from 3.0 per cent in 2002 to 3.9 per cent in 2003. Strong performanceby the US, China, and Russia, and a strong turnaround in Japan helped to brighten the

world economic outlook in 2003. Volume of world trade in goods and services also

grew rapidly by 4.5 per cent, compared to only 3.1 per cent in the previous year. The

robust performance of India and the emerging market economies also contributed to

the good performance of the world economy.

Growth in 2002-2003 (4%) had been hampered by a withering drought which had

reduced farm output. The state-run meteorological department had forecasted

another healthy monsoon, in welcome news for the economy.

The surging growth in 2003-2004 rivals the strong gross domestic product figures of

the mid-1990s after India opened up sectors of its inward-looking economy to foreign

and private investors.

Trends in GDP:

The quarterly GDP data released by the CSO indicate GDP growth rates at 5.7 per

cent, 8.4 per cent, and 10.4 per cent respectively in the first three quarters of 2003-04.

The GDP growth rate of 10.4 per cent in the 3rd quarter of 2003-04 was the highest inany quarter since at least 1997-98, when CSO started compiling quarterly estimates,

and was supported by a growth of 16.9 per cent in agriculture, forestry and fishing,

6.5 per cent in industry and 9.0 per cent in the services sectors.

The growth recovery in 2003-04 was accompanied by continued maintenance of

relative stability of prices. Inflation, as measured by the wholesale price index (WPI),


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was 4.6 per cent at end-March 2004 over end-March 2003, and 5.5 per cent on

average. The manufacturing sector was the major contributor accounting for nearly

80 per cent of the inflation. Within the manufacturing sector, the prime movers were

sugar, edible oils, textiles, leather and leather products, basic metal and alloys and

iron and steel.

Fiscal policies:

The Union budget of 2003-04 laid considerable emphasis in fiscal consolidation, one

of the five priorities enunciated in the budget speech. In the budget, gross tax revenue

was budgeted to increase by a modest 13.3 % over revised estimates for 2002-03. The

growth envisaged for the Union excise duties and customs was even lower at 10.8%

and 8.5%. Revenue expenditure was budgeted to grow over 7.2% over 2002-03 to

Rs.3,66,227 crores. Total expenditure was budgeted to grow at 8.6%. Fiscal and

revenue deficits were budgeted 5.6% and 4.1% of GDPRevenue deficit increased from Rs.107880 to Rs.112292.

Fiscal deficit increased from Rs.131306 to Rs.153637.

Aggregate expenditure of the Central government increased by Rs.33141 on account

of higher expenditure under capital amount.

Direct taxes:

The guiding philosophy in the tax measures was a harmonious mix of stability and

continuity. Rates of income tax and corporation tax were left unchanged. Surcharge

on income tax was withdrawn for individuals and Hindu undivided families (HUF),

except for those with an annual income of Rs.8.5 lakh and above. For corporate

assesses and certain other categories of institutions, the rate of surcharge was halved

from 5 per cent to 2.5 per cent. Other important direct tax measures included

incentives for housing and infrastructure and rationalisation of provisions relating to

amalgamations and demergers. A number of measures aimed at reforming tax

administration were announced. These included outsourcing non-core activities,

abolition of discretion based selection of returns for scrutiny, simplification of tax

returns, abolition of tax clearance certificates for persons leaving India and

simplification of procedures to be followed during search and seizure.


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Excise duty:

Excise duties were rationalised with the introduction of a three-tier duty structure of 8

per cent, 16 per cent and 24 per cent (except for petroleum products, tobacco

products, pan masala, textiles and specific rated products. In the case of excise duties,

other important measures included an incentive package for the textile industry and

extension of maximum retail price (MRP) based levy to chewing tobacco and

insecticides.

Customs duty:

The peak rate of customs duty was reduced to 25 per cent, excluding agriculture and

dairy products. Customs duty included reduction in the customs duty on project

imports with a certain threshold investment and reduction in customs duty on

specified items for promoting the information technology sector.

Inflation:

Inflation is the rate at which the general level of prices for goods and services is rising

and, consequently, the purchasing power of currency is falling.

Inflation is measured at WPI or CPI.

Inflation occurs due to an imbalance between demand and supply of money, changesin production and distribution cost or increase in taxes on products. When economy

experiences inflation, i.e. when the price level of goods and services rises, the value

of currency reduces. This means now each unit of currency buys fewer goods and

services.

It has its worst impact on consumers. High prices of day-to-day goods make it difficult

for consumers to afford even the basic commodities in life. This leaves them with no

choice but to ask for higher incomes. Hence the government tries to keep inflation

under control.

The growth recovery in 2003-04 was accompanied by continued maintenance of

relative stability of prices. Inflation, as measured by the wholesale price index (WPI),

was 4.6 per cent at end-March 2004 over end-March 2003, and 5.5 per cent on

average. The manufacturing sector was the major contributor accounting for nearly

80 per cent of the inflation. Within the manufacturing sector, the prime movers were


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sugar, edible oils, textiles, leather and leather products, basic metal and alloys and

iron and steel.

A firming of energy and primary product prices had resulted in the inflation rate

crossing 6 per cent in January 2004. However, the inflation rate softened considerably

during March 2004. The high point-to-point inflation through much of 2003-04 and its

sharp deceleration in March 2004 were partly because of the carryover of the price

increase that took place in the last quarter of 2002-03, especially in March 2003. Retail

price inflation, as measured by the Consumer Price Index for Industrial Workers (CPI-

IW), touched a peak of 5.1 per cent in April 2003 followed by a declining trend and

reached 3.5 per cent in March 2004. CPI inflation declined further to 2.2 per cent in

April 2004, compared to 5.1 per cent in April 2003, and abundant food grain stocks

helped in maintaining stability in food prices.

Monetary policy:

In 2003-2004 the conduct of the monetary policy in India had to address the issue of

surge in capital flows leading to increased purchase of foreign currency by the RBI,

and consequent expansion of reserve exchange assets of the RBI (adjusted for

revaluation) increased by Rs.1,41,428 crores as compared with an assertion of

Rs.82090 crores in 2002-03, resulting in excess liquidity. The liquidity was contained

through open market sale of Government securities held by the RBI and repos under

the LAF.

Bank rate reduced by 25 basis points to 6 % effective from the close of business onApril 29, 2003.

CRR reduced by 25 basis points from 4.75 % to 4.5 % effective from June 14, 2003

Banks free to extend direct finance to the housing sector up to Rs.10 lakh I rural areas

and semi-urban areas as part of priority sector lending.

Banks were advised by the RBI to increase the loan limit without collateral to small

scale industries with good track record and financial position from Rs.15 lakhs to Rs.25

lakhs.

Balance of payments:

A strong balance of payments (BOP) position in recent years has resulted in a steady

accumulation of foreign exchange reserves. After a robust growth of US$21.3 billion

in 2002-03, foreign exchange reserves (including gold, SDRs and Reserve position in


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IMF) increased by an unprecedented US$36.9 billion in 2003-04. The level of reserves

crossed the US$100 billion mark on December 19, 2004 and stood at US$119.3 billion

as of May 31, 2004. This accretion to reserves is attributed not only to capital inflows

and current account surplus, but also to valuation gains arising from a steady

appreciation of the major non-US dollar global currencies (the Euro and the Pound

Sterling in particular) against the US dollar.

Current Account:

In the period up to 2003-04, exports and imports followed a similar rising trajectory.

Though there was a deficit in merchandise trade, software exports and remittances

from Indian workers - essentially a form of export of labour services - compensated

for it, leaving an overall surplus on the current account. 2004-05 onwards, even robust

growth in software exports has been unable to compensate for the rapidly climbing

merchandise trade deficit.

Imports have been growing at a compounded annual average growth rate (CAGR)

that is 4 per cent higher than that of exports over the same period. This is the cause of

Indias burgeoning current account deficit. Clearly, this is not a problem that has

arisen overnight, but has been building up for nearly a decade.

Capital Account:

The capital account has also continued to strengthen. The size of the capital account

surplus during April-December 2003-04 was far more than that for the full year 2002-

03. Earlier, the capital account surplus in Indias balance of payments used to bepartially offset by current account deficits, leading to lower overall surpluses.

However, since 2001-02, surpluses in both, the current and capital accounts have

resulted in larger overall surpluses, which have led to accumulation in the foreign

exchange reserves of the country.

Fiscal deficit:

Fiscal deficit represents shortfall in government's revenues compared to

expenditures. It is expressed as a percentage of GDP.

The combined fiscal deficit of the Centre and the States, which had been decreasingin the early nineties, worsened subsequently to reach a level of 10.1 per cent in the

revised estimates (RE) for 2002-03. The combined revenue deficit as a proportion of

GDP, after declining from 4.2 in 1990-91 to 3.6 per cent in 1996-97, increased to 7.0

per cent in 2001-02, to decline again to 6.7 per cent in 2002-03 (RE) and further to a

budget estimate (BE) of 5.8 per cent in 2003-04. For 2003-04, the combined fiscal

deficit was budgeted at Rs.2,59,265 crores, constituting 9.4 per cent of GDP.


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Exchange rate:

The weakening of the US dollar, caused mainly by widening US deficits, has affected

the rupee-dollar exchange rate. The Indian rupee, which started strengthening from

June 2002 onwards, had appreciated, on a monthly average basis, by 8.8 per centagainst the US dollar by March 2004. On annual average basis, the rupee, after

depreciating by 1.5 per cent in 2002-03, appreciated by 5.3 per cent in 2003-04 vis--

vis the US dollar. The movements in the rupee value were smooth and orderly,

avoiding undue adjustment costs. Furthermore, while the rupee appreciated against

the US dollar in 2003-04, it depreciated against the currencies of major non-dollar

trading partners. Given the inflation differential, the appreciation has been less

pronounced in trade weighted effective terms, with the Real Effective Exchange Rate

(REER) of the rupee (5-country index with base 1993-94) appreciating by around 2 per

cent on an annual basis in 2003-04.

Year average: Rs. 45.747

Extraneous factors:

Global Factors:

Mar 19, 2003- Invasion of Iraq by American and British led coalition begins without

United Nations support and in defiance of world opinion

May 14, 2003- 2003 invasion of Iraq: In what becomes known as the "Mission

Accomplished" speech, U.S. President George W. Bush declares that "major combat

operations in Iraq have ended" on board the USS Abraham Lincoln off the coast ofCalifornia.


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Macro-economic overview- 2004-2005

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 everexcept 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.

The long-term growth prospective of the Indian economy is moderately positive dueto its young population, corresponding low dependency ratio, healthy savings and

investment rates, and increasing integration into the global economy. The Indian

economy has the potential to become the world's 3rd-largest economy by the next

decade, and one of thelargest economies by mid-century. And the outlook for short-

term growth is also good as according to the IMF, the Indian economy is the "bright

spot" in the global landscape. India also topped theWorld Banks growth outlook for

2015-16 for the first time with the economy having grown 7.3% in 2014-15 and

expected to grow 7.5-8.3% in 2015-16.

India has the one of fastest growingservice sectors in the world with annual growth

rate of above 9% since 2001, which contributed to 57% of GDP in 2012-13. India has

capitalized its economy based on its large educated English-speaking population to

become a major exporter of IT services, BPO services, and software services with

$167.0 billion worth of service exports in 2013-14. It is also the fastest-growing part of

the economy. The IT industry continues to be the largest private sector employer in

India. India is also the fourth largest start-up hub in the world with over 3,100

technology start-ups in 2014-15. The agricultural sector is the largest employer in

India's economy but contributes to a declining share of its GDP (17% in 2013-14).

Indiaranks secondworldwide in farm output. TheIndustry sector has held a constant

share of its economic contribution (26% of GDP in 2013-14). The Indian auto mobile

industry is one of the largest in the world with an annual production of 21.48 million

vehicles (mostly two and three wheelers) in FY 2013-14. India has $600 billion worth

ofretail market in 2015 and one of world's fastest growing E-Commerce markets.

India's two major stock exchanges, Bombay Stock Exchange and National Stock

Exchange of India,had a market capitalization of US$1.71 trillion and US$1.68 trillion
https://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)https://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)https://en.wikipedia.org/wiki/World_Bankhttps://en.wikipedia.org/wiki/World_Bankhttps://en.wikipedia.org/wiki/Service_Sectorhttps://en.wikipedia.org/wiki/Information_Technologyhttps://en.wikipedia.org/wiki/Business_Process_Outsourcinghttps://en.wikipedia.org/wiki/Softwarehttps://en.wikipedia.org/wiki/Agricultural_sectorhttps://en.wikipedia.org/wiki/List_of_largest_producing_countries_of_agricultural_commoditieshttps://en.wikipedia.org/wiki/Industryhttps://en.wikipedia.org/wiki/Retailing_in_Indiahttps://en.wikipedia.org/wiki/Bombay_Stock_Exchangehttps://en.wikipedia.org/wiki/National_Stock_Exchange_of_Indiahttps://en.wikipedia.org/wiki/National_Stock_Exchange_of_Indiahttps://en.wikipedia.org/wiki/National_Stock_Exchange_of_Indiahttps://en.wikipedia.org/wiki/National_Stock_Exchange_of_Indiahttps://en.wikipedia.org/wiki/Bombay_Stock_Exchangehttps://en.wikipedia.org/wiki/Retailing_in_Indiahttps://en.wikipedia.org/wiki/Industryhttps://en.wikipedia.org/wiki/List_of_largest_producing_countries_of_agricultural_commoditieshttps://en.wikipedia.org/wiki/Agricultural_sectorhttps://en.wikipedia.org/wiki/Softwarehttps://en.wikipedia.org/wiki/Business_Process_Outsourcinghttps://en.wikipedia.org/wiki/Information_Technologyhttps://en.wikipedia.org/wiki/Service_Sectorhttps://en.wikipedia.org/wiki/World_Bankhttps://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)https://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)


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respectively as of Feb 2015, which ranks11th & 12 largest in the world respectively

according to the World Federation of Exchanges. India also home to world's third

largest Billionaires pool with 97 billionaires in 2014 and fourth largest number of ultra-

high-net-worth households that have more than 100 million dollars.

Trends in GDP:

With a normal monsoon, the growth in agriculture can be assumed to be at the trend

growth rate of about 3 per cent and further assuming that industry and services sectors

maintain their current growth momentum, the real GDP growth during 2004-05, in the

normal course, could be 6.5 per cent.

The real GDP growth during 2004-05 could well be higher at around 7.0 per cent.

For the present, for the purpose of monetary policy formulation, real GDP growth for

2004-05 may be placed in the range of 6.5 to 7.0 per cent, assuming sustained growth

in the industrial sector, normal monsoon and good performance of exports.

Macroeconomic performance in 2004-05 turned out to be stronger than anticipated.

Although beset by an uneven and deficient South-West monsoon, below normal

North-East monsoon and the base effect of a seven-year peak growth of 9.6 per cent

achieved in 2003-04, real GDP originating from 'agricultural and allied activities' rose

by 1.1 per cent in 2004-05.

The industrial recovery firmed up and broadened during the year, led bymanufacturing and 'electricity, gas and water supply', considerably mitigating the

setback to agriculture.

In the second and third quarters, the uneven spread of the South-West monsoon from

mid-July, despite the early onset, led to an absolute decline in agricultural growth.

Deceleration in growth rates of financing, insurance, real estate, business services,

community, social and personal services in relation to the corresponding quarter of

the previous year dampened the buoyancy of the overall services sector in the second

quarter of 2004-05 with the slowing down becoming more pronounced in the third

quarter of 2004-05 due to deceleration in trade, hotels, restaurants, transport and

communication.

A significant feature of the macroeconomic developments in 2004-05 was the

resurgence of the industrial sector, propelled by buoyant exports and a brightening

of the domestic investment climate in an environment of rising business optimism and

consumer confidence. Industry contributed 26 per cent to overall growth of the
https://en.wikipedia.org/wiki/List_of_stock_exchangeshttps://en.wikipedia.org/wiki/List_of_stock_exchanges


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economy, up from 17 per cent in 2003-04, in spite of a secular decline in its share in

GDP.

'Agriculture and allied activities', on the other hand, exhibited considerable volatility

in terms of contribution to real GDP growth. In 2004-05, agriculture and allied

activities contributed 3 per cent of real GDP growth as against 24 per cent in2003-04.

The services sector remained the main engine of growth of the economy during 2004-

05. Recent gains in growth momentum under 'trade, hotels, transport and

communication' were consolidated during the year, benefiting from a sharp rise in net

tonne kilometres (8.2 per cent) and passenger kilometres (6.9 per cent) in respect of

railways, a surge in the production of commercial vehicles (30.4 per cent), expansion

in cargo handled at major ports (11.1 per cent), increase in the gross trading index

(8.6 per cent) and rising tele-density a result of a 30.3 per cent increase in the stock

of telephone connection, during April-December, 2004-05. The growth of community,

social and personal services remained stable at the previous year's level, reflecting

the commitment to fiscal consolidation and expenditure containment.

FISCAL POLICY:

Direct taxes

The budget estimates for 2004-05 reveal an endeavour of the State Governments to

carry forward fiscal reforms.

A number of States have underscored the need to increase the magnitude and

efficiency of tax revenue mobilisation. The general approach is to rationalise and

simplify the tax structure, broaden the tax base and have moderate rates of taxation.

Most of the State Governments have reiterated the need to contain unproductive

expenditures and reorient spending towards developmental purposes. Several State

Governments have already enacted Fiscal Responsibility legislation (FRL) and

formulated medium-term fiscal plans to bring about an orderly correction of their

financial positions.

The recent implementation of the Value Added Tax (VAT) by a number of States, with

effect from April 1, 2005, is an important milestone in the area of tax reforms.


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Indirect taxes

Customs duty

Customs duty, non-alloy steel, to be reduced from 15 per cent to 10 per cent. While

retaining customs duty on palm oil at 65 per cent.

Customs duty of 5 per cent on some items of plantation machinery to be extended to

more items pertaining to tea and coffee plantation sector.

Excise duty

Revenue receipts of the Centre were lower by 2.7 per cent than their budgeted level

for 2004-05 due to decline in both tax and non-tax revenues. The gross tax revenue

was 3.7 per cent lower than the budget estimates (BE) mainly on account of lower

corporation tax collections and union excise duties .The lower collections from excise

duties reflected the post-budget reduction of duties in respect of certain petroleum

products and non-alloy steel to contain inflationary pressures.

Inflation:

The unseasonal rains in producing areas had an unfavourable impact on production

and a subsequent supply to markets. Again the price hike in Diesel led to increase in

transportation cost of vegetables. This led to a high inflation.

The inflation rate during 2004-05 is likely to be influenced to a significant extent by

international oil prices and trends in commodity prices.In addition, the lagged effect

of persistence of excess liquidity on aggregate demand cannot be ignored as it could

have some potential inflationary impact. In view of the current trends, assuming no

significant supply shocks and appropriate management of liquidity, the inflation rate

in 2004-05, on a point-to-point basis, may be placed at around 5.0 per cent.

Wholesale price index (WPI):

Headline inflation, measured by year-on-year (y-o-y) changes in the wholesale priceindex (WPI), moved in two distinct phases during 2004-05.The first phase, i.e., April-August 2004 was marked by a hardening of domestic prices of coal, petroleum

products, iron and steel and other metals, reflecting lagged adjustments to the

increase in international prices. Prices of petroleum products were revised upwardseffective June 16 and August 1, 2004. Coal prices were also raised in June 2004. The

inadequate and uneven South-West monsoon began to push up prices of food itemsand non-food agricultural commodities such as cotton and oilseeds by July 2004.


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As a result, headline inflation rose sharply to a peak of 8.7 per cent by end-August2004.

Consumer price index (CPI):

Retail price inflation, measured by y-o-y variation in the consumer price index forindustrial workers (CPI-IW), accelerated to 4.8 per cent in September 2004 from 2.2

per cent in the beginning of the financial year and 2.9 per cent a year ago.

The food group (weight of 57 per cent) accounted for as much as 45 per cent of the

overall retail inflation (y-o-y) in September 2004.

Consumer price inflation decelerated thereafter to 3.8 per cent by December 2004

reflecting the easing of the impact of the monsoon on food prices.

Consumer price inflation firmed up to 4.4 per cent in January 2005 mainly due to

increase in the prices of fish, meat, sugar, kerosene oil and housing, before

decelerating to 4.2 per cent in February 2005. On an annual average basis, CPI

inflation at 3.8 per cent in February 2005 remained broadly at the level of the

previous year.

Monetary policy:

As regard the global developments, recovery appears more sustainable now and

there is greater resilience in emerging economies. It is essential to recognise thatinterest rates in major economies are likely to harden while the adjustments in

currency imbalances would continue to take place.

Oil prices seem to persist at the current high level though they could move sharply

in either direction. The geopolitical uncertainties impacting the international oil

economy do not show any signs of waning.

Thus, while there are significant positive indications of economic recovery, there

are noticeable uncertainties and risks that should be reckoned with while designing

the stance of monetary policy..

Consistent with the real growth of GDP and inflation, the projected expansion of

money supply (M3) for 2004-05 is placed at 14.0 per cent. In tune with this order of

growth in M3, increase in aggregate deposits of scheduled commercial banks is set

at Rs.2, 18,000 crores which is higher by 14.5 per cent over its level in the previous

year.


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This magnitude of credit expansion is expected to meet adequately the credit needs

of all the productive sectors of the economy.

However, such an increase may have an adverse impact on investment demand which

has shown signs of pick-up after prolonged sluggishness.

An assessment of domestic factors, points to stability but in the leading economies of

the world, there is a greater potential for tightening rather than easing of monetary

policies.

Monetary policy would continue to enhance the integration of various segments of the

financial market, improve credit delivery system, nurture the conducive credit culture

and improve the quality of financial services.

While the economy has the resources and resilience to withstand supply shocks, thepossible consequences of continued abundance of liquidity need to be monitored

carefully. As such, the inflationary situation needs to be watched closely and there

could be no room for complacency on this count.

With the development of market repo and CBLO segments, the call money market has

been transformed into a pure inter-bank market, including primary dealers, since

August 2005.

Balance of payments:

Current Account:

Surpluses on account of invisible transactions have financed a significant portion of

the merchandise trade deficit that has traditionally characterised India's balance of

payments.

Through 2001-04, sizeable invisible surpluses comfortably financed the merchandise

trade gap and spilled over into current account surpluses. Invisible receipts increased

by 37.5 per cent during April-December 2004 over the corresponding period of theprevious year.

Software exports, in which India is a world leader, continued to be buoyant on the

back of sustained growth in industrial countries.

The current account turned into a deficit of US$5.4 billion in 2004-05.


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The deficit was caused by a burgeoning excess of merchandise imports over exports,

which was left uncompensated by the net surplus in invisibles.

Compared with 2003-04, when loan inflows had turned into net outflows, such inflows

shot up rapidly during 2004-05 and bolstered the size of the capital account surplus

with good support from robust foreign investment inflows.

The current account continues to be in deficit with the size of the deficit during the first

half of the current year (April-September 2005) almost twenty seven times that of the

deficit in the corresponding previous period.

The rapidly enlarging trade deficit, buoyed by remarkable import growth, has been

pushing the current account deficit. During the period 2001-02 to 2003-04, the

invisibles (net) always overcame the trade deficit to maintain the current account in

surplus. However, the trend was reversed in 2004-05 and appears to be continuing in2005-06.

The current account, after being in surplus during 2001-02 to 2003-04, reverted to a

deficit in 2004-05. This was despite a robust growth in net invisibles account fuelled

by software exports and private transfers. The current account deficit (CAD) is

attributable to the widening trade deficit, driven primarily by the rise in international

prices of petroleum products and gold. Thus large merchandise trade deficit coexists

with a lower deficit on the goods and services account because of the surplus on non-

factor services. Even in the years when there were some surpluses on the current

account, India had deficit on goods and services account and a relatively larger tradedeficit.

Capital Account:

Net capital flows during 2004-05 were dominated by foreign investment. Portfolio

flows brought in by foreign institutional investors (FIIs) went through significant shifts

in the early part of the year before cumulating into a surge that was interrupted only

briefly in the early part of January 2005.

The appetite for investing in India was also shared by foreign direct investors whoresponded positively to the on-going liberalisation.

Drawing strength from the strong investor enthusiasm and credit rating upgrades,

Indian entities expanded their access to international capital markets through foreign

currency convertible bonds, trade credits and external commercial borrowings.


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Even as net outflows continued under non-resident Indian (NRI) deposits, banks

compensated for the shrinkage in foreign currency funds by borrowing overseas and

drawing down nostro balances.

Exchange Rate:

The excess supply conditions that prevailed in the foreign exchange market during

the major part of 2003-04 persisted at the beginning of 2004-05.

Pressures began to emerge by mid-May 2004 due to a shift in market sentiment

driven by turbulence in the equity market and rising global oil prices.

The ebbing of capital flows, the rising demand for imports and the surge in

international oil prices drained away the excess supplies, leading the Indian rupee to

depreciate against the US dollar by 4.5 per cent during May-July 2004.

With the resumption in portfolio flows in August, the rupee started gaining strength

against the US dollar.

The US dollars weakness against the major international currencies and a decline in

international crude oil prices helped the rupee to recover lost ground and appreciate

against the US dollar by 6.6 per cent during August-December 2004.

During 2004-05, the rupee moved in the range of Rs.43.36-46.46 per US dollar,

depreciating by only 0.7 per cent over its end-March 2004 level.

On the other hand, the rupee depreciated against the Pound Sterling and the Euro by

3.0 per cent and 6.0 per cent, respectively, and appreciated by 2.1 per cent against

the Japanese Yen (Chart 46).

Although the five-country (trade-weighted) nominal effective exchange rate (NEER)

of rupee depreciated by 3.3 per cent during April-January 2004-05, the real effective

exchange rate (REER) fell marginally by 0.4 per cent, indicating fair valuation.


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Extraneous factors:

Global environment:

Globally, inflation began to rise in early 2004, driven up by strong input demand fromthe global recovery and the continued expansion of the Chinese economy. Demand-

side pressures on global inflation remained relatively weak, despite concerns about

easy monetary conditions fuelling asset prices. Reflecting the supply-side character

of inflation, producer prices tended to lead consumer prices in most economies. As

commodity costs represent only a small share of the overall costs, the increase in

commodity prices was initially absorbed by firms in their profit margins, creating a

wedge between producer and consumer prices.

A number of central banks, most notably the US Federal Reserve, began to signal a

reversal of their accommodative monetary policy stance in order to stabilise inflation

expectations. The US Federal Reserve raised its target Federal Funds Rate in sevenequal stages by 175 basis points to 2.75 per cent between June 2004 and March 2005.

Commodity prices, which had risen sharply in the first half of 2004, stabilised at

elevated levels by the end of the year. Fuel prices surged up by 30.9 per cent, on an

average, in 2004 on top of an increase of 16.7 per cent in the previous year. Non-fuel

commodity prices (covering prices of food, beverages, agricultural raw materials and

metals) rose on an average by 18. 6 per cent in 2004, led by metals (36.4 per cent).

The increase in commodity prices in the international markets in US dollar terms was

much higher than in terms of the Euro or the Japanese Yen. This reflected the

depreciation of the US dollar by 9.4 per cent against the Euro and 6.7 per cent against

the Yen in 2004.

The global economy continued to expand at a robust pace during 2004, although the

rate of growth moderated from the exceptionally high levels observed at the

beginning of the year.

Domestic environment:

The financial year started with the 14th Lok Sabha election during April 20 and May10, 2004. Over 670 million people were eligible to vote, electing 543 members of the

14th Lok Sabha. The ruling Bharatiya Janata Party (BJP) and its alliance National

Democratic Alliance conceded defeat.

Initiatives taken by the previous government, in a number of sectors like telecom,

roads, ports and civil aviation have begun to yield results and made a good impact on
https://en.wikipedia.org/wiki/Bharatiya_Janata_Partyhttps://en.wikipedia.org/wiki/National_Democratic_Alliance_%28India%29https://en.wikipedia.org/wiki/National_Democratic_Alliance_%28India%29https://en.wikipedia.org/wiki/National_Democratic_Alliance_%28India%29https://en.wikipedia.org/wiki/National_Democratic_Alliance_%28India%29https://en.wikipedia.org/wiki/Bharatiya_Janata_Party


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economic growth. The Survey stressing the role of higher foreign investment both FDI

and FII for accelerated economic growth, said trade liberalization, introduction of

greater competition and open foreign investment policies have been successful in

transforming several sectors of the Indian manufacturing industry into globally

competitive entities.

The major programmes initiated under the new government during the year include,

launching of the National Food for Work programme in 150 most backward districts,

introduction of National Rural Employment Guarantee Scheme, additional budgetary

support for planned programmes like food for work, Sarva Shiksha Abhiyan, mid-day

meal, basic health care, accelerated irrigation benefit programme, drinking water

and roads, imposition of a cess of 2 per cent on Central taxes for universal education

and a new universal health insurance scheme for the poor.

The December 26, 2004 Indian Ocean tsunami was caused by an earthquake that is thought

to have had the energy of 23,000 Hiroshima-type atomic bombs.

The wave killed people in 14 different countries around the Indian Ocean totalling over

250,000 and death toll in India around 9675.

Government of India announced a special rehabilitation of Rs. 3,644 cr. & Indian officials

estimate that it will cost 125 million dollars to repair the ships and replace fishing equipment


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Macro-economic overview - 2005-2006

Demonstrating strengths, the Indian economy, after growing at 8.5 per cent and 7.5

per cent in the two previous years, was projected to grow at 8.1 per cent in the year

2005-06.

After dipping below 1.0 per cent in 2004-05, mostly on account of erratic rainfall,agricultural and allied sectors growth in 2005-06 was projected at 2.3 per cent

Significant dimensions of the dynamic growth in recent years were: a new industrial

resurgence; a pick-up in investment; modest inflation in spite of spiralling global

crude prices; rapid growth in exports and imports with a widening of the current

account deficit; laying of some institutional foundations for faster development of

physical infrastructure; progress in fiscal consolidation; and the launching of theNational Rural Employment Guarantee (NREG) Scheme for inclusive growth and social

security.

Against the annual average growth rate of 8.0 per cent envisaged in the Tenth Five

Year Plan (2002-03 to 2006-07), the average rate is estimated to have been 7.0 per cent

in the first four years ending in 2005-06.

Industry and services continued to expand steadily. Since the beginning of the Tenth

Plan in 2002-03, with annual growth of 7.0 per cent or more, industry and servicesacted as the twin engines propelling overall growth of the economy.

Growth in financial services (comprising banking, insurance and real estate services),

which after dipping in 2003-04 had bounced back in the year, maintained the

momentum with progressive maturing of Indian financial markets and the ongoingconstruction boom. However, community, social and personal services, which include

public administration and defence, reflecting the process of fiscal consolidation andincreasing efficiency of fiscal expenditure management, experienced a growth

deceleration of more than a percentage point.

Pick-up in investment, reflecting the high business optimism, not only strengthened

industrial performance but also reinforced the growth outlook itself. The rally in grossdomestic capital formation (GDCF) that had commenced in 2002-03 continued.

Stock market index returns of 11 per cent in 2004 followed by 36 per cent in 2005provide a good measure of investor sentiments. The bell-weather BSE Sensex crossedthe 10,000 mark on February 6, 2006.


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Trends in GDP:According to the national income data released by the Central Statistical Organisation

(CSO) on February 7, 2006, the advance estimate (AE) for growth of GDP at factor cost

at constant (1999-2000) prices in 2005-06 at 8.1 per cent was up 0.6 percentage pointsover the 7.5 per cent growth recorded in 2004-05

The CSO has changed the base year for calculation of national income aggregates at

constant prices from 1993-94 to 1999-2000. The revised growth rate with base 1999-

2000 is the same as or less than the rate with base 1993-94 for each of the four earlieryears ending in 2003-04.

Growth trend for the last three years appears to indicate the beginning of a new phase

of cyclical upswing in the economy from 2003-04. The initial momentum to this newphase of expansion, in 2003-04, was provided by agriculture. After a somewhat

subdued impetus from the farm sector in 2004-05, there is a moderate recovery inagricultural growth in 2005-06

Fiscal Policies:Continuing with the process set in motion in the previous year, the Budget for 2005-06

sought to further the NCMP objectives of growth, stability and equity in a calibratedmanner. Maintaining a growth rate of 7-8 per cent per annum, promoting investment,

generating employment, accelerating fiscal consolidation, ensuring higher fiscaldevolution and focusing on agriculture, manufacturing and infrastructure were the

key objectives.

Budget 2005-06 sought to achieve these objectives through a series of initiatives,

which included: hike in gross budgetary support (GBS) for the plan by 16.9 per centon a like-to-like basis from Rs.1,45,590 crore in 2004-05(BE) to Rs.1,72,500 crore in

2005-06 (BE); provision of livelihood security for crores of poor families through theNational Rural Employment Guarantee Scheme (NREGS), the legislation for which was

passed by the Parliament on August 24, 2005; a visionary development proposal Bharat Nirman for building infrastructure, especially in rural areas; an outlay ofRs.1,100 crore for covering 1.25 lakh villages in five years under a massive

programme of rural electrification; creation of an SPV to overcome the infrastructuredeficit and provision of guarantees to the extent of the borrowing limit of Rs. 10,000

crore; enhanced outlay on NHDP from Rs. 6,514 crore in BE 2004-05 to Rs. 9,320 crore

to speed it up; provision of Rs. 5,500 crore for National Urban Renewal Mission(NURM); and a focus on outcomes rather than outlays.

Direct Taxes:

In the area of direct taxes, the Budget for 2005-06 carried forward the process initiated

in the previous Budget. In personal income tax, the tax rates were revised for various

tax brackets conferring gain to all taxpayers through higher exemption limits and


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scaling up, even as standard deduction was withdrawn. In another significant move,

neutrality of taxes between forms of savings was achieved through a general rebate

on savings in any approved instrument up to Rs.1lakh.

Budget for 2005-06 introduced two new taxes: a fringe benefit tax targeted at those

benefits enjoyed collectively by the employees and not attributable to individual

employees, which are to be taxed in the hands of employer; and a tax on banking cash

transactions (withdrawals) over a certain threshold in a single day. Taking a leaf out

of the international best practices, corporate income tax was reduced to 30 per cent,

albeit with a higher surcharge of 10 percent and reduced depreciation allowance that

is a better approximation to the replacement life-value.

Indirect taxes:

Customs Duty:

Budget for 2005-06 reduced peak customs duty on non-agricultural products to 15 per

cent with steeper reductions for capital goods and raw materials and corrections for

inverted duty structures.

As a part of oil prices management, in an era of unprecedented rise in international

prices, customs duty on crude petroleum was halved from 10 per cent to 5 per cent;

customs duty on petroleum products reduced to 10 percent from 20 percent and 15

per cent; customs duty on subsidised products, namely domestic LPG and PDS

kerosene, made nil; and excise duties on motor spirit and high speed diesel

converted to specific duties together with an 8 percent ad valorem component.

In excise, Government intends to bring as many goods as possible to the median

CENVAT rate of 16 percent. Towards this, the Budget for 2005- 06 reduced duties on

polyester filament yarn, tyres and air-conditioners from 24 per cent to 16 per cent.

Excise Duty:

Excise duties on MS or petrol, and HSD fixed as a combination of ad valorem and

specific duties: at 8 per cent plus Rs.13 per litre for MS, and 8 percent plus Rs.3.25 per

litre for HSD. Duty on Liquefied Petroleum Gas (LPG) for supply to domestic

households and kerosene for ultimate sale through public distribution system

reduced from 8 per cent to nil.

Duty on iron and steel raised from 12 per cent to 16 per cent. Duty on cement clinkers

per MT increased from Rs.250 to Rs.350 as an anti-avoidance measure.


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Inflation:

WPI:

Inflation, measured by a point-to-point increase in the Wholesale Price Index (WPI)declined from 5.7 per cent on April 2, 2005, to a low of 3.3 per cent on August 27, 2005.

Despite increasing thereafter, prices have remained at comfortable levels with theWPI-inflation at 4.1 per cent on February 4, 2006 vis--vis 5.0 per cent on February 5,

2005. As on February 4, 2006, the fuel group, with an inflation rate of 7.6 per cent,

contributed 40.5 per cent to the overall inflation, which was marginally lower than 42.8per cent a year ago. Much of the inflation in the fuel group is attributable to the pass

through effected in June and September 2005,in the form of enhanced retail prices of

petrol and diesel, precipitated by the flare-up in global oil prices.

Decelerating trend in inflation relating to manufactured products group observedsince the last quarter of 2004-05 continued as the inflation rate for this group dropped

from 4.5 per cent a year ago to 2.4 per cent on February 4, 2006. This deceleration inboth wholesale and retail prices, in the aftermath of the introduction of value addedtax (VAT) in most of the States with effect from April 1, 2005, helped to mobilise

popular support behind a fundamental reform of State-level sales taxes a reformtermed by some as the most important tax reform in post-independent India.

CPI:

Inflation, year on year, in terms of consumer price index for agricultural labourers(CPI-AL) and of consumer price index for industrial workers (CPI-IW) was 3 per cent

and 5 per cent, respectively. Data indicated that inflation in CPI-AL remained below

that in CPI-IW for each of the months of the current financial year including December2005. Furthermore, with inflation rate for food group (with a higher weight in CPI thanin WPI) lower than that of overall inflation, CPI inflation (measured in terms of both

CPI-AL and CPI-IW) remained below WPI-inflation until October 2005.Inflation in both

CPI-AL and CPI-IW, after declining to 3.2 per cent and 3.4 per cent respectivelywithsome minor fluctuationsbetween April and August, 2005, revealed an upward trend.

In December, 2005, inflation in CPI-IW was 5.6 per cent. The upward trend inconsumer prices was primarily on account of hardening of retail prices of vegetables

and pulses.

Monetary Policy:Maintaining price stability continued to be one of the main objectives of monetary

policy. For achieving this the policy variables were recalibrated appropriately. While

the Bank Rate and the cash reserve ratio (CRR) were kept unchanged during thecurrent year at 6.0 per cent and 5.0 per cent, respectively, the fixed reverse rate under

the Liquidity Adjustment Facility (LAF) of the Reserve Bank of India (RBI) was raisedthree times, by 25 basis points each, to reach 5.50 per cent on January 24, 2006.With


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the given spread of 100 basis points vis--vis the reverse rate, the rate is pegged at6.50 per cent since January 24, 2006.

RBIs policy response was in line with the cautious approach in many other countries

of moving policy interest rates in a measured way in the face of the threat of

inflationary expectations firming up with high crude oil prices.

The year-on-year growth of broad money (M) at 16.4 per cent on January 20, 2006 wasnot only higher than the projected14.5 per cent in RBIs Annual Policy Statement for

2005-06, but also higher than the rate observed a year ago.

Price stability despite a rapid increase in money supply during the current year

testified to the investment-driven nature of the credit growth and stability of inflation

expectations based on confidence in the appropriate stance of monetary and fiscal

policies.

Balance of Payments:

Current Account:There was a deficit in the current account of the BOP, which emerged in 2004-05 afterthree consecutive years of surpluses, and has assumed much larger dimensions

during the current year. During April-September 2005-06, the current account deficitenlarged to around US$13.0 billion, which was more than twice the deficit (US$5.4

billion) in the whole of 2004-05. While net invisibles continued to rise, it was notenough to neutralize the rapidly expanding trade deficit, which at US$31.6 billionduring April-September 2005-06 was only around US$5.0 billion less than that

recorded in twelve months of 2004-05.

Trade Deficit:

The sharp rise in current account deficit reflects the burgeoning trade deficit duringthe year. Although, net invisibles increased, but was not enough to neutralize theexpanding trade deficit.

While the surge ahead in merchandise exports observed since 2002-03 continued,such growth was surpassed by an even faster rise in merchandise imports.

Merchandise imports have been rising more rapidly than exports since 2003-04,reflecting perhaps the overall industrial recovery that commenced from the second

quarter of 2002-03. The heavy demand for imports arising from increasing buoyancy

and robustness of Indian industry may have led to a sustained rise in growth of

merchandise imports.

Capital Account:

With robust inflows, during 2004-05, the surplus of US$31.6 billion recorded in thecapital account more than compensated the current account deficit and resulted in an

addition of more than US$26 billion, on BOP basis, to the existing stock of foreignexchange reserves. In April-September 2005, while the capital account surplus at

US$19.5 billion remained higher than the current account deficit of US$13.0 billion,


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there was a slowdown in reserve accretion on BOP basis. The dominance of non-debtcreating flows in the capital account continued.

Within foreign investment, portfolio flows, comprising mainly foreign institutional

investor (FII) investment, were the dominant variety. At US$4.2 billion during April-

September 2005, FII flows (net) were higher than not only the FDI flows of US$2.3billion, but also the FII flows of US$339 million in April-September 2004. FDI flows

(net) during April-September 2005 were US$2.3 billion up by only US$0.3 billionfrom such flows of US$2.0 billion in the first half of 2004-05.

Exchange Rate:The weakening of the US dollar vis--vis other major global currencies, which resulted

in valuation losses of US$5.0 billion in reserves in the first half of 2005-06, also gotreflected in the movements of the Rupee vis--vis the US dollar. During 2004-05, the

Rupee had appreciated against the US dollar (2.2 per cent) in nominal terms, whiledepreciating against the Euro (-4.5 per cent), Pound (-6.3 per cent), and the Japanese

Yen (-2.6 per cent). However, in the first ten months of 2005-06, on average, the Rupeehas strengthened against all major currencies. The appreciation was the strongest vis--vis the Japanese Yen (6.4 per cent) followed by Pound (4.5 per cent), the Euro (4.3

per cent), and the US dollar (2.1 per cent). In 2005-06, in 5-country export-weightednominal effective exchange rate (NEER) terms (base year 2000), the Rupee

appreciated in all months until July 2005, and depreciated in subsequent months untilDecember 2005. In 5-country export-weighted real effective exchange rate (REER)terms (base year 2000), the same pattern was observed, with the exception of

November 2005, which witnessed a mild appreciation.

Extraneous Factors:

International Environment:

Following a temporary slowdown in mid-2004, global GDP growth picked up through

the first quarter of 2005, with robust services sector output more than offsettingslowing global growth in manufacturing and, latterly, trade. In the second quarter,however, in part reflecting the impact of higher oil prices, signs of a renewed soft

patch emerged, with leading indicators turning downward and business confidenceweakening in most major countries (Figure 1.2). While global manufacturing and

trade are now strengthening, and leading indicators have picked up, the continuing

rise in crude oil and refined product priceslatterly exacerbated by the catastrophiceffects of Hurricane Katrinais an increasingly important offset.


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Domestic Environment:

Growth of 9.0 per cent in 2005-06, surpassed expectations. While the up-and-down

pattern in agriculture continued with growth in the two recent years, and servicesmaintained its vigorous growth performance, there were distinct signs of sustained

improvements on the industrial front.

Entrenchment of the higher growth trends, particularly in manufacturing, has boosted

sentiments, both within the country and abroad.

Introduction of VAT in 21 states in April 2005 resulted in an increase in inflation interms of WPI.

Further, following the targets of five year plans much work was done

towards social betterment pinnacling in launch of NREGA.

The overall macroeconomic fundamentals are robust, particularly withtangible progress towards fiscal consolidation and a strong balance of

payments position. With an upsurge in investment, the outlook was

distinctly upbeat.


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Macro-economic overview 2006-2007

The economy averaged growth of 8.1% in the past three fiscal years (2003/04 through

2005/06). Growth during this period was driven largely by the acceleration in industry

and services save in 2003/04 when agriculture, recovering from the severe drought

in the previous year, had a role to play. The sub-sectors that were key drivers of

growth were manufacturing, construction, communication, and financial & businessservices. The impressive showing was also reflected in improvement in per capital

income, which increased to Rs 29,642 from Rs 25,956 during 2005-06.

The overall improvement in the performance could also be attributed to an impressive35.9 per cent growth in capital formation that stood at Rs 14,87,786 crore (Rs 14.87786

trillion) during 2006-07.

Such higher level of investment was made possible by a significant 34.3 per centincrease in domestic savings that were estimated at Rs 14,41,423 crore (Rs 14.41423

trillion) during 2006-07 at current prices.

The share of financing, insurance and real estate in the GDP also increased to 14.3 per

cent in 2006-07, compared to 13.8 per cent in the previous year.

Trends in GDP

The economy grew by 9.6 per cent during 2006-07, leading to over 14 per cent

increase in the per capital income, the government announced on Thursday.

The improved growth in the GDP, up from 9.4 per cent in 2005-06, has been achieved

due to all around improvement in mining, manufacturing and services sectors, whichhelped to offset the slower growth in agriculture sector, according to the quick

estimates released by the Central Statistical Organisation (CSO).

While manufacturing grew 12.3 per cent in 2006-07 as compared to 9.1 per cent inthe previous fiscal, trade, hotels, transport and communication services grew 13 per

cent as compared to 10.4 per cent a year earlier.

Mining and quarrying also grew 5.1 per cent during the year as against 3.6 per cent

a year ago.

In absolute terms, the country's GDP stood at Rs 28,48,157 crore during 2006-07 as

against the earlier estimate of Rs 28,44,022 crore. The per capita income stood at Rs

22,483 during 2006-07 as compared to Rs 20,734 in the previous fiscal.

The government has set a target of an average annual GDP growth of 9 per cent for

the Eleventh Five Year Plan.


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Fiscal Policies

The Union Budget has placed the fiscal deficit at 3.8 per cent of GDP for the year2006-07 as against 4.1 per cent in the previous year in the spirit of the FRBM Act,

2003.

The net market borrowing programme of the Centre for 2006-07 is budgeted atRs.1,13,778 crore as against Rs.95,370 crore in the previous year. While the size of

the Government borrowing programme is relatively larger than in the previous

year, this has to be viewed in the backdrop of the buoyant growth of the economy,

growing appetite of non-banks for government securities and the need for manybanks to strengthen their SLR portfolio for statutory as also for liquidity management

purposes.

Tax proposals

In Budget 2006-07, P. Chidambaram, Minister of Finance of the UPA II proposed

implementation of Goods and Services Tax (GST) by April 1, 2010.

Indirect Taxes:

Customs

Peak rate for non-agricultural products reduced from 15 per cent to 12.5 per cent.

Reduction of customs duty on 10 anti-AIDS and 14 anti-cancer drugs to 5 per cent; on

certain lifesaving drugs, kits and equipment from 15 per cent to 5 per cent; these

drugs also exempt from excise duty and CVD.

Concessional project rate of 10 per cent to be extended to pipeline projects for

transportation of natural gas, crude petroleum and petroleum products.

Rates on clearances by EOUs to the Domestic Tariff Area (DTA) adjusted at 50 per

cent of basic customs duty plus excise duty on like goods.

Direct Taxes

No change in rates of personal income tax or corporate income tax;

No new taxes are being imposed.

Marginal revision in certain tax rates in the quest for equity-Minimum Alternate Tax(MAT) rate increased from 7.5 per cent of book profits to 10 per cent which is only

one-third of the normal rate; long-term capital gains arising out of securities included

in calculating book profits; period to take credit for MAT increased from five years to

seven years.

Fringe Benefit Tax (FBT) introduced last year as a revenue raising measure; justified

on the principles of horizontal equity and vertical equity.


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Service tax

New services to be covered including ATM operations, maintenance and

management; registrars, share transfer agents and bankers to an issue; sale of spaceor time, other than in the print media, for advertisements; sponsorship of events, other

than sports events, by companies; international air travel excluding economy class

passengers; container services on rail, excluding the railway freight charges;business support services; auctioneering; recovery agents; ship management

services; travel on cruise ships; and public relations management services.Coverage of certain services now subject to service tax to be expanded.

Leasing and hire purchase to be treated on par with loan transactions, interest andinstalment of principal amount to be abated in calculating value of the service.

Proposal to set April 1, 2010 as the date for introducing national level

Goods and Service Tax (GST); service tax rate increased from 10 percent to 12 per

cent as another step towards converge between service tax rate and the CENVAT rate;

net impact likely to be very small in view of credit available for service tax or exciseduty payable.

Inflation

Headline inflation for 2005-06 was lower than anticipated. While increased

competition and productivity gains in several sectors have also contributed to some

moderation in inflation in the recent period, policy measures have ensured low and

stable inflation expectations. The pass-through of international oil price increase has

been only partial and the second round effects in India have so far turned out to belower than anticipated earlier. Taking into account the real, monetary and global

factors having a bearing on domestic prices, containing inflationary expectations

would continue to pose a challenge to monetary management. The policy endeavour

would be to contain the year-on-year inflation rate for 2006-07 in the range of 5.0-5.5

per cent.

Consumer Price Index (CPI)

Consumer price inflation measured both by the CPI-UNME (Urban Non-ManualEmployee) and CPI-IW (Industrial Worker), which had stabilized around 4% in 2005,

started to move up beginning November 2005, when both the above indices reportedinflation of 5% or higher. An analysis of the CPI-IW by component indicates that the

principal contributor to inflation has been food. The rate of inflation in the CPI-IW

index of food (weight of 46% in the new series)went up from an average of 2.5%

during the 10-month period Jan-Oct 2005 to 5.8% during the next 6-month period of

Nov 05-Apr 06. In May 2006 this went up further to 8.0%. Thus, of the total CPI-IWinflation rate of 6.3% in May 2006,as much as 58% (higher than its weight in the index)


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was on account of food items alone. The other important contributor to CPI-IW inflationwas housing which had averaged a rate of 6.6% in the first 6 months of 2006. In June

2006, the CPI-IW had risen to 7.6% and the CPI-UNME to 6.5%.

Wholesale Price Index

As per the latest data available, inflation as measured by the Wholesale Price Index

(WPI) was recorded at 4.6% for the week ending 29 July 2006. WPI inflation forprimary food had touched 8.3% in the first week of June 2006, a sharp step-up fromthe beginning of April when it was 5.9%. This has since declined to 4.4% by the end

of July 2006.Food grain prices were higher by 9.5% at the end of the second week of June, but

have since declined to 7.3% by end-July 2006.Wheat prices rose by 12.9% at the end of March just before the rabi harvesting season.

The inflation rate has since declined, but remained over 10% in early June, andreached 7.9% by July 29.

The prices of pulses have risen sharply and continuously from 18-20% in January 2006to over 25% in March and to 33% between April and June.Although there has been some moderation in recent weeks, this has been modest with

the inflation rate in end-July still as high as 28%.The WPI price index for fruits & vegetables remained subdued till the end of May and

rose to 6.3% by the first week of June. Much of the agitation on this front came fromretail prices which skyrocketed in certain markets in May and June. In the most recent

week, the index for fruit & vegetables has declined by as much as 6.8% from its peak

value in the third week of June.

Monetary Policy

The Third Quarter Review of January 24, 2006 noted that risks to growth and stability

are high from rising domestic demand, the incomplete pass-through of crude prices

into domestic prices and from global developments. Emphasising the need to shore

up the gains of recent high growth, the monetary policy stance was articulated in

favour of a greater emphasis on price stability through measured but timely and even

pre-emptive policy action to anchor inflation expectations.

Developments in the ensuing months vindicate this pro-active monetary policy

stance. With inflation contained and inflationary expectations evolving consistent

with the policy stance, real growth has quickened in an environment of price andfinancial stability, raising expectations of a structural shift in the medium-term

growth path of the economy. Monetary policy has been particularly effective in

ensuring that the cost-push impulses from oil prices have not fed through into

aggregate demand conditions. In the external sector, the current account deficit has

remained within manageable proportions, comfortably financed by buoyant capital


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34

flows. Monetary management during 2005-06 was conducted broadly in conformity

with the stance of the policy set out in the policy statements during the year.

Trade and balance of payments

During the current year 2006-07 exports are expected to reach the target of US $ 125billion if the present rate of growth of exports is maintained during the last quarter of

the year. The sustained growth of merchandise exports at more than 20 per cent

during the last few years is more than twice the growth of Gross Domestic Product

(GDP).

India's trade deficit widened 40.5 percent in the fiscal year that ended in March to$56.74 billion, and analysts said a strong rupee would hit exports further in months to

come.

Current Account:

Exports of goods increased by 21 % during 2006-07 compared to 23 % in 2005-06.Exports grew mainly on account of tea, spices, and engineering and petro goods.

Imports growth at 22 per cent in 2006-07 (32 per cent in 2005-06). Imports grew mainly

on account of non-oil imports and not oil-imports as it has generally been the case.

Non-oil imports increased by 25% in 2006-07 (21.8% in 2005-06). The major non-oil

import items were capital goods, metalliferrous ores, metal scrap and gold and silver.

Crude oil imports during 2006-07 recorded some moderation in growth at 30.4 %

(47.3 % in 2005-06). The slowdown in oil imports was largely because of a moderationin crude oil prices. The average price of the Indian basket of international crude (a

mix of Dubai and Brent varieties) stood at $ 62.4 per barrel during 2006-07 as

compared with US $ 55.4 per barrel during 2005-06. This implies that the prices

increased by 13% in 2006-07 much lower than 42% increase seen in 2005-06. In

volume terms, the oil import demand rose to 13% in 2006-07 from 8 % in 2005-06,

tracking the growth in industrial sector.The service exports increased by 37% in 06-07 compared to 68% in 05-06. Software

exports increased by 29% on 06-07 compared to 35% in 05-06.

Capital account:

FDI has a larger share in foreign investments than FII, a trend last seen in 2002-03.Outward FDI and FII have also grown sharply at 273% and 85%, showing Indians

appetite for investing abroad is increasing.

External Commercial Borrowings have grown at a shocking rate of 491% this year and

are now at about USD 16 billion. That is why RBI revised the rates corporates can pay

for ECB.The total capital flows have increased by 92% and despite the increasing current

account deficit, we have a huge BoP surplus at USD 36.6 billion, an increase of 143%.


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35

Exchange RateToward the end of 2006, foreign exchange inflows, especially of dollars, into India

started rising sharply. This put upward pressure on the rupee's exchange rate against

the dollar. India's steady economic growth offered several opportunities for foreigncompanies. Between April 2006 and March 2007, FDI of $ 16 billion flowed in to India.

The rupee's appreciation against the dollar was seen to be beneficial to the Indianeconomy in some ways, and detrimental in other ways. The rise in the value of rupee

meant that inflation was curbed. The inflation rate in India declined from 6.73 percent

in February 2007 to 4.10 percent in August 2007.In June, 2007, the Economist Intelligence Unit estimated that for the year 2007, the

rupee's average annual exchange rate against the dollar would be 41.3 (a 13.5 percentreal appreciation year on year), and for the year 2008, it would be 40 (6 percent)

Extraneous Factors:

Stock Market:

Since the second week of May 2006, equity markets across the world have beennegatively affected by a widespread re-rating of risk, from interest and exchange

rates to petroleum prices to intensification of conflict in West Asia.

These developments have reflected a big increase in risk perception (or premium)

which has resulted in the withdrawal of funds from some of these markets. During the

current financial year, net sales by foreign institutional investors (FII) in Indiaamounted to nearly US$ 1 billion (most of it in May) till the end of July 2006 although

year-to-date inflows for calendar 2006 continue to be positive at over US$ 2.9 billion.Nevertheless the Indian market continues to enjoy fairly high price earning

(historical) multiples.

The sharp weakening of equity markets after 10 May 2006 was due to mountingdisquiet with regard to the aggressive pricing of risk that had characterised a long

period of robust growth, high levels of business confidence and strong recovery in

corporate profitability. Other global factors fuelled this concern further.

Broadly emerging markets lost between 5% (e.g. Poland, Czech Republic andMexico) and 15% (India, Indonesia, Thailand, Taiwan and Russia). Amongst industrial

economies, losses were somewhat lower from 2% in Britain and Switzerland to 7% inGermany and 10% in Japan, Sweden and the US (NASDAQ). China (Shanghai) has

been an outlier in 2006, but that is partly due to its poor performance in 2005 and in

2004.

Industrial SectorIndian Industries have entered in to an atmosphere of higher competition in the era of

globalization.The resilience shown by the industrial sector against the hardening of global oil prices

is reflective of inherent strengths and capabilities that the industrial sector has built

up over the years since the initiation of economic reforms in the country.


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36

Besides higher levels of investment, issues of governance and management includingpolicies relating to appropriate pricing and user charges would need to be addressed

to achieve satisfactory results. Given the rising international crude oil prices andstagnant domestic crude oil production, an integrated approach to efficient use of

energy - both oil and non-oil energy resources - assumes importance.

Services Sector

India's services sector has grown very fast as it holds a larger portion of young

peoples. The educated young masses in India have brought tremendous success for

the country in the recent years. The services sector in the country has benefited from

the availability of vast skilled labour. In the coming years, India is expected to benefit

further from the demographic dividend emanating from a higher proportion of

younger population. There is need to improve the availability of educational facilities

at all levels - primary, secondary and tertiary - to equip the labour with the necessary

skills to maintain current competitive advantage.

External Sector

The external sector of the Indian economy is also performing better. India is in a path

to capture 1% of the global trade in the near future. Merchandise export growth of 24per cent per annum, on average, in the past four years points to the growing

competitiveness of Indian manufacturing. Improvements in infrastructure assume

critical importance for maintaining and improving our competitiveness as also

encouraging investment in export production and sustaining the pace of export

growth in the longer term.

For the full potential of earnings from exports of services to be realised, issues relatingto skill enhancement and quality of education assume greater importance. Demand

for education, especially higher education, is expected to grow immensely in thecoming years in view of the demand emanating from knowledge intensive nature of

the services sector as well as demands from the manufacturing sector.


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37

Review and Analysis (2003-2007)

Tenth 5 year plan: (2002-2007)

The primary aim of the 10th Five Year Plan is to renovate the nation extensively,

making it competent enough with some of the fastest growing economies across theglobe.

Targeted GDP growth rate of 8% per annum.

Increasing the mobility of all the available financial resources of India, and

optimizing them as well.

Setting up of a state-of-the-art infrastructure for all the existing industries in

India.

Encourage the initiative of capacity building within the Indian industrial sector.

Creating a friendly, amiable and pleasant investment environment in India.

Encouraging sufficient transparency in the corporate sectors of India.

Introduction of reforms in the industrial sectors, which are more investor-

friendly in nature.

2003-04 the fiscal deficit was pegged at 4.73%, the growth envisaged for the Union

excise duties and customs was even lower revenue expenditure was budgeted to

grow over 7.2% over 2002-03 to Rs. 3,66,227 crores. Fiscal and revenue deficits werebudgeted 5.6% and 4.1% of GDP. From 2004 to 2007 there was a decline in the fiscal

deficit from 4.4 to 3.8 in the backdrop of the buoyant growth of the economy, growingappetite of non-banks for government securities and the need for many banks to

strengthen their SLR portfolio for statutory as also for liquidity management purposes.

4.734.4

4.13.8

2003-04 2004-05 2005-06 2006-07

Fiscal deficit(% of GDP)


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38

In 2003-04 the rupee appreciated by 5.3 per cent in 2003-04 vis--vis the US dollar,

this weakening of the US dollar was caused mainly by widening US deficits. In 2004-

05 the ebbing of capital flows, the rising demand for imports and the surge in

international oil prices drained away the excess supplies, leading the Indian rupee to

depreciate against the US dollar by 4.5%Toward the end of 2006, foreign exchange inflows, especially of dollars, into India

started rising sharply. This put upward pressure on the rupee's exchange rate againstthe dollar. India's steady economic growth offered several opportunities for foreign

companies.

IN 2003-04 Imports have been growing at a compounded annual average growth rate

(CAGR) that is 4 per cent higher than that of exports over the same period. This is the

cause of Indias burgeoning current account deficit. In 2004-05 the deficit was caused

by a burgeoning excess of merchandise imports over exports. In 2005-06 the heavy

demand for imports arising from increasing buoyancy and robustness of Indian

46.57

45.12

43.92

41.48

2003-04 2004-05 2005-06 2006-07

Exchange rate

2.3

-0.8

-1.3-1.1

2003-04 2004-05 2005-06 2006-07

CAD(% of GDP)


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39

industry may have led to a sustained rise in growth of merchandise imports. In 2006-

07 the current account deficit has remained within manageable proportions,

comfortably financed by buoyant capital flows.

2003-04 GDP is estimated to have grown by a sharp 8.2 per which was possible dueto one of the most bountiful monsoons in years in India, however in 2004-05 modest

expectations were further pared down to around 6.1 per cent when rainfall, became

deficient in the crucial sowing month of July and the shortfall in the south-west

monsoon turned out to be 13 per cent. 2005-06 saw moderate recovery in agricultural

sector thus increasing the GDP.T was in 2006-07 GDP growth of 9.2% was achieved

due to all around improvement in mining, manufacturing and services sectors, which

helped to offset the slower growth in agriculture sector

WPI

In 2003-04 WPI was 5.4 per cent on average. The manufacturing sector was the major

contributor accounting for nearly 80 per cent of the inflation. In 2004-05 was marked

by a hardening of domestic prices of coal, petroleum products, iron and steel and

other metals, reflecting lagged adjustments. In 2005-06 the deceleration in both

8.3

6.2

8.49.2

2003-04 2004-05 2005-06 2006-07

GDP

5.4

6.4

4.4

5.3

3.84.2 4.2

5.3

2003-04 2004-05 2005-06 2006-07

Inflation Trends

Inflation(WPI) Inflation(CPI)


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wholesale and retail prices, in the aftermath of the introduction of value added tax

(VAT) in most of the States. In 2006-07 food grain prices, pulses and fruits and

vegetable, etc. led the WPI to increase to 5.3%

CPI

In 2003-04 the high point-to-point inflation through much of 2003-04 and its sharp

deceleration in March 2004 were partly because of the carryover of the price increase

that took place in the last quarter of 2002-03.In 2004-05 Consumer price inflation

firmed up to 4.4 per cent in January 2005 mainly due to increase in the prices of fish,

meat, sugar, kerosene oil and housing. In 2005-06 The upward trend in consumer

prices was primarily on account of hardening of retail prices of vegetables and pulses.

During the year 2006-07 the increase in CPI can be attributed to increase in the prices

of food and housing.

Starting from 2003-04 the Fiscal deficit saw a steady decline from 4.73% to 3.8% in the

backdrop of the buoyant growth of the economy. Talking about the WPI, it treaded

upwards initially from 5.4% to 6.4% due to increase in the prices of food items but it

came down again to 5.3% due to the introduction of VAT across various states.

However, the CPI seems to be increasing due to the increase in food prices. The deficit

in Current account was caused by a burgeoning excess of merchandise imports over

exports. In 2005-06 The heavy demand for imports arising from increasing buoyancy

and robustness of Indian industry may have led to a sustained rise in growth of

merchandise imports. The trends in exchange rates from 2003 to 2007 showed a

robust economic growth and the widening of US deficits.

5.4 6.4 4.4 5.33.8 4.2 4.2 5.32.3

-0.8 -1.3 -1.1

46.57 45.12 43.9241.48

4.73 4.4 4.1 3.8

2003-04 2004-05 2005-06 2006-07

Economic indicators

Inflation(WPI) Inflation(CPI) CAD(% of GDP) Exchange rate Fiscal deficit(% of GDP)


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References:

indiabudget.nic.in

timesofindia.indiatimes.com

thehindu.com

Case: India on the moveHBS case study

Video: Political and economic views of contemporary India
http://www.thehindu.com/http://www.thehindu.com/http://www.thehindu.com/

macro economic overview 2003-07

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