The Economy

It still remains to be seen as to how many of the UPA government's intentions on economic reform actually become operational, and how many fail to make it out of the “consultative” process between the UPA allies.

The United Progressive Alliance (UPA) government has been in office for some five months now. Prime Minister Manmohan Singh's government has unsurprisingly reiterated its commitment to carrying the process of economic reforms forward. The nature of the alliance however is such, that the Left parties who are opposed to a sizeable component of the reform agenda, has till date been successful in stalling many of the UPA government's initiative—significant among them being the raising of Foreign Direct Investment (FDI) caps on telecommunication, airports and insurance that had been announced in the Budget speech in early July 2004. It still remains to be seen as to how many of the UPA government's intentions on economic reform actually become operational, and how many fail to make it out of the “consultative” process between the UPA allies.

The global economic outlook since mid-July 2004, when the last macro-review was written has softened further, with US economic data weaker-than-expected, and gross domestic product (GDP) growing in second (April-June) quarter by 3.3 per cent (on annualised basis), down from 4.5 per cent in the first quarter of 2004. It might also be noted that growth in each of the immediately preceding four quarters had been stronger—averaging 5.1 per cent.¹ Japan had a sizzling first quarter growth, on annualised basis, of 6.4 per cent, following on a spectacular 7.6 per cent growth in the fourth quarter of 2003. Since then however, conditions have turned down significantly with second quarter of 2004 having much lower growth of 1.3 per cent.² In the Eurozone, second quarter 2004 GDP grew by 2.1 per cent (on annualised basis), lower than the 2.8 per cent of the first quarter.³ At an aggregate level, however global output growth for 2004 was revised upward by the International Monetary Fund from 4.6 per cent in the April 2004 World Economic Outlook (WEO) to 5.0 per cent in the October WEO—due almost entirely to higher than anticipated output growth in emerging economies—from Asia to Latin America to East Europe and Russia.⁴

¹Gross Domestic Product: Second Quarter 2004 (Final): Bureau of Economic Analysis, US Department of Commerce, September 29, 2004

²The 2^nd Preliminary Estimate of National Expenditure April-June 2004, Economic and Social Research Institute, Cabinet Office, Government of Japan, September 10, 2004

³Second estimate for the second quarter of 2004, Euro-indicators, news release 123.2004 dated October 14, 2004, Eurostat.

⁴World Economic Outlook, International Monetary Fund, October 2004, Table-1.1.

High oil prices, and hence, inevitably higher energy prices across the board, besides importing inflationary pressures in consuming economies, have also eroded the potential economic upswing that had been expected to materialise in this year and the next.

Unemployment in advanced countries continues to remain at high levels, and forward movement in the stabilisation of West Asia does not yet look convincing. Crude oil prices have soared through the summer of 2004, fuelled by strong demand in Asia, as also elsewhere, continued tightness in supply positions, and what seems like an unending sequence of crises affecting producer nations, all working together to take prices to levels that had not seemed possible early in 2004. High oil prices, and hence, inevitably higher energy prices across the board, besides importing inflationary pressures in consuming economies, have also eroded the potential economic upswing that had been expected to materialise in this year and the next.

The security environment in India remains stable, having improved dramatically through 2003. The UPA government has continued to move to de-escalate tensions with Pakistan, and the evidence of infiltration across the Kashmir line of control (LoC) this summer, does tend to indicate further improvement. However, internal difficulties within Pakistan, as General Musharraf's government tries to contain the jehadist Frankenstein, continue to imbue the western front with security concerns. Insurgent activities in the north-eastern parts of India, assisted by the nebulous nature of state control and accountability in the bordering regions have heated up in spots and also pose a source of serious concern. The inability of the political establishment in Nepal to achieve pacification of the Maoist guerrillas also continues to create unsettled conditions. However, if the normalisation of relations with China proceeds with speed and the ground conditions in Pakistan improve, the other hotspots that continue to fester on India's other borders will perhaps become somewhat easier to deal with.

Economic Growth

At the end of September 2004, the Central Statistical Organisation (CSO) estimated that GDP growth in the first quarter (April-June) 2003–04 was 7.4 per cent.⁵ In sectoral terms that comprised a 3.5 per cent expansion in GDP arising out of agriculture & allied activities, 6.8 per cent growth in industry and 9.5 per cent growth in services [see Table 1.2]. The expansion in agriculture in the first quarter derived mostly from the bumper rabi (winter) crop of last year, quite a bit of which is harvested and processed in the months of April and May. The strong outturn in the service sector had much to do with the growth of 9.3 per cent in “community, social & personal services” (that includes government), which quite plausibly was linked to the parliamentary elections held in May 2004. Had “community, social & personal services” expanded at a more normal rate of 6 per cent, then service sector growth would have been 8.6 per cent (comparable to the annual average of 8.7 per cent in 2003–04) and overall GDP growth in the April-June quarter of 2004 would have been 7.0 per cent. The expenses associated with the May 2004 elections, it is thus not entirely indefensible to conclude, provided at least a 0.4 percentage point boost to first quarter GDP growth in 2004–05.

⁵Quarterly Estimates of Gross Domestic Product, April-June 2003–04, Central Statistical Organisation, September 30, 2004.

Table 1.1

Sectoral annual growth rates in the decade post-reform

	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005* (forecast)

GDP at factor cost	5.9	7.3	7.4	7.8	4.8	6.6	6.0	4.4	5.8	4.0	8.2	6.3
Agriculture & allied activities	4.1	5.0	−0.9	9.6	−2.4	7.1	0.5	−1.4	6.8	−5.2	9.1	−1.0
Non-agriculture	6.7	8.5	10.9	7.1	7.6	6.4	8.1	6.3	5.5	6.9	8.0	8.4
Of which: Industry	5.2	10.2	11.7	7.0	4.3	3.4	5.3	6.5	3.3	6.4	6.7	7.6
Services	7.7	7.1	10.4	7.2	9.8	8.2	9.7	6.2	6.6	7.1	8.7	8.8
Memo items
Manufacturing - registered and unregistered	8.5	12.0	14.9	9.7	1.5	2.5	4.4	7.1	3.7	6.2	7.3	8.0
Trade, hotels, transport, & communication	7.1	10.4	13.3	7.8	7.7	7.1	8.3	7.8	8.6	7.0	11.2	10.5
Finance, insurance, real estate & business services	13.4	5.6	8.2	7.0	11.6	8.4	9.6	3.5	4.5	8.8	6.8	7.5
Community, social & personal services	3.5	3.2	7.9	6.3	11.7	9.9	12.1	6.1	5.3	5.8	6.0	7.1

Note: Forecast for financial year 2004–05 based on available data and general indicators.
Source: Data for all years up to 2003–04 from Central Statistical Organisation, various press notes up to June 30, 2004.

Table 1.2

Sectoral quarterly growth rates—year-on-year basis

	2001–02				2002–03				2003–04				2004–05

	Q1	Q2	Q3	Q4	Q1	Q2	Q3	Q4	Q1	Q2	Q3	Q4	Q1

GDP at factor cost	4.7	5.4	6.2	6.6	5.1	5.5	2.0	3.7	5.3	8.6	10.5	8.2	7.4
Agriculture & allied activities	4.3	7.0	6.2	9.7	0.6	2.9	9.8	6.3	0.1	6.8	16.5	16.0	3.8
Non-agriculture	4.8	5.0	6.2	5.7	6.5	7.6	6.8	6.7	6.9	9.0	8.4	7.7	8.5
Of which:Industry	1.9	2.6	3.8	4.9	5.3	7.2	6.8	6.4	6.0	6.3	6.4	7.9	6.8
Services	6.5	6.4	7.5	6.2	7.2	7.8	6.8	6.9	7.4	10.4	9.5	7.6	9.5
Memo items
Manufacturing—registered and unregistered	3.2	3.4	3.7	4.4	4.0	6.7	6.9	7.3	6.6	7.4	7.5	7.5	8.0
Trade, hotels, transport, & communication	7.7	9.0	8.1	9.6	6.4	7.4	6.5	7.7	7.3	9.9	13.3	13.0	10.5
Finance, insurance, real estate & business services	4.4	5.0	4.8	3.9	9.6	9.8	8.6	7.5	5.7	6.4	6.5	8.0	7.0
Community, social & personal services	6.5	3.4	9.2	2.9	6.2	6.4	5.6	5.1	9.4	15.2	5.3	4.0	9.3

Source: Central Statistical Organisation, Quarterly Estimate of Gross Domestic Product—Press Notes up to September 30, 2004.

The estimate of GDP growth in 2003–04 was revised marginally upward in June 2004 from 8.1 per cent to 8.2 per cent. In sectoral terms this comprised 9.1 per cent expansion in agriculture, 6.7 and 8.7 per cent growth in industry and services respectively [see Table 1.1], with non-agriculture growing at the rate of 8.0 per cent.

In the previous issue we had remarked on how the large volatility of growth in the agriculture sector, which following the waywardness of the monsoon, was largely responsible for the observed volatility in aggregate GDP growth over the years. In some contrast, the non-agricultural sector—that is, industry and services—has demonstrated lower volatility and that too, at a fairly high level of growth. For the seven-year period between 1997–98 and 2003–04, the average of annual GDP rates of growth was 5.9 per cent, that for agriculture 2.1 per cent, industry 5.1 per cent and services 8.0 per cent. The non-agricultural sector as a whole grew by 7.0 per cent. The purpose of taking the period starting from 1997–98 is because it: (a) excludes the very rapid expansion in manufacturing that followed after the initiation of the reform programme; and (b) it excludes the effect of the big bounce that agriculture received in 1996–97, in part courtesy of a contraction in the previous year. Taking standard deviation as a measure of volatility, aggregate GDP growth in the period had a value of 1.36 per cent, while for the non-agricultural sector it had a much lower value of 0.90 per cent. Agriculture & allied activities quite unsurprisingly had a much higher standard deviation of 5.13 per cent.

It has been argued that some of the growth in the latter part of the 1990s was due to the effects of the higher salary payouts arising from the implementation of the Fifth Pay Commission, beginning 1997–98. The direct impact of this is of course evident in the “public admin-istration” component of the services sector, though surely second order and subsequent effects would have been manifest in other sectors. If we take the “public administration” component out, then for the period 1997–98 to 2003–04, the average annual growth rate of GDP less this component was 5.6 per cent and the standard deviation was 1.46 per cent. Similarly, for the non-agricultural sector (with public administration excluded), the average annual growth was 6.9 per cent and the standard deviation was 0.81 per cent.

In looking at the outlook for economic growth, one must take explicit cognizance of the fast growing and more stable trajectory of growth of the nonagricultural sector, quite separately and distinct from what happens to agriculture.

The upshot of all this is the reiteration of a point that we have repeatedly made in this journal, namely that in looking at the outlook for economic growth, one must take explicit cognisance of the fast growing and more stable trajectory of growth of the non-agricultural sector, quite separately and distinct from what happens to agriculture. Undoubtedly there are linkages, but at best they are numerically not that significant. Furthermore, the dominant factor which is defining whatever linkage truly exists, is likely to be the fact that the geographical sub-set of agriculture that makes up a disproportionately large share of the rural market for manufactures and other modern services, namely the richer farm belts of north-western India, and some of the fertile southern deltaic and commercial crop growing regions, are relatively insulated from the vagaries of the monsoon.

Outlook for 2004–05

It is reasonable to expect that the kharif crop will be smaller than last year, and even if the rabi crop does well, on the aggregate some contraction in overall GDP arising from the sector for the full year is very likely.

The exceptionally high rate of growth in 2003–04 was owed in large measure to the rebound of agriculture from the depths that it had plunged to in the previous year, because of the widespread failure of the south-west monsoon of 2002. Even had the monsoon in 2004 been a satisfactory one, it is most unlikely that we would have had more than a marginal expansion of incomes in the farm sector. In the event the SW monsoon 2004 turned out to be deficient to the extent of 13 per cent in terms of total precipitation. While in 2003 only three meteorological sub-divisions had suffered deficient rainfall, in 2004 the figure was 13. It is difficult to see how there will not be a contraction in aggregate output, even if the irrigated north-west which bore the brunt of the deficiency is less susceptible compared to the dry lands of the peninsula. It is reasonable to expect that the kharif (summer) crop will be smaller than last year, and even if the rabi (winter) crop does well, on the aggregate some contraction in overall GDP arising from the sector for the full year is very likely. We estimate a 1 per cent decline in the GDP from the farm sector [see Table 1.1].

Our estimates for the different components of industry and services are based on a combination of the trends apparent over the past several quarters, industrial production and trade data available up to August/September and other indirect indicators of output expansion, besides the anecdotal evidence—admittedly mostly gleaned from the corporate experience. On that basis we see a stronger performance in manufacturing and other industrial sectors and a continuation of the expanding trend in other parts of the service sector. Key numbers are placed in the extreme right hand column of Table 1.1, with the estimate of aggregate GDP growth at 6.3 per cent; that for industry at 7.6 per cent and for services at 8.8 per cent, with non-agriculture together doing 8.4 per cent. Manufacturing output growth has averaged 8 per cent for calendar year 2004 (January to August), and we expect that its GDP counterpart would approximate this value for the complete fiscal year 2004–05.

In the previous issue (July 2004) we had projected growth for 2004–05 of around 6.6 ± 0.1 per cent, that is, 6.5–6.7 per cent. In the issue prior to that (March 2004) we had estimated growth at 6.4 per cent. Both of these projections had taken into account a small expansion in agriculture of about 1.7 per cent—with a small upside in the July forecast, since the monsoon conditions till early July was very good. Confidence in the mounting strength in manufacturing and other industries, as well as in the service sector was however the primary reason to slightly up the forecast in July. Compared to conditions then, we have further upped our estimate of growth from the non-agricultural sector from 8.0 to 8.4 per cent, while building in a likely contraction in the agricultural sector.

Official Forecast

The Reserve Bank of India (RBI) in its Mid-year Policy Statement of October 26, 2004, has brought its growth forecast down to 6.0 to 6.5 per cent, from its earlier projection of 6.5–7.0 per cent. Our analysis as given above is in broad agreement with the central bank's present position.

Savings and Investment—An Estimate for 2003–04

National accounts data for GDP by disposition continue to be made available with nearly a year's delay at the end of January of the following year, and the provisional figures generally are significantly revised in the next year. Thus, at the moment we still have to make do with the provisional estimates for 2002–03 and the revised estimates for 2001–02. However, the RBI does make available the savings of households that are made in the form of financial assets for the previous financial year in its Annual Report for the year. Households in the parlance mean individuals and unincorporated business. In 2003–04, gross financial savings of households increased to 15.1 per cent of GDP from 13.6 per cent in the previous year.⁶ The liabilities of households to the banking system rose to 3.2 per cent of GDP, from 2.9 per cent in the previous year. Thus, the net financial savings of the households available for the rest of the economy (including government) to borrow stood at 11.8 per cent of GDP in 2003–04, up from 10.7 per cent in 2002–03—a significant increase of 1.1 percentage point of GDP.

⁶Table 2.18, Annual Report 2003–04, Reserve Bank of India, August 2004.

The RBI Annual Report estimates that the revenue deficit of the Central and State governments declined from 6.6 per cent in 2002–03 to 6.2 per cent of GDP in 2003–04 on the basis of revised estimates (RE).⁷ Although there is some difference between RE and the audited accounts it generally is not large enough to make a difference beyond the second place of decimals. The revenue deficit as computed by the budgetary process is not the same as that done by the national accounts process and hence there is a difference between the budgetary revenue deficit and the measure of the negative savings or dissavings by the government system in the national accounts statistics (NAS). For 2002–03 the NAS estimate of government dissavings was 5.7 per cent of GDP, somewhat lower than the 6.1 per cent of 2001–02.⁸ The budgetary revenue deficit in 2001–02 had been 7.0 per cent and had come down to 6.6 per cent in 2002–03, which was a 0.4 percentage point of GDPdecline—exactly of the same magnitude as the reduction in the NAS measure of government dissavings (from 6.1 to 5.7 per cent of GDP). By the same token it is plausible to infer from the reduction in 2003–04 of the budgetary revenue deficit from 6.6 to 6.2 per cent of GDP that the NAS measure of government dissavings in 2003–04 must have declined by close to 0.4 percentage points relative to 2002–03. That gives us an estimate of 5.3 per cent for the negative savings of government in 2003–04.

⁷Ibid. Chapter IV.

⁸National Accounts Statistics, January 2004, Central Statistical Organisation.

Starting with the numbers for net financial savings of households and the dissavings of government, we can work our way towards making a reasonable estimate of what might have been the magnitude of savings in the economy in 2003–04. That is, excluding the “savings in physical assets”—a number that broadly corresponds to the physical assets (and inventory) constructed by households and unincorporated business. Total domestic savings less “savings in physical assets” basically corresponds to the financial resources that are available to the private corporate and public sector (government and state-owned companies) for capital accumulation. The current account deficit,⁹ which is the net foreign savings available for financing domestic investment, links this savings estimate to investment made by corporates and government. For the sake of convenience, we shall refer to the ratio of this component of investment (representing the domestic and international financial resources used by private corporates and the public sector for capital formation) to GDP, as [part] investment ratio, so as to distinguish it from the overall investment ratio, which includes the “savings in physical assets”.

⁹ The definition of current account balance used in the NAS differs from the RBI reportage, since it excludes official current transfers and excludes the adjustment that the RBI has begun to make for reinvested earnings of foreignowned companies in India and Indian-owned companies overseas.

We take a marginal improvement in the retained earnings of state-owned corporates to 3.8 per cent in 2003–04, relative to 3.7 per cent in 2002–03 and no change in the retained earnings of departmental enterprises. That then gives us an overall dissaving for the public sector at 1.4 per cent, compared to 1.9 per cent of the previous years and the 2.7 per cent of 2001–02.

Private corporate savings (retained earnings) have improved significantly in 2003–04, relative to the previous year and we estimate that this number as a proportion of GDP would be 3.6 per cent, which is a small improvement over the 3.4 per cent of the previous year.

The combination of the above gives us an estimate of 14.1 per cent for gross domestic savings in 2003–04, compared to the reported NAS number of 11.9 per cent in the previous year. However, if we were to factor in the RBI revised estimate of household financial savings in 2002–03 as available in this year's Annual Report, then assuming all other things unchanged, the aggregate domestic financial savings number for 2002–03 would be 12.3 per cent—but still quite a bit lower than the estimate of 14.1 per cent for 2003–04. Net capital inflow (NAS current account deficit) was −0.5 per cent of GDP in 2002–03 and has risen to −1.4 per cent in 2003–04. The negative sign of course indicates that there was a current account surplus. Knocking this off, what we get is that the financial resources available to government and private corporate sector for capital formation in 2003–04, that is, 12.6 per cent of GDP, represented an increase by 1.7 percentage points of GDP over the reported number, and perhaps 1.3 percentage points of GDP greater than what might eventually be the revised number for 2002–03. That gives us an improvement in the range of 10–14 per cent in the [part] investment ratio. While such an order of increase in the [part] investment ratio is quite significant, one must hasten to add that the same measure has had higher values for much of the 1990s.

An increase in the [part] investment ratio actually means that the real growth in the relevant variable was indeed larger. Thus, investment by corporates and government in 2003–04 must have grown by between 18 and 22 per cent in real terms (using the implicit GDP deflator, not an investment-specific deflator). We of course do not know what happened with the category “investment/savings in physical assets” i.e. the household and unincorporated sector. Assuming that this ratio remained unchanged (12 per cent) in 2003–04, then, the overall investment rate would have risen from 23.9 per cent in 2002–03 to 24.6 per cent of GDP in 2003–04. That is, an increase of between 5.4 and 7.1 per cent in the aggregate investment ratio, which corresponds to areal growth of 13.6 to 15.3 per cent. If we remember that comes on top of a 10.7 per cent increase in real fixed capital formation in 2001–02, we get a sense of what might be happening in investment activities and what is driving the current growth process.

Investment and Accelerating Growth on a Sustained Basis

In the previous issue, we had presented a chart plotting the rate of increase in fixed capital formation at constant prices in terms of institutional classes which seemed to reinforce the anecdotal evidence that there is likely to be an in-phase expansion of fixed asset creation by the private corporate sector, public corporate sector, unincorporated businesses and government. Although, no additional data has since become available we are reproducing it in Chart 1, in so far as the issue is of considerable live interest in the light of the evidence of rising investment in the form of higher credit off-take by the commercial sector from the banking system, and the strong growth of both output of the domestic machinery sector and the import of equipment, besides the anecdotal corporate investment story. We have also placed the estimate that we have made above for 2003–04 in the chart for total investment only—the portion marked out in a circle. Chart 1Rate of change in fixed capital formation by ownership categories

Since 1998, there has been an ongoing process of consolidation in the Indian private corporate sector—the first in its history in fact.

We have discussed in the previous issue the question of the divergent behaviour of private corporate and unincorporated businesses, but it is certainly worth reiterating here. After the splurge of investments in the immediate post-reform period, many large firms that had grown up in a culture of permissive bank lending and protective tariffs, suddenly found themselves over-leveraged and in poor shape to take on competition—both domestic and global. Since 1998, there has been an on-going process of consolidation in the Indian private corporate sector—the first in its history in fact. In consequence, firms that had the financial capacity to expand focused their attention on acquiring revenue-earning assets. In consequence, fresh investment in fixed asset creation was temporarily swamped by investment in acquisition, write-offs and laying-off of surplus labour. This behaviour was restricted to large corporates and held little meaning for unincorporated businesses, where fresh investment almost inevitably had to mean fresh asset creation. Hence most likely, the variation in the behaviour between the two parts of the Indian private sector.

The urgency to accelerate economic growth—both as the obvious imperative for achieving higher employment and incomes and lower poverty and as an outcome, conditions that permit success in re-election—has encouraged the political establishment to raise the bar, so to say.

Over the first three years of the new millennium (2000–01 to 2003–04), average GDP growth has been 5.6 per cent, while average per capita GDP has risen by 3.8 per cent, certainly not much comfort, and at a great distance away from the promise of the early years following economic reform. Leave alone the years of strongest growth between 1993–94 and 1996–97, even that for the entirety of the decade of the 1990s post-reform (including 1993–94), average GDP and per capita GDP growth were much higher at 6.5 and 4.6 per cent, respectively. Sluggish agriculture in this case is not the culprit, as the nonagricultural component of the economy which grew at an average rate of 7.9 per cent through the post-reform 1990s, registered a growth of 6.7 per cent in the immediate post-2000 years. The urgency to accelerate economic growth—both as the obvious imperative for achieving higher employment and incomes and lower poverty and as an outcome, conditions that permit success in re-election—has encouraged the political establishment to raise the bar, so to say. The previous National Democratic Alliance (NDA) government had some years ago decided that the target rate of economic growth in the Tenth Plan (2002–07) period ought to be raised to 8 per cent. The UPA government has unsurprisingly taken a more realistic call at above 7 per cent, perhaps 7.5 per cent.

The Baseline and Accelerating from it

Where is the economy today, in terms of the baseline—that is, the level of economic growth which would be sustainable if things were to continue more or less as they presently obtain? Agriculture & allied activities has over the past decade averaged growth of 2.8 per cent, but through the year-to-year gyrations it has been falling and the average rate over the previous five years is 2.0 per cent, and were we to include the current fiscal, then the underlying rate may well be discerned to be a little lower than 2.0 per cent—somewhere closer to 1.75 per cent. Industry and services—that is, non-agriculture—is more tightly clustered around 7.0 per cent in the previous five-year period, but it is on the rise, and the sustainable rate is probably 7.5 per cent. That gives us a baseline growth for aggregate GDP of 5.9 per cent, say 6.0 per cent.

If the level of investment optimism that exists currently can be maintained, it is not inconceivable that industry and services will be able to average output expansion of 8.5% on a sustained basis, with some help from the policy side and some easing of infrastructural bottlenecks.

If we wish to lift this to 7.0 per cent, and agriculture does not slip any more (that is, it continues to grow at close to 2 per cent annually on an average basis), the non-agricultural component, namely industry and services will have to accelerate to 8.5 per cent. If the level of investment optimism that exists currently can be maintained, then it is not inconceivable that industry and services will be able to average output expansion of 8.5 per cent on a sustained basis, with some help from the policy side and some easing of infrastructural bottlenecks, which again for the most part emanate from policy constraints. Sustained GDP growth of 7.0 per cent would see per capita GDP rise annually by over 5.3 per cent, which in the presence of other policy instruments should result in considerable reduction of poverty and increase in employment.

Raising the sustainable level of growth to 7.5 per cent and more (and per capita income growth closer to 6 per cent), in the absence of a very large increase in the rate of growth of agricultural incomes (to above 4 per cent), would need that non-agriculture output expansion is lifted up to over 9 per cent. That is not inconceivable, but would need a much larger magnitude of creative policy intervention. Significant changes in the policy regime and the structure by which such policies are effectuated will be needed to provide a big boost to manufacturing activity, which in the present stage of economic development, appears to be the only way to push non-agricultural output growth on a sustained basis to over 9 per cent. That includes removing the clutter that makes for instance, electricity generation and distribution an unviable business proposition in most parts of the country, and forces enterprises to choose to remain in the “unorganised” sector, rather than enter the regulatory jungle that the “organised” sector is rewarded with. It certainly includes improving the efficiency of public expenditure which accounts for a very sizeable 30 per cent of GDP and improving the channels by which enterprises have access to the credit and capital markets. These are not infeasible, nor implausible targets, but they are very tough to get significant traction on.

The private corporate sector following significant restructuring is much stronger today. The extent to which the principal growth agent—private enterprises from farm to corporate—can be provided the space to maximise his/her efforts is something that is the outcome of the governance process. How successfully the UPA government will traverse this path is a call that is difficult to make, for intentions alone do not craft the final outcome. The political hurdles that have been clearly presented by some of the government's allies to several of its stated intentions make the whole business somewhat difficult to predict.

World Crude Oil Prices

Current Atlantic benchmark crude prices of close to and on occasion over $55 per barrel (/bbl) for WTI and $50/bbl for UK Brent were certainly not something that anyone expected at the beginning of 2004. For much of 2003, UK Brent was fairly steady at around or over $30/bbl and that was the way the year ended. The prospect that with the fall of Saddam Hussain, Iraqi crude would flow in quantity into the market had seen prices fall sharply to $25/bbl in April and May 2003, but that expectation soon changed into a longer wait as the grim postwar situation in Iraq began to unfold. The increase by as much as $20/bbl or by a whopping 40 per cent between January and September 2004 was not the outcome of any single event, but the fallout of a complex set of factors.

The widespread assumption that the resumption of Iraqi crude in substantial volume was only a matter of months, had the result through 2003 of building into market expectations a kind of complacence.

First, the widespread assumption that the resumption of Iraqi crude in substantial volume was only a matter of months, had the result through 2003 of building into market expectations a kind of complacence. Iraq was producing 2.8 to 3.0 million barrels per day (mb/d) through much of 1999 and 2000. It was widely believed at the outset of the 2003 invasion of that country, Iraq was capable of producing 4 mb/d with some investment to bring its creaking oil infrastructure up to standard, leave alone the much larger volumes that its deposits are capable of yielding with significant development investment. Iraq was producing between 2.0 and 2.5 mb/d till the end of 2002; following on the US-led occupation of that country its output has been below this level and continually threatened by interruption due to insurgent activities. That amounts to an expectation gap in excess of 2 mb/d—which given that world output is currently straining at 83 mb/d to meet global oil demand is a very sizeable gap indeed.

Second, demand growth has been much stronger than ex-pected—due to unexpected increase in demand from Asian economies, primarily China and India, which together amounted for over 1 mb/d of additional demand in 2004. Moreover, demand growth in the US has also been robust despite higher retail prices.

In this context of unexpectedly tight supply and burgeoning demand, other developments came to be imbued with much greater destabilising potential, than they might have had in easier supply conditions. The crackdown by Russian tax authorities on Yukos, the largest oil producer in that country, did not actually disrupt production seriously, but the possibility was sufficient to spook markets. Similarly, the political developments in Venezuela, the likely disruption in Nigeria, the series of hurricanes in the Gulf of Mexico, and the agitation by Norwegian oil workers, each one of them sequentially helped to tilt market expectations towards fears of further supply disruptions and hence towards higher prices.

On top of all this, has been the possible impact of a weaker US dollar—the currency in which oil prices have traditionally been expressed. Although, it is unclear to what extent dollar weakness has had a role to play in higher prices, if any, it is not unreasonable to speculate that producers and exporters do indeed use different exchange rates to calibrate what their output responses ought to be in such a fluid and dynamic situation.

The oil business has been a cartel for about as long as it has existed. Only the cast of characters has changed, with OPEC nations in charge (more-or-less) ever since 1973. A cartel exists through its ability to restrict output. Demand is given from outside, so if I and my cronies who control the supply agree to cut back production, then the price will rise. Those outside of the cartel also gain by not rocking the boat overmuch such that prices begin to slide. On occasion—as during the Asian crisis—demand falls so precipitately, that the discipline of the cartel fails, and prices plummet as they did so memorably to $10/bbl in December 1998. But there is a plus side to this cartel business, which is that, there ought in theory to be a supply cushion which producers can fall back upon if demand rises more strongly than expected.

Why should producers not simply smile with glee and watch prices soar? Because they have an interest in price stability; prices that are too high can spur technological changes that can reduce demand in the long term—as it did in the OECD, especially Europe, in the 1980s after the second oil price shock. Prices that are too high can also spur exploration and kick-in marginal high-cost sources. Most crucially, if oil prices rise too fast and to too high a level, it impacts economic growth adversely and then future period demand for oil is less than it would otherwise have been. For all of these reasons, the OPEC has always operated with some kind of a price band in mind: if prices were to fall below this they would cut back on production and if prices were to rise above the band, then they would step up output.

The inability of the OPEC cartel, particularly of its Arab members, to maintain its traditional supply cushion and prevent prices to rise as much as they indeed have, has much to do with the reasons enumerated above. In addition, the collapse of oil prices in 1998 and 1999 had undermined the confidence of western oil companies in allocating financial resources to develop new sources and as a result there simply was not enough new capacity to accommodate the unexpected surge in demand from developing Asia. Chart 2Crude Prices—Brent US$ and europer barrelPrices for one-month deliveries (spot) from January 2000 to October 2004 Prices are averages for the month, except for October 2004

Something about crude benchmark prices needs to be mentioned here. Traditionally, WTI (West Texas Intermediate) is the benchmark crude for US markets and rules a couple of dollars per barrel more than UK Brent, and the latter trades another two to three dollars over Persian Gulf light crude oils. While the WTI-Brent differential has not changed much, the Brent-Dubai spread increased to $4 in August 2004, then to $8 in mid-September and has increased further to $12/bbl in the first half of October. Thus, while WTI has soared to $55 and Brent to above $50, Dubai crude prices are still below $40/bbl.¹⁰ How much longer this favourable differential will last, is another matter, but for India which purchases the bulk of her imported crude from the Persian Gulf, it is indeed considerable relief.

¹⁰Oil Market Report, International Energy Agency, October 2004.

In October and in the months to come, while production losses in the Gulf of Mexico would be remedied, further increase in supply from Iraq is perhaps unlikely, but increases from Saudi Arabia are expected.

Over the past month, OPEC members have raised production to try and ease the supply tightness. OPEC managed to raise supply by 710 kb/d (thousand barrels per day) in September 2004 (compared to August), largely because of a 540 kb/d increase in Iraqi supplies (from a low of 1.8 mb/d in the previous month) and more output from Saudi Arabia,¹¹ which country was reported to be able to raise output by 1 mb/d over a period of some months.¹² But non-OPEC supplies fell in September (for the third month in a row) by 100 kb/d—largely because of hurricanes in the Gulf of Mexico. In October and in the months to come, while production losses in the Gulf of Mexico would be remedied, further increase in supply from Iraq is perhaps unlikely, but increases from Saudi Arabia are expected. On the demand side, there seems to be evidence that demand in China is easing with growth in August 2004 slowing down to 6 per cent, from 12 per cent in July and 25 per cent in the April-June quarter. The International Energy Agency in its October report writes that: “Meanwhile, preliminary data for July have been adjusted downwards, to 6.19 mb/d, close to original forecast levels. The demand forecasts for the fourth quarter and 2005 have been reduced in anticipation of further demand slowdowns.”¹³

¹¹ibid

¹²Oil Market Report, International Energy Agency, September 2004.

¹³Oil Market Report, International Energy Agency, October 2004, p. 9.

However, heating oil stocks in the US are currently believed to be relatively low and that has been hardening prices in the third week of October. However, the winter supply factor will ease in November and December, but given the current tightness of supply and strength of demand, as well as the ability of demand to apparently withstand such high prices, it will be unreasonable to expect a significant easing of oil prices till spring 2005.

Balance of Payments Position

Notwithstanding the 58% increase in the value of oil imports during April-September 2004 and the 26% increase in non-oil imports, the expansion of the trade deficit has been kept in check by the strong performance in exports.

Surging merchandise imports, assisted by nearly 60 per cent increase in the oil import bill, have continued to characterise external trade in India. Although export growth also has been strong, on balance the merchandise trade deficit has increased. The data released by the Director General of Commercial Intelligence & Statistics (DGCI&S) indicate that for the first half of the current fiscal year imports grew by 34 per cent, compared to 21 per cent in the corresponding period of 2003–04. Exports rose by 24 per cent in the April-September period of 2004–05, relative to 9 per cent the same period last year. The merchandise trade deficit expanded by 70 per cent this year, a somewhat smaller expansion than the 108 per cent increase registered in the corresponding period of the previous year. Basically, notwithstanding the 58 per cent increase in the value of oil imports during April-September 2004 and the 26 per cent increase in non-oil imports, the expansion of the trade deficit has been kept in check by the strong performance in exports.¹⁴ A more detailed discussion about the composition and direction of merchandise trade is given at the end of this chapter.

¹⁴ Press Release, “Double Digit Export Growth Continues—India's Foreign Trade Data: April-September 2004–05”, Press Information Bureau (PIB), Government of India, October 15, 2004.

At Table 2, we present a summary of the Balance of Payments (BoP) for the first six months (January-June) of calendar years 2003 and 2004. Notable are (a) the sharp expansion in merchandise exports (29 per cent) which matches the proportionate increase in merchandise imports; (b) a 45 per cent increase in the net balance on miscellaneous general services; and (c) the massive change in the net balance in investment income from a large negative number to a small positive one. These have brought about a large seven-fold increase in the current account surplus. On the capital account side, noteworthy are (a) the doubling of portfolio investment, and (b) the large increase inoffshore loans and bond issuance. Table 2

Major Balance of Payments Aggregates First six months of calendar years 2003 and 2004

Unit: US $ million

	January–June 2003			January–June 2004

	Credit	Debit	Net	Credit	Debit	Net

Merchandise Trade	27,387	35,510	−8,123	35,402	45,733	−10,331
Total Invisibles	21,789	12,791	8,998	33,184	17,510	15,674
of which:
Travel & Transportation	2,725	2,912	−137	4,001	3,726	275
Misc. General Services	8,548	5,049	3,449	16,099	9,722	6,377
Of which: software	5,484	367	5,117	7,041	301	6,740
Private remittances	8,234	283	7,951	8,649	260	8,389
Investment income*	1,643	4,239	−2,596	3,079	3,065	14
Current Account Balance	49,176	48,301	875	68,586	63,243	5,343
Foreign Investment	8,210	4,674	3,536	21,796	15,887	5,909
O/w Direct Investment**	2,061	494	1,567	3,240	1,146	2,094
Portfolio Investment	6,149	4,180	1,969	18,556	14,741	3,815
Loans (incl. Bonds)	8,843	10,359	−1,516	14,074	11,006	3,068
Banking Capital	8,955	5,402	3,553	8,773	7,071	1,702
“Other” capital	3,022	1,215	1,807	3,623	2,060	1,563
Total Capital Account	29,030	22,067	6,963	48,266	36,373	11,893
Overall Balance of Payments	79,698	70,214	9,484	117,211	99,616	17,595

Note: *After adjustments made for re-invested earnings of foreign owned companies operating in India and net of direct investments of Indian owned companies overseas.
** Including re-invested earnings as above.
Source: India's Balance of Payments in Dollars, Reserve Bank of India, September 30, 2004.

Current Account

In 2003–04, the BoP merchandise trade deficit was $16.7 billion, representing an increase of 29 per cent over the previous year. In the first quarter (April-June) of the current fiscal, the BoP goods deficit was placed at $6.3 billion, representing a 26 per cent increase over the corresponding quarter in the previous year. The net balance on invisibles rose by 76 per cent year-on-year to $3.2 billion, which was 9 per cent higher than that of the immediately previous quarter (Jan-March 2004). The resultant current account surplus at $1.9 billion was in sharp contrast to the small deficit in the corresponding quarter of the previous year.

Remittances continue to clock steady expansion, while investment income has in the last two quarters turned direction completely, possibly due to the positive sign and magnitude of reinvested earnings by Indianowned companies overseas.

At Table 3.1, the pattern of expansion of key elements in the category “Invisibles” which include both the export of services, as well as the flow of factor income, is presented. At Table 3.2, key elements of the BoP for the previous nine quarters are reported. Earnings from export of software services show consistent year-on-year growth in excess of 30 per cent, while the export of services other than software (miscellaneous general services less software) shows erratic, but strong growth nevertheless. Remittances continue to clock steady expansion, while investment income has in the last two quarters (Jan-Mar and Apr-June 2004) turned direction completely, possibly due to the positive sign and magnitude of reinvested earnings by Indian-owned companies overseas ($1.2 billion in 2003–04). Table 3.1

Changes in Key Items of Invisible Earnings on a Quarterly Basis Total Value and Change†

2000–01, 2001–02, 2002–03, 2003–04 and 2004–05

Unit: US dollar millions

Item		Fiscal year	Q-1 (April–June)		Q-2 (July–Sept)		Q-3 (Oct–Dec)		Q-4 (Jan–March)

			$ million	Change	$ million	Change	$ million	Change	$ million	Change

Miscellaneous Services, including Software and Expenses of overseas branches of Indian companies	Credit	2000–01	1,973	1%	2,861	35%	3,884	51%	4,157	19%
		2001–02	3,576	81%	4,232	48%	3,675	−5%	3,567	−14%
		2002–03	4,033	13%	4,609	9%	5,303	44%	4,790	34%
		2003–04	3,758	−14%	4,317	−6%	3,712	−30%	8,022	67%
		2004–05	8,077	115%

	Debit	2000–01	1,176	−27%	2,317	30%	3,053	95%	3,339	90%
		2001–02	3,021	157%	3,179	37%	2,462	−19%	2,236	−33%
		2002–03	2,966	−2%	3,056	−4%	2,639	7%	2,981	33%
		2003–04	2,068	−30%	2,626	−14%	997	−62%	4,824	62%
		2004–05	4,898	137%

	Net	2000–01	797	125%	544	60%	831	−17%	818	−53%
		2001–02	555	−30%	1,053	94%	1,213	46%	1,331	63%
		2002–03	1,067	92%	1,553	47%	2,664	120%	1,809	36%
		2003–04	1,690	58%	1,691	9%	2,715	2%	3,198	77%
		2004–05	3,179	88%

Of which Software Services	Net	2000–01	1,198		1,611		1,421		1,520
		2001–02	1,700	42%	1,683	4%	1,770	25%	1,731	14%
		2002–03	1,963	15%	2,054	22%	2,415	36%	2,431	40%
		2003–04	2,544	30%	2,750	34%	2,992	24%	3,364	38%
		2004–05	3,376	33%

Remittances from overseas Indians	Credit	2000–01	3,378	23%	3,318	10%	3,136	−2%	3,041	−8%
		2001–02	3,720	10%	2,246	−32%	3,056	−3%	3,170	4%
		2002–03	3,581	−4%	3,767	68%	3,858	26%	3,968	25%
		2003–04	4,266	19%	5,455	45%	6,074	57%	3,440	−13%
		2004–05	5,209	22%

Investment Income	Net position	2000–01	−1,465	78%	−1,163	9%	−1,143	38%	−1,158	19%
		2001–02	−961	−34%	−814	−30%	−1,014	−11%	−886	−23%
		2002–03	−1,334	39%	−981	21%	−1,402	38%	−1,288	45%
		2003–04	−1,308	−2%	−1,426	45%	−2,226	59%	162	nm
		2004–05	−148	−89%

Total of all Invisibles	Net position	2000–01	2,370	−1%	2,946	24%	3,290	−11%	2,932	−37%
		2001–02	3,240	37%	2,508	−15%	3,532	7%	4,205	43%
		2002–03	3,162	−2%	4,258	70%	5,265	49%	4,362	4%
		2003–04	4,636	75%	5,930	59%	7,363	40%	7,496	72%
		2004–05	8,178	76%

Note: † The change is the variation with respect to the same quarter in the previous year.
Figures above are revised numbers, except for Jan-March 2004 and April-June 2004 which are initial estimates and subject to revision.
Source: As in Table-2 above.

Table 3.2

Net position—Major Balance of Payments Aggregates

Previous Nine Consecutive Quarters

Unit: US $ million

	2002–03				2003–04				2004–05

	Q1	Q2	Q3	Q4	Q1	Q2	Q3	Q4	Q1

Merchandise Trade	−2,752	−2,661	−4,350	−3,147	−4,976	−3,658	−4,019	−4,057	−6,274
Total Invisibles	3,407	4,503	5,265	4,362	4,636	6,888	5,724	7,496	8,178
Of which:
Travel & transportation	−242	−59	4	−164	27	124	589	563	−288
Misc. General Services	1,087	1,553	2,664	1,809	1,690	1,691	2,715	3,198	3,179
O/w Software	1,963	2,054	2,415	2,431	2,544	2,750	2,992	3,364	3,376
Private remittances	3,535	3,639	3,829	3,804	4,147	6,419	6,050	3,270	5,119
Investment income	−1,089	−741	−1,402	−1,288	−1,308	−1,426	−2,226	162	−148
Current Account Balance	655	1,842	915	1,215	−340	2,272	3,348	3,439	1,904
Foreign Investment	840	239	1,525	1,436	2,025	2,954	4,921	4,592	1,317
O/w Direct Investment	1,103	370	780	843	649	818	811	859	1,235
Portfolio Investment	−263	−131	745	593	1,376	2,136	4,110	3,733	82
Loans (incl. Bonds)*	−479	−914	−126	−2,306	798	1,031	−5,004	221	2,847
Banking Capital	661	1,793	4,338	1,620	1,930	300	3,385	582	1,120
Other capital	857	1,144	464	980	1,209	1,598	947	1,009	554
Capital Account Balance	1,527	2,256	6,201	1,614	5,661	5,881	4,248	6,332	5,561
Overall BoP Balance	1,664	4,925	6,080	4,311	5,464	8,592	7,294	10,071	7,524

Note:* This category includes external assistance.
Figures above are revised numbers, except for Q4 of 2003–04 and Q1 of 2004–05 which are initial estimates and subject to revision.
Source: As in Table-2 above.

Capital Account

Net inflow on the capital account in the first quarter of 2004–05 was placed at $5.6 billion, which was only marginally lower than that of the last quarter of 2003–04 that had seen record portfolio investment flows. However, quite unlike the preceding quarter, the April-June quarter of 2004 witnessed negligible portfolio inflows, but significant stepping up of inflows on account of loans (including bonds and external assistance), banking activities and foreign direct investment.

Oil Import Bill—Position in 2003–04 and Expectations for 2004–05

The oil import bill in 2003–04 was $20.6 billion, a 17 per cent increase from $17.6 billion in the previous year. Indian refineries however export surplus refined petroleum products and on net basis, the oil import bill was $17.1 billion in 2003–04, 13 per cent higher than in the previous year.¹⁵

¹⁵Appendix Table VI.3, Annual Report, Reserve Bank of India, August 2004.

In quantitative terms, import of crude oil rose to 91 million tonnes (m.t.) in 2003–04, an increase of 11 per cent over that of the previous year (82 m.t.). Including other refined petroleum products the total quantity of petroleum and products imported in 2003–04 amounted to 99 m.t., an increase of 11 per cent over that of the previous year (89m.t.).¹⁶ The implicit price increase in the value of imports in 2003–04 was thus about 3 per cent.

¹⁶Appendix Table 1.30, Commodity Balance of Petroleum and Petroleum Products, Economic Survey 2003–04, p. S-30.

At the trade deficit stage, the combined impact of higher crude oil prices and expanded consumption should add about $10 billion to the BoP merchandise deficit for 2004–05.

In the first half of 2004–05, refinery throughput has expanded by little over 8 per cent, indicative of strong demand. Although the domestic market has for the most part not been exposed to the impact of the full increase in crude prices, there has nonetheless been an increase of 11 per cent over the course of the past six months, and demand (as measured by refinery throughput) in the second quarter (July to September) was certainly weaker than in the first. Given that further increases in domestic prices are inevitable, higher prices are bound to negatively impact demand growth in the last five months of the fiscal year. For the full year, it is thus likely that demand growth will be lower than that for the first half, and may be between 5 and 6 per cent. However, the prices that will have to be paid in the second half of the current fiscal will be higher than was paid in the first half, by a factor of 12 to 15 per cent. We know that the oil import bill in the first half was $14.5 billion. Despite assuming some continued demand moderation in the course of the second half, the oil import bill for 2004–05 is thus likely to be between $30 and $32 billion—which will represent an increase of $9–11 billion (or by 40 to 55 per cent) over the previous year. Increased value of exports of refined products will pare the value of the increment in net terms by $1 billion. Even so, at the trade deficit stage, the combined impact of higher crude oil prices and expanded consumption should add about $10 billion to the BoP merchandise deficit for 2004–05.

Current Account Outlook for 2004–05

For the first half of the year, DGCI&S exports in dollar terms were higher by 24.4 per cent, which includes the impact of higher value of refined petroleum products as well as non-oil items that make up the overwhelming bulk of India's exports. Taking that oil exports had risen in value by 45 per cent, the non-oil component of exports would then have had expanded by 23 per cent. Assuming a slowing down of nonoil exports to 17 per cent in the second half, we get an export growth of non-oil items for the year as a whole at 20 per cent. That would mean overall merchandise exports growth by a little over 21 per cent on BoP basis to cross $77 billion in 2004–05, up from $63.6 billion in 2003–04.

On balance, a figure of $27 billion for the BoP merchandise trade deficit for the full year would seem to be a reasonable estimate, with the possibility that it might be a couple of billion dollars on either side of the estimate—that is, $27 ± 2 billion or $25 to $29 billion.

On the import side, non-oil imports have grown 26 per cent in the first half, and we can expect this trend to hold for the rest of the year, giving us on BoP basis, non-oil merchandise imports of $74 billion. Oil imports as we have estimated above would be in the range of $30–32 billion and the total value of merchandise imports on BoP basis would be between $104 and $106 billion. That leaves us with an estimate of $27 to $29 billion for the BoP merchandise trade deficit—an increase of 60 to 75 per cent from the previous year. However, export growth of non-oil items could turn out to be stronger than assumed for the second half. If such exports do not slow down to 17 per cent, but continue on the same trajectory as in the first half, the merchandise trade deficit could be lower at between $24 and $27 billion. On balance, a figure of $27 billion for the BoP merchandise trade deficit for the full year would seem to be a reasonable estimate, with the possibility that it might be a couple of billion dollars on either side of the estimate—that is, $27 ± 2 billion or $25 to $29 billion.

In our previous issue (July 2004), we had estimated the BoP merchandise trade deficit for 2004–05 at between $20 and 23 billion. The increase is on account of a much larger oil import bill, offset to some extent by stronger exports.

On the invisibles front, service exports registered an increase of 58 per cent in 2003–04, while private remittances went up by 28 per cent and net investment income (outgo) was smaller. As suggested above, this is likely to have been due to the magnitude of reinvested earnings by Indian owned companies overseas which totalled $1.2 billion in 2003–04. In the first quarter of 2004–05, on year-on-year basis, net service exports rose by 87 per cent, remittances were up 23 per cent and there was a big drop in net investment income outflows. Service exports will continue to expand, perhaps not in the fashion of the first quarter and likely to be proportionately less than in 2003–04. Remittances have shown a trend of steady increase and there is no reason to believe that this will not persist. The investment income outflow picture ought to change in the subsequent quarters (and might do so on revision for the first quarter too) and a very conservative assumption is that of a level similar to the previous year. On this basis, it appears that the net surplus position on invisibles in 2004–05 is likely to be about $31 billion. However, if the decline in net investment income outflows is sustained, then this figure will be higher at $32–33 billion, albeit with further upside potential, if net service exports turn out stronger than has been assumed here.

That would leave a current account surplus of some $5 billion ($32 minus $27 billion). This will have a downside of up to $2 billion due to the possibility of a larger merchandise trade deficit, and a corresponding upside of up to $5 billion on account of favourable goods trade balances plus a stronger showing in invisibles. That is, a current account surplus of between $3 and $10 billion, with the most likely outcome falling between $4 and $6 billion.

Foreign Investment

It ought to be remembered that FDI flows had been very weak in the beginning of last year and to that extent the inflow to date in the current year is still relatively modest.

Fresh net foreign direct investment (FDI) inflows, in the fiscal up to July 2004, stood at $1.6 billion, which is of course a significant increase from the $0.4 billion in the corresponding period of last year [see Table 3.3]. However, it ought to be remembered that FDI flows had been very weak in the beginning of last year and to that extent the inflow to date in the current year is still relatively modest. If the FDI proposals that were made in the Union Budget in July 2004 are given effect to, there could be a sizeable increase in these flows in the balance of the year. Table 3.3

Inward foreign investment—stock and changes

Unit: US dollars millions

As on 31 Mar	For the year/month					Cumulative

	FDI	Portfolio flows			Total foreign inv.	FDI	Portfolio flows			Total foreign inv.

		Overseas Issuance	FII	Sub-total			Overseas Issuance	FII	Sub-total

1993	315	240	1	244	559	541	240	1	254	795
1994	586	1,520	1,665	3,567	4,153	1,127	1,760	1,666	3,821	4,948
1995	1,314	2,082	1,503	3,824	5,138	2,441	3,842	3,169	7,645	10,086
1996	2,144	683	2,009	2,748	4,892	4,585	4,525	5,178	10,393	14,978
1997	2,821	1,366	1,926	3,312	6,133	7,406	5,891	7,104	13,705	21,111
1998	3,557	645	979	1,828	5,385	11,363	6,536	8,083	14,619	25,982
1999	2,462	270	−390	−61	2,401	13,825	6,806	7,693	14,499	28,324
2000	2,155	768	2,135	3,026	5,181	15,980	7,574	9,828	17,402	33,382
2001	4,029*	831	1,847	2,760	6,789	20,009	8,405	11,675	20,080	40,089
2002	6,131*	477	1,505	2,021	8,152	26,130	8,882	13,180	22,062	48,192
2003	4,660*	600	377	979	5,639	30,790	9,482	13,557	23,039	53,829
2004	4,675*	459	10,918	11,377	16,052	35,465	9,941	24,475	34,416	69,881
2003–04: monthly data
April	58	15	285	300	358	58	15	285	300	358
May	122		469	469	591	180	15	754	769	949
June	168		629	629	797	348	15	1,383	1,398	1,746
July	180	17	408	425	605	366	32	1,791	1,823	2,351
August	196	286	494	778	974	562	318	2,285	2,601	3,325
September	262	29	904	933	1,195	824	347	3,189	3,534	4,520
October	127		1,622	1,622	1,749	951	347	4,811	5,156	6,269
November	142	6	883	889	1,031	1,093	353	5,694	6,045	7,300
December	270	50	1,549	1,599	1,869	1,363	403	7,243	7,644	9,169
January	122	14	1,147	1,161	1,283	1,485	417	8,404	8,805	10,452
February	382	42	696	738	1,120	1,867	459	9,100	9,543	11,572
March	168		1,834	1,834	2,002	2,035	459	10,934	11,377	13,574
2004–05: monthly data
April	217	35	846	881	1098	217	35	846	881	1,098
May	217	135	−457	−322	−105	434	170	389	559	993
June	380	0	−477	−477	−97	814	170	−88	82	896
July	173	0	−432	−432	−259	1,585	170	−520	−350	1,585

Note:* Adjusted as per new method relating to estimation of foreign direct investment.
Source: Monthly Bulletin, Reserve Bank of India, Statement No 46, S-815, October 2004.

Overseas issuance in the form of Global Depository Receipts (GDR) and American Depository Receipts (ADR) are down in the first four months of 2004–05, but these will increase in the second half of the year. There are several overseas equity issuances that have already been announced, including that from manufacturing companies and banks. Net portfolio inflows on account of foreign institutional investors (FII) did not recover from the post-election shock till July, but such flows have picked up in September and October. Total FII inflows for the months of August, September and October (up to 26th) are $630, $515 and $490 million, respectively—totalling $1.64 billion. Table 3.4

NRI Deposits—stock and changes

Unit: US $ million

	As at the end of Month				Flows for the year/month

	FCNR (B)	NR (E) RA	NR(NR) RD	Total	FCNR (B)	NR (E) RA	NR (NR) RD	Total

Previous fiscal years
Mar-1995*	10,114	4,556	2,486	17,156	−294	1,033	732	1,471
Mar-1996*	9,975	3,918	3,542	17,435	−139	−638	1,056	279
Mar-1997*	9,802	4,983	5,604	20,389	−173	1,065	2,062	2,954
Mar-1998	8,468	5,637	6,262	20,367	−1,334	654	658	−22
Mar-1999	7,836	6,045	6,618	20,499	−632	408	356	132
Mar-2000	8,172	6,758	6,754	21,684	336	713	136	1,185
Mar-2001	9,076	7,147	6,849	23,072	904	389	95	1,388
Mar-2002	9,673	8,449	7,052	25,174	597	1,302	203	2,102
Mar-2003	10,199	14,923	3,407	28,529	526	6,474	−3,645	3,355
Mar-2004	10,979	20,496	1,773	33,248	−22	−17	−141	−180
2003–04
April	10,009	15,933	3,274	29,306	−100	901	−158	643
May	9,994	16,673	3,063	29,730	−105	627	−233	289
June	10,080	17,745	2,965	30,790	86	876	−133	829
July	9,880	18,451	2,796	31,127	−200	580	−189	191
August	9,924	18,765	2,646	31,335	44	193	−168	69
September	9,952	19,023	2,496	31,471	28	287	−146	169
October	10,547	19,983	2,397	32,927	595	699	−133	1,161
November	10,668	19,772	2,209	32,649	121	60	−158	23
December	10,845	20,233	2,111	33,189	177	304	−116	365
January	10,929	20,357	1,997	33,283	84	28	−124	−12
February	11,040	20,553	1,881	33,474	111	153	−120	144
March	10,961	20,559	1,746	33,266	−79	−13	−138	−230
2004–05
April	10,889	21,251	1,630	33,770	−72	301	−150	79
May	11,020	20,272	1,500	32,792	131	−512	−95	−476
June	11,054	19,731	1,379	32,164	34	−541	−121	−628
July	11,183	19,442	1,302	31,927	129	−289	−77	−237

Note: * For these years FCNR(A) has been included.
All figures are inclusive of accrued interest.
Source: Statement No. 45: “NRI Deposits-outstanding”, RBI Bulletin, S-814, October 2004.

External commercial borrowings (ECB) have aggregated $5 billion, including fully convertible bonds for calendar year up to the end of October 2004. There are several big-ticket prospective issuance likely before the end of this fiscal, including a $0.5/1 billion 3–5 year note from State Bank of India (SBI) and substantial offerings from large Indian private corporates. About $3 billion ECB offerings, excluding SBI, is in the immediate pipeline. The ECB placement till March 2005 is expected to be substantially more.

Foreign Currency Assets of the Reserve Bank of India

In the past six issues of this journal we have been reporting our estimate of the accretion to RBI's foreign currency assets due to revaluation gains arising from the movement in cross rates of the major currencies.¹⁷ Over the past year, the RBI has also shared the composition of the sources of accretion to the foreign currency assets with the general public, the latest in the series of releases bringing up the position up to the end of September 2004.¹⁸ At Table 3.5, we have provided our past estimates and the actual position as revealed in the eventual BoP statement. It may be observed that our previous estimates have turned out to be accurate within reason, given the crudeness of the approach adopted. The estimate for the second quarter of 2004–05 is also provided.

¹⁷ Since the forex assets are held in different major currencies, and the aggregate is expressed in one currency (US dollars), the nominal increase in the dollar value of foreign currency assets is always due to a combination of valuation changes and real accretion. However, the impact is significant when there is considerable change in the cross rates of major currencies, as had happened in 2002 and 2003, and is continuing in 2004.

¹⁸Report on Foreign Exchange Reserves (covering period up to June 2004), Reserve Bank of India, September 30, 2004.

Table 3.5

Increase in the foreign currency assets of the Reserve Bank of India

Revaluation and real components—estimates up to Q2 of 2004–05

Unit: US$ million

	2002–03				2003–04				2004–05

	Q1	Q2	Q3	Q4	Q1	Q2	Q3	Q4	Q1	Q2 (3 July to 30 Sept 2004)

Nominal increase	3,654	4,960	7,331	4,896	6,656	8,667	10,138	10,097	7,270	−340
Overall Surplus in BoP	1,664	4,925	6,080	4,311	5,464	8,592	7,294	10,071	7,524
= Real increment	1,664	4,925	6,080	4,311	5,170	8,360	7,294	10,071	7,524
Implicit impact of revaluation	1,990	35	1,251	585	1,486	307	2,844	26	−254
Computed revaluation impact	1,150 to 1,900	−100 to −150	912	423	1,463	800	2,500*	−96	−395	75
Computed real increment	2,500 to 1,900	4,900 to 4,950	6,694	4,486	5,193	7,867	7,638*	10,194	7,665	−415

Notes:* Figures reported in previous issues of this journal for periods up to Q1 of 2004–05—from Table 4.4, Money & Finance April–June 2004, No. 17, p. 109 and earlier issues.
Sources: Exchange rates for the four currencies are from the daily noon rates of the Federal Reserve Bank of New York, except for 2002–03 estimates, which are based on the rates published by the International Monetary Fund. Aggregate foreign currency assets of the RBI from the respective Weekly Statistical Supplements up to 9 October 2004. The foreign exchange currency assets on the last end of each quarter are from the RBI's Report on Foreign Exchange Reserves, September 30, 2004 and similar releases by the RBI earlier.

SectorsMonsoon

South-west (SW) monsoon in 2004 (June to September) was at an aggregate level deficient to the extent of 13 per cent of the long period average. It of course makes a big difference whether the belownormal precipitation is in relatively wet or semi-arid/arid regions, since the impact on the latter is far more damaging. At Table 4.1, we present the outcome in all the years from 2000 to 2004 of the SW monsoon in those meteorological sub-divisions that are indeed relatively more dependent on the rains. Table 4.1

South West Monsoon Rain Dependent Meteorological Sub-divisions—Current and Previous Monsoons

Rain Dependent Areas—Meteorological divisions		Normal* Precipitation in millimetres		Variation** from normal in per cent

				1 June - 30 September

		Annual	S.W. monsoon	2000	2001	2002	2003	2004

1	Gangetic W. Bengal	1,593	1,136	8	−5	5	−19	−1
2	Orissa	1,417	1,160	−19	22	−19	5	−10
3	Jharkhand	1,400	1,105	−2	10	3	−14	−19
4	Bihar	1,248	1,048	14	4	1	10	−11
6	South Interior Karnataka	1,216	659	21	−8	−44	−26	−6
5	Himachal Pradesh	1,181	774	−7	−16	−20	3	−46
7	Chhattisgarh	1,173	1,206	−22	6	−16	20	−15
8	East Madhya Pradesh	1,173	1,097	−33	−12	−13	20	−20
9	Vidarbha	1,080	976	−3	−9	−3	−5	−30
10	Coastal Andhra	1,072	575	24	−5	−26	4	−8
11	Gujarat region	962	934	−31	−10	−24	20	5
12	Telangana Andhra	956	767	22	−12	−23	6	−26
13	West Madhya Pradesh	919	904	−37	−20	−22	3	−15
14	Madhya Maharashtra	886	700	−9	−7	−15	−8	16
15	Tamil Nadu	869	316	1	−16	−45	6	9
16	Jammu & Kashmir	854	514	−1	6	22	−10	−25
17	Marathawada	847	704	11	−13	−3	−15	−16
18	Rayalseema Andhra	833	381	47	11	−33	9	−8
19	North Interior Karnataka	741	491	17	−15	−31	−35	−12
20	East Rajasthan	626	624	−30	−17	−60	−6	−9
21	Saurashtra, Kutch & Diu	442	486	−54	−9	−25	29	−6
22	West Rajasthan	335	263	−22	−10	−71	22	−39

Note:* Annual precipitation is the median value for the 8-year period 1995–2002, while that for the SW monsoon is the long-period (moving) average for 2004 as reported by the Meteorological Department. Although the annual rainfall data is availabel up to 2002 from the Statistical Pocketbook
**Shading indicates that rainfall during the SW monsoon was deficient (less than −20 per cent) or scanty (less than −60 per cent) relative to the long-period average
Sources: Southwest Monsoon End-of-season report, Indian Meteorological Department; Table 2.2, Annual Rainfall, Statistical Abstract, 2002, Central Statistical Organisation. Table 22.3 Annual Rainfall, Statistical Pocketbook 2003, Central Statistical Organisation.

This year, a large part of the shortfall in precipitation was in the Indo-Gangetic belt that is otherwise wellwatered and irrigated. Hence, while an adverse impact of a subnormal monsoon is inevitable the magnitude should be milder than say in 2000–01.

In the parlance, if rainfall is 20 per cent & below of normal in a meteorological sub-division, it is termed as being “deficient”, while if it is 60 per cent and less it is termed “scanty”. While a total of 13 subdivisions at the national level were deemed to have received “deficient” rainfall, of the more rain-dependant regions, a total of five sub-divi-sions (including Himachal Pradesh) fell into this category in 2004. This is certainly not as bad as it was in 2002, when 10 of these sub-divisions were in the “deficient” and two in the “scanty” category, and not even as bad as in 2000 when six geographically large sub-divisions fell into the “deficient” category. This year, a large part of the shortfall in precipitation was in the Indo-Gangetic belt that is otherwise wellwatered and irrigated. Hence, while an adverse impact of a sub-normal monsoon is inevitable the magnitude should be milder than say in 2000–01. Then again there were good late rains in October and the prospects of the rabi (winter) harvest have to that extent been improved.

AgricultureOutlook for 2004–05

It has been the experience that the initial estimates have always erred on the side of caution and going by previous years, the kharif foodgrain output is more likely to be 4 to 5% more than the initial estimates.

The preliminary estimates that have been emanating from the Agriculture Ministry in late September 2004 is that the kharif (summer) foodgrain harvest would be about 100 m.t., about 11 per cent less than that of last year. That there would be some decline in output in foodgrain production is self-evident given the performance of the monsoon. However, it has been the experience that the initial estimates have always erred on the side of caution and going by previous years, the kharif foodgrain output is more likely to be 4 to 5 per cent more than the initial estimates. The Centre for Monitoring the Indian Economy (CMIE) has a close working relationship with the Agriculture Ministry and has estimated that the kharif foodgrain crop would be 105 m.t. Price signals show decline in the price of foodgrain items and thattoo is indicative of a fairly good harvest, especially given that official stocks of grain have come down significantly and are presently hovering about the minimum buffer stock requirements.

Using the 1993–94 weighting diagram (which is a modified version of the 1981–82 weights), the impact of foodgrain output on agricultural GDP would be between nil and −2 percentage points.

It is also reported that the Agriculture Ministry on the basis of good late rains in September and October, is expecting an enormous rabi (winter) crop of up to 125 m.t. of foodgrain which would involve a 25 per cent increase over last year's fairly good-sized crop. While an increase over last year's crop, which was lower than that of 1999–2000, is eminently plausible, it might be more reasonable to expect something like 103 m.t. to, at most, 108 m.t. of foodgrain output. That would mean total foodgrain output for the year at between 203 m.t. and 213 m.t.—between a decline of 4.25 per cent and an increase of 0.4 per cent. With something like 208 m.t. as being a likely output level, the decline in foodgrain production would be of about 1.9 per cent. Using the 1993–94 weighting diagram (which is a modified version of the 1981–82 weights), the impact of foodgrain output on agricultural GDP would be between nil and −2 percentage points.

The summer groundnut and other oilseed crop has been reportedly stronger than that of last year and the winter oilseed output should also be good, lending possibility to at least a maintenance of total output at last year's level and at best a modest increase. Table 4.2

Output of Principal Agricultural Commodities

Unit: Million Tonnes except for cotton & index

	1998–99	1999–00	2000–01	2001–02	2002–03	2003–04	2004–05

Rice	86.1	89.7	85.0	93.3	72.7	86.4	84.0
Wheat	71.3	76.4	69.7	72.8	65.1	72.7	72.1
Coarse cereals	31.3	30.3	31.1	33.4	25.3	36.8	37.8
Pulses	14.9	13.4	11.1	13.4	11.1	14.9	15.2
Kharif foodgrain	102.9	105.5	102.1	112.1	87.8	112.0	100–105
Rabi foodgrain	100.7	104.3	94.7	100.8	86.4	100.0	103–108
Total of Foodgrain	203.6	209.8	196.8	212.9	174.2	212.1	203–213
Groundnut	9.0	5.3	6.4	7.0	4.4	8.3	8.0
Rape and mustard	5.7	5.8	4.2	5.1	3.9	5.8	6.5
Soybean	7.1	7.1	5.3	6.0	4.6	7.9	8.0
Total of nine oilseeds	24.8	20.7	18.4	20.7	15.1	25.1	25.6
Cotton (million 170 kg bales)	12.3	11.5	9.5	10.0	8.7	13.8	15.5*
Sugarcane	288.7	299.3	296.0	297.2	281.6	236.2	220–230**
Index of Agricultural
Production (1981–82=100)	177.8	176.8	167.3	178.3	150.5	179.6

Notes:* Taken from the trade estimate (Cotton Advisory Board) and converted using last year's respective CAB and government output figures to arrive at a number comparable to the data of previous years.
** See text for explanation. This is below official estimates.
Sources: (i) Department of Agriculture & Co-operation for output data up to 2003–04. Index of Agriculture Production (1981–82=100) from Economic Survey, Government of India 2003–04.
(ii) Estimates for 2004–04 from Press reports on Agriculture Ministry's Rabi Conference 17–18 September 2004 and Centre for Monitoring the Indian Economy, October 2004, pp.20–22.

Cotton output is set to increase considerably this year, going by the trade estimates (Cotton Advisory Board or CAB), but sugarcane is expected to have another disappointing year. It has been reported that acreage is significantly lower in major growing states and the industry expects a major decline in the manufacture of centrifugal sugar in mills. Compared to last year's (sugar year: October 2003 to September 2004) output of 13.6 m.t., it is expected that in the current sugar year, production of centrifugal sugar might be as low as 11.0 m.t. Working backwards that translates to a sugarcane output of 200 m.t., which under more favourable circumstances might go up to 220 m.t., and implies a reduction in sugarcane output by 7–15 per cent.

Market gardening, horticulture, fishing and animal husbandry generally show increase year-on-year. Thus, non-foodgrain output could change by −0.8 to + 0.5 percentage points—the possibility of contraction arising entirely from sugarcane.

Were we to combine the outlook for foodgrain, and nonfoodgrain crops, it would seem that we could be looking at a change in the GDP arising from such activities in 2004–05 lying in a range from −3.0 to +0.5 per cent. While it is entirely possible that the expectation that yield improvements might improve the production of sugarcane, the reasonable thing to conclude from this is that the GDP arising from farm activities (including animal husbandry, fishing and forestry) would contract by 1 per cent in 2004–05.

Industry

Over the first five months of fiscal 2004–05, industrial output as measured by the general IIP rose by 7.9%, compared to 5.9% during the same period in the previous year, and 5.2% in 2002–03.

Over the first five months of fiscal 2004–05, industrial output as measured by the general Index of Industrial Production (IIP) rose by 7.9 per cent, compared to 5.9 per cent during the same period in theprevious year, and 5.2 per cent in 2002–03. The same trend of a lifting growth rate is seen in the manufacturing IIP that grew by 8.2 per cent in the first five months of 2004–05, compared to 6.5 and 5.1 per cent in the two preceding years, respectively. Machinery & equipment has seen strong output expansion to 27.6 per cent in April-August 2004–05, sharply up from 5.1 and 2.0 per cent in 2003–04 and 2002–03, respectively. Production expansion of transport equipment however has come down sharply this year, but more about that later. Electricity generation has picked up smartly by 7.7 per cent in this fiscal to August, compared to a nearly flat 2.5 per cent growth last year. Mining activities have been lifted, albeit by a smaller extent to 5.2 per cent this year, from 4.1 per cent in the last. Chart 3Industrial Growth in General and Manufacturing IIPAnnualised rates up to August 2004

That story also appears to hold mostly good if we look at IIP by use-base for the comparable period of April to August. Thus, capital goods output rose by 14.3 per cent in 2004–05, relative to 9.2 per cent in the same period in 2003–04 and 7.8 per cent in 2002–03. Consumer goods output too has strengthened to 8.8 per cent in 2004–05, from 8.0 and 7.3 per cent for the two respective previous years. However, while durable consumer goods output has picked up over the three years, nondurable consumer goods output has decelerated. Production of intermediate goods has also picked up strongly to 8.8 per cent in the current fiscal from 4.4 and 1.9 per cent in the prior two years. Table 5.1

Index of Industrial Production: Growth rates (annualised) by sectors

Unit: per cent

Year	Period	General	Manufacturing	Electricity	Mining

1995–96		13.0	14.1	8.1	9.7
1996–97		6.1	7.3	4.0	−1.9
1997–98		6.7	6.7	6.6	6.9
1998–99	Full Year	4.1	4.4	6.5	−0.8
1999–00		6.7	7.1	7.3	1.0
2000–01		5.0	5.3	4.0	2.8
2001–02		2.7	2.9	3.1	1.2
2002–03		5.8	6.0	3.2	5.8
2003–04		7.0	7.3	5.1	5.2
2001–02	Q-1	2.2	2.6	2.2	−1.6
	Q-2	2.4	2.5	4.0	−0.2
	Q-3	2.7	2.9	2.1	1.7
	Q-4	3.3	3.3	4.1	1.6
2002–03	Q-1	4.3	4.1	3.7	6.8
	Q-2	6.5	6.9	3.3	6.2
	Q-3	5.8	6.1	4.5	4.7
	Q-4	6.2	6.9	1.5	5.7
2003–04	Q-1	5.7	6.0	4.2	5.6
	Q-2	6.6	7.6	1.9	2.9
	Q-3	7.3	7.9	4.3	4.4
	Q-4	8.1	7.9	9.8	8.1
2004–05	Q-1	7.8	8.2	5.9	5.7
	Q-2 (estimated)	8.1	8.3	9.3	4.9
	Q-3 (forecast)	7.5	8.3	4.0	4.0

Note: Quarterly growth rates are with respect to the corresponding quarter in the previous year. Figures for the second quarter of 2004–05 (July-September) are estimates based on the data up to August 2004 and forecast for September 2004. Third quarter figures are forecast values.
Source: Central Statistical Organisation, Press Note on Index of Industrial Production, issues up to October 12, 2004.

Table 5.2

Index of Industrial Production: Growth rates (annualised) by Use-based Classification

Unit: per cent

Year	Period	Basic Goods	Capital Goods	Intermediates	Consumer Goods

					Total	Durables	Non-durables

Weight out of 1,000		355.65	92.57	265.14	286.64	53.65	232.99
1995–96		10.7	5.4	19.3	12.8	25.8	9.8
1996–97		3.0	11.4	8.1	6.2	4.6	6.6
1997–98		6.5	5.8	8.0	5.5	7.8	4.9
1998–99	Full Year	1.5	11.5	5.9	1.9	4.6	1.2
1999–00		6.3	8.0	9.0	6.0	15.3	3.2
2000–01		4.3	1.7	4.7	8.0	14.6	5.8
2001–02		2.4	−3.4	1.6	6.0	11.5	4.1
2002–03		4.8	10.5	3.9	7.1	−6.3	12.0
2003–04		5.5	13.6	6.4	7.0	11.6	5.8
2001–02	Q-1	1.4	−6.0	3.3	4.8	7.4	3.9
	Q-2	2.4	−7.4	2.5	6.0	17.3	1.6
	Q-3	2.2	−0.9	0.2	6.9	11.6	5.3
	Q-4	3.7	0.6	0.4	6.2	9.6	5.1
2002–03	Q-1	5.5	5.2	0.2	6.6	−1.7	9.9
	Q-2	4.5	13.4	3.5	9.8	−10.4	18.8
	Q-3	4.5	13.3	4.5	6.3	−4.3	10.2
	Q-4	4.9	10.0	7.3	5.8	−8.2	10.4
2003–04	Q-1	4.4	8.4	2.8	8.6	4.0	11.1
	Q-2	4.2	11.6	7.1	7.3	9.3	6.7
	Q-3	5.2	10.2	9.4	6.7	13.8	4.5
	Q-4	8.0	23.0	6.1	5.6	19.0	2.0
2004–05	Q-1	4.6	13.6	11.0	7.3	11.7	4.8
	Q-2 (estimated)	5.7	15.0	6.3	10.2	14.0	8.9
	Q-3 (forecast)	4.9	14.7	6.5.	8.9	16.6	6.3

Note: As in Table 5.1 above.
Source: As in Table 5.1 above.

The Indian economy has changed significantly over the past decade and the base-year basket of goods either at the aggregate level or sub-sectoral levels in at least some cases leaves much to be desired.

The continued use of 1993–94 as the base year without doubt introduces some element of distortion in the measurement of industrial output. The Indian economy has changed significantly over the past decade and the base-year basket of goods either at the aggregate level or sub-sectoral levels in at least some cases leaves much to be desired. Undoubtedly some of this may emerge from response problems—with individual producing units less keen to co-operate in the post-licensing era—but even where the data is otherwise fairly obvious, problems exist and these most certainly have to do with the composition of the base-year basket. The most obvious case is that of transport equipment. The production data is readily availabel for all varieties of commercial vehicles, passenger cars, off-road vehicles, two- and three-wheelers and tractors. A quick look at the statistics that is currently availabel till August/September 2004 indicates very strong growth in all categories. However, the corresponding 2-digit IIP category indicates that transport equipment saw output expansion of merely 0.4 per cent in this fiscal up to August.

Direct industry data for the April-August 2004 period indicate that production of medium/heavy commercial vehicles grew by 47 per cent, up from 29 per cent last year; output of light commercial vehicles expanded by 34 per cent, compared to 24 per cent in the corresponding period of last year; production of passenger cars & multi-utility vehicles grew 28 per cent, slightly down from 39 per cent last year. Production of two- & three-wheelers was up 15 per cent, compared to 8 per cent last year. The domestic sales of tractors rose 39 per cent this fiscal to August, compared to a decline by 13 per cent in the comparable period of last year. While some of the sales growth of tractors was due to de-stocking, production too has picked up; in August 2004 output grew by 52 per cent and cumulative production for April to August is believed to have grown by between 15 and 20 per cent. Ignoring for a moment that the industry has been moving in the direction of greater value addition, the principally relevant output data seem to indicate output expansion in the range 15 to 47 per cent: something that surely does not gel with an aggregate measure of 0.4 per cent.

2-Digit Level Analysis

Several industrial groups, which had consistent poor records of growth in the recent years, did experience a reversal of fortunes in 2003–04, but in the current fiscal there has been a slowing down. Notable examples are:

Paper and paper products: From −9 and 3 per cent in 2000–01 and 2001–02, up to 6.8 per cent and 15.6 per cent in the next two years. However, in the current fiscal up to August, growth has slid back to below 5 per cent.

Basic metal & alloys: From below 2 and 4 per cent in 2000–01 and 2001–02, up to 9.2 per cent in each of the subsequent two years. But in the current fiscal up to August there is a decline by 2 per cent.

Some categories began to show big improvements only in 2003–04 and have continued to strengthen in 2004–05:

Machinery & equipment (excluding transport): From growth of between 1 and 2 per cent in 2001–02 and 2002–03, up to 16 per cent in 2003–04 and 28 per cent in the first five months of 2004–05.

“Other” manufacturing industries: From an average of 1.2 per cent in the four years between 1999–2000 and 2002–03, to 7 per cent in 2003–04 and 12 per cent in the first five months of 2004–05.

Basic chemicals & chemical products, which by weight is the single largest manufacturing 2-digit category in the IIP, had taken a dip in 2001–02 and 2002–03, growing by 4.8 and 3.7 per cent respectively, in these years. The weak patch began in December 2001 and reached its nadir in April 2003 (a month in which it had a year-on-year growth of −5 per cent, the weakest monthly result in the present data series). Since April 2003, the sector has seen strong output recovery with last year's growth averaging 8.7 per cent and in the current fiscal 19 per cent till August.

Food products continue to show negative output growth, largely on account of lower sugar production. Cotton textiles, textile and leather products that have been in negative territory in the past one or two years, are all showing some progress in the current fiscal.

The beverage & tobacco category, which has generally experienced strong growth in recent years, though growing strongly has slowed down somewhat in 2003–04. Food products continue to show negative output growth, largely on account of lower sugar production. Cotton textiles, textile and leather products that have been in negative territory in the past one or two years, are all showing some progress in the current fiscal.

Table 5.3 lists the annualised rates of output growth for each of the seventeen 2-digit industry groups, ranked in descending order of average growth for the five-year period 1999–00 to 2003–04. The industry groups can be categorised into four principal groups:

The top three groups—beverage, tobacco etc.—had average growth of between 8.4 and 12.1 per cent in the previous five-year period. These groups account for 20 per cent of base-year (1993–94) output. The best performer in 2003–04 was transport equipment, followed by machinery & equipment (excluding transport). In the current fiscal it is machinery that has shown explosive growth.

The second category of five industry groups (43 per cent of base year output)—from basic chemicals through to basic metals & alloys—had average growth lying within a band of between 5.9 and 6.9 per cent. Basic chemicals & products, which has the largest weight of 18 per cent in manufacturing, recovered in August 2003 and has experienced strong growth since, continuing into the first five months of the current fiscal year. Manmade fibres picked up last year and more so in the current fiscal. Non-metallic mineral (mostly cement) which has grown at quite a modest pace in recent years, including 2003–04, has tended to stagnate this year. Basic metals and alloys after smart output expansion in the two previous years, has contracted this year.

The third category of four groups—food products through apparel—had average growth of between 3.9 and 4.6 per cent. The category accounted for 19 per cent of base-year (1993–94) manufacturing output. Within this, food products showed marked recovery in 2002–03 but has been flat last year and shown significant contraction this year, mostly due to weak sugarcane crop and hence lower sugar production.

The fourth and last category of five industry groups—metal products through wood products—averaged growth of −7.0 to 2.6 per cent in the five-year period. It accounted for 18 per centof base-year (1993–94) manufacturing output. Here “other manufacturing” industries has shown a sharp recovery in output expansion both in 2003–04 and in 2004–05.

Table 5.3

Annualised Growth Rates for Manufacturing at the 2-digit level

Unit: per cent

Group	Description of sector	Weight in 1000	Average 1995–1998*	Average 2000–2004†	1999–00	2000–01	2001–02	2002–03	2003–04	2004–05 (April-August)
(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)	(9)	(10)	(11)

The faster growing industry groups: 7 per cent and higher
22	Beverage, tobacco etc.	23.82	15.4	12.1	7.6	4.3	12.2	27.9	8.6	8.5
35–36	Machinery (excl. transport)	95.65	9.8	8.7	17.7	7.3	1.3	1.6	15.6	27.7
37	Transport equipment & parts	39.84	10.8	8.4	5.7	−2.0	6.8	14.6	17.0	0.4
Industry groups with moderate growth: Above 5 and up to 7 per cent
30	Basic chemicals & chemical products	140.02	10.1	6.9	10.0	7.3	4.8	3.7	8.7	19.2
32	Non-metallic mineral products	43.97	15.0	6.6	24.4	−1.2	1.2	5.1	3.6	−0.5
24	Man-made fibres, wool & silk yarn	22.58	14.6	6.4	11.9	5.8	4.4	3.0	6.8	9.1
31	Rubber, plastic, coal & refined petroleum products	57.28	5.0	6.3	−1.1	11.8	11.1	5.5	4.5	3.1
33	Basic metal & alloys	74.53	8.4	5.9	5.0	1.8	4.3	9.2	9.2	−2.0
Industry groups with slow growth: 3 to below 5 per cent
20–21	Food Products	90.83	5.1	4.6	4.2	10.1	−1.6	11.0	−0.5	−7.9
28	Paper & paper products	26.52	10.5	4.5	6.3	−9.1	3.1	6.8	15.6	4.7
29	Leather, leather & fur products	11.39	8.4	4.5	13.8	10.7	5.3	−3.3	−3.9	5.8
26	Textile products incl RMG	25.37	17.9	3.9	2.0	4.0	2.4	14.4	−3.2	4.6
Industry groups with negative growth: Flat and up to −7 per cent
34	Metal products & parts (excl. Machinery)	28.10	8.8	2.6	−1.2	15.0	−10.0	6.4	2.6	3.2
38	Others industries	25.59	25.3	2.3	−16.0	11.7	8.9	0.1	7.2	12.4
23	Cotton textiles	55.18	8.3	0.3	6.7	2.9	−2.2	−2.7	−3.1	7.8
25	Jute & mesta	5.90	12.3	−0.4	−0.9	0.8	−5.9	8.3	−4.2	−8.3
27	Wood, products & furniture	27.01	15.6	−7.0	−16.2	2.9	−11.0	−17.6	6.8	−10.8
2–3	Overall Manufacturing	793.58	9.4	5.7	7.1	5.3	2.9	6.0	7.3	8.2
Distribution of Rates of Growth
	Median Value		9.1	4.6	5.7	4.3	3.1	5.5	6.8	4.6
	25 percentile value		5.0	2.6	−0.9	1.8	−1.6	1.6	−0.5	−0.5
	75 percentile value		10.5	6.6	10.0	10.1	5.3	9.2	8.7	8.5
	Nos. of industry groups = mean		11	6	6	8	9	8	6	5
	Nos. industry groups < 1/3 rd of mean		0	5	6	4	5	5	5	6

Note:* Averages for 3 years—1995–96, 1996–97 and 1997–98.
† Average growth rate for the 5-year period—1999–2000 to 2003–04. Ranked in descending order of 5-year average growth, that is, column (5).
Source: As in Table 5.1 above.

Prices & InflationWholesale or Producer Prices

At the start of the current financial year the outlook for inflation appeared to be benign, even though it was quite well understood that the announcement of elections had put on hold upward revision of prices of refined petroleum products.

Inflation has become a hot button policy issue in the last few months. The previous financial year closed with WPI inflation at 4.6 per cent in March 2004, significantly down from the 6 per cent plus of January. Thus, at the start of the current financial year the outlook for inflation appeared to be benign, even though it was quite well understood that the announcement of elections had put on hold upward revision of prices of refined petroleum products. With crude oil prices continuing to rise, it was also clear that the inevitable revision that would follow after the elections would cause inflation to pick up. It is in this context that the RBI had in its Annual Policy Statement in May 2004 placed inflation at the end of 2004–05 at “around 5.0 per cent”. In the previous issue (July 2004) we had expected that: “WPI inflation is likely to remain close to 6 per cent at the end of September and December 2004. However, it is likely that the rate would decline subsequently to little over 5 per cent by the end of March 2005”. Table 6.1

Components of Wholesale Price Inflation

Base 1993–94=100

Unit: per cent

Calendar Year	All Commodities	Foodgrain (cereal & pulses)	Other Primary Food items	Oilseeds & Edible Oil and Cotton & Cotton textiles	Commercial Energy	Manufactured Goods	Core(x)^†

Weight	100%	5.01%	10.39%	6.78%	14.23%	63.75%	70.37%
Average of weeks for the completed calendar year up to 2003 and part year for 2004
1998	5.8	4.9	14.8	9.9	6.0	3.9	4.4
1999	3.5	18.4	−2.0	−3.2	5.5	3.4	2.9
2000	6.3	0.9	5.7	−4.1	25.6	2.7	2.4
2001	5.2	−1.5	4.6	2.6	14.7	2.9	3.2
2002	2.5	0.2	3.9	3.7	4.5	1.7	1.8
2003	5.3	2.1	1.1	14.5	6.7	5.0	5.9
For the last week of January to September and the first two weeks of October 2004
31-Jan-04	6.9	0.5	1.3	15.1	7.4	6.3	6.7
28-Feb-04	5.2	0.1	2.2	14.7	3.6	6.7	6.7
27-Mar-04	4.6	−0.5	1.2	8.7	2.5	6.7	6.4
1-May-04	4.6	−2.2	4.1	4.7	6.0	5.0	4.8
29-May-04	5.6	−1.4	4.3	4.6	7.3	5.2	5.9
26-Jun-04	7.0	−2.1	−0.3	3.3	12.0	7.2	7.4
31-Jul-04	8.0	0.6	4.8	5.9	10.1	8.0	8.5
28-Aug-04*	8.3	1.6	8.6	7.3	12.6	6.7	7.5
25-Sep-04*	7.4	1.3	1.9	6.5	10.6	7.2	7.8
2-Oct-04*	7.2	1.3	1.9	4.7	10.7	7.0	7.5
9-Oct-04*	7.1	1.2	1.0	5.2	10.7	7.1	7.4

Notes:* Figures for weeks marked with asterisk are on the basis of provisional estimates. All previous periods are based on revised estimates.
† Core (by exclusion) rates of inflation, which excludes primary food items and energy from the index—the standard procedure.
Source: Office of the Economic Adviser, Ministry of Commerce & Industry, Government of India, up to press release of October 25, 2004.

This has proved to be an underestimate, as inflation zoomed to 7.5 per cent for the week ending July 26. Through August, WPI infla-tion climbed past 8 per cent, peaking at 8.3 per cent at the end of August. It has subsided somewhat since and for the week ending October 9, was down to 7.1 per cent. It is however true that had government allowed petroleum companies to raise prices in line with the increase in prices of imported crude, the current rates of inflation would have been higher.

Estimates for December 2004 and March 2005

Our estimate of WPI inflation at the end of 2004–05 is 6.4 per cent and that at the end of December 2004 at 7.3 per cent. Both assume that there will be some upward revision of petroleum product prices in November-December and again the last quarter of 2004–05—with the inflation in commercial energy running at over 14 per cent on annualised basis, compared to 11 per cent now (in October 2004). If for whatever reason these prices are not revised upward, the computed inflation would surely be lower, but there will be corresponding negative effects on tax receipts and/or the profitability of state-owned oil companies—depending on how the price impact is avoided.

Policy Response to Inflation

In August 2004, as price levels rose sharply, Government took a series of measures relating to reducing import duties on commodities that have had the most to do with the present round of inflation. The import duty on steel was reduced to 5 per cent and similarly so for a range of items. The import and excise duties on refined petroleum products were altered effectively reducing refining and marketing margins and easing the price impact on the consumer. The RBI continued to tighten liquidity through its sales of bonds/treasury bills under the Market Stabilisation Scheme and eventually in September by raising the Cash Reserve Ratio (CRR). These underlying changes in liquidity conditions have served to raise the call money rate from about 4.25 per cent by over 50 basis points to over 4.80 per cent. In its October policy statement, the RBI has moved further to hike the repo rate (deposit facility for banks) by 25 basis points to 4.75 per cent—a move that indicates further tightening, since an effective rate (call money) which does not exceed the deposit facility by a significant margin does not make for a meaningful setting of monetary parameters.

Composition of Inflation

The composition of inflation has, as we have repeatedly stated in previous issues, had a narrow basis with a small selection of items doing most of the inflating. In the first round of inflation in 2003, this came from a combination of oilseeds & edible oil, raw cotton & fabrics, with steel joining the party in August 2003. In the current round it has been petroleum products, steel, iron ore, cotton textiles, sugar and non-metallic minerals.

As may be seen from Table 6.2, oilseeds, edible oil and raw cotton had run out of fuel by early 2004 and cotton textiles by the end of August 2004. In fact, over the past few weeks prices of raw cotton have fallen significantly and for the week ending October 9, 2004 annualised inflation for the items is running at −11 per cent. It is likely that prices of cotton textiles will follow suit and the combination should have a small dampening impact on overall inflation. Table 6.2

Sources of Wholesale Price Inflation in 2004

Base 1993–94=100

Unit: per cent

	Weight	31 Jan 2004	27 Mar 2004	26 Jun 2004	31 July 2004	28 Aug 2004*	2 Oct 2004*

Overall WPI inflation	100.0	5.9	4.6	6.1	8.0	8.3	7.2
Foodgrain	5.01	0.5	−0.5	−2.0	0.6	1.6	1.2
Other primary food	10.39	1.3	1.2	−1.2	4.8	8.6	1.9
Raw cotton	1.36	30.5	12.3	3.8	4.6	3.8	−5.4
Oilseeds	2.67	6.2	−0.5	−1.6	7.3	11.7	9.5
Commercial Energy	14.23	7.4	2.5	11.8	10.1	12.5	10.7
Petroleum products	6.99	8.9	0.2	15.8	14.2	19.2	16.8
Manufactured Goods	63.75	6.3	6.7	6.6	8.0	6.7	7.0
Dairy products	0.69	9.0	11.6	9.1	8.1	6.2	3.4
Grain mill products	1.03	10.0	11.8	2.1	2.3	2.1	2.0
Sugar, khandsari & gur	3.93	10.3	14.5	18.8	12.2	14.3	14.6
Edible oil	2.76	8.9	7.1	−0.3	2.0	.3.2	1.9
Tea & coffee processing	0.97	20.3	20.3	−0.4	7.5	0.8	9.2
Cotton textiles	4.22	20.2	15.3	10.9	10.2	8.3	6.8
Iron and steel	3.64	34.6	34.2	43.8	45.1	30.4	26.5
Non-ferrous metals	1.47	4.5	4.2	4.1	4.8	5.1	6.5
Chemicals, manmade textiles, rubber & plastics products	19.04	0.6	0.3	2.5	2.6	2.0	3.1
Non-metallic minerals	2.52	4.4	3.0	6.2	7.2	7.7	7.9
Machinery & machine tools	8.36	2.0	3.0	2.6	5.1	4.1	5.6
All other manufactured goods	15.14	3.0	5.1	2.6	6.8	5.9	6.5
Contribution to overall WPI inflation—in percentage points
Primary Food articles	15.40	0.03	−0.02	−0.10	0.49	0.89	0.20
Oilseeds & Edible Oil	5.42	0.41	0.18	−0.05	0.25	0.40	0.31
Cotton & Cotton Textiles	5.57	1.27	0.81	0.51	0.49	0.40	0.22
Dairy, grain mill, sugar, and tea & coffee items	6.62	0.77	0.97	0.82	0.63	0.63	0.71
Iron & steel	3.64	1.26	1.24	1.59	1.64	1.10	0.96
Non-ferrous metals	1.47	0.07	0.06	0.06	0.07	0.07	0.09
Chemicals, manmade textiles, rubber & plastics products	19.04	0.14	0.05	0.55	0.56	0.48	0.60
Non-metallic minerals	2.52	0.11	0.08	0.16	0.18	0.19	0.20
Machinery & machine tools	8.36	0.17	0.25	0.22	0.43	0.34	0.47
All other manufactured goods	15.14	0.46	0.77	0.39	1.03	0.90	0.98

Notes: * Figures for 28th August and 2nd October 2004 and are on the basis of provisional estimates. All previous periods are based on revised estimates.
Source: as in Table 6.1.

Presently, other than petroleum products, it is an inflation story centred around steel, sugar and to some extent nonmetallic minerals (mostly cement).

Presently, other than petroleum products, it is an inflation story centred around steel, sugar and to some extent non-metallic minerals (mostly cement). While early in 2004 and in 2003, items other than those highlighted above, showed benign inflation, that picture is changing in recent months as becomes evident from a perusal of Table 6.2. Non-ferrous metals, machinery items, chemicals have all begun tosee prices beginning to rise. The residual item of “all other manufactures” that accounts for 15 per cent of the base-year weight has seen inflation move from 3 per cent in the first quarter of 2004 steadily to 6.5 per cent by the beginning of October 2004. Clearly the inflationaryphenomenon is becoming broader-based. Hence, the impact potential for a policy that sets out to alter inflationary expectations is greatly enhanced.

Consumer Price Inflation

One of the reassuring factors of inflationary behaviour in both 2002–03 and 2003–04, was that consumer price inflation consistently stayed at moderate (by historical standards) levels and much below the WPI inflation rates as may be seen in the accompanying Chart 4. Chart 4Consumer and Wholesale Rates of InflationMonthly Basis—January 2000 to October 2004

However, consumer prices inflation has picked up from under 3 per cent in April 2004, to over 4 per cent now. The CPI-UNME (urban non-manual employee) crossed 4 per cent in August, but has gained no further in September 2004. The CPI-IW (industrial worker) touched 4.6 per cent in August and 4.8 per cent in September 2004. Both CPI-UNME and CPI-IW inflation are still significantly below the WPI inflation rate. The variance reflects the compositional difference in the basket of the consumer price and producer price indices, and also of the concentration of inflationary pressures on non-food traded goods and food prices of course continue to be soft.

Inflation—different measures and implications for policy

The practice internationally is to link the conduct of monetary policy with that of consumer price movements, not the inflation contained in producer price indices, and certainly not wholesale prices of a mixed bag of final and intermediate goods. In India however, for historical reasons the WPI inflation has been at the centre of attention. For one, it comes out every week, is fairly up-to-date and gives a commodity-wise decomposition. In the case of consumer prices indices, the periodicity is monthly, there is in consequence a greater lag and there is no (publicly) availabel decomposition in terms of commodity-groups. The availabel detail corresponds more to a design crafted when location-wise dearness allowance was perhaps seen to be the principal driving force in estimating inflation in the first place.

If consumer price inflation is that much lower than WPI inflation, it is necessary to bear this fact in mind when looking to possible shifts in monetary policy. While WPI inflation was above 8% in August 2004, CPI inflation has at most lifted over the 4% level.

However, if consumer price inflation is that much lower than WPI inflation, it is necessary to bear this fact in mind when looking to possible shifts in monetary policy. While WPI inflation was above 8 per cent in August 2004, CPI inflation has at most lifted over the 4 per cent level.

The question could be asked as to why should the monetary authorities react with alacrity to the sudden shifts in WPI inflation brought about by price increases in a selection of manufactured commodities and petroleum products, when the broader-based CPI index indicates more benign inflation? The argument is bolstered by the distinction between prices of tradeables and non-tradeables, with the presumption that inflation that derives more from non-tradeables is what one ought to be more sensitive about. However, there are two problems with this.

First, continuing inflation in tradeables will eventually spill over into non-tradeables, as has indeed happened on every past occasion. Second, the CPI indices are constructed with base year in the 1980s. Thus the CPI-IW has a base year of 1982 and the CPI-UNME one of 1984–85. We surely understand that the consumption basket has changed very considerably in the intervening two decades, with a decline in the weight for food and a greater share for items that are or behave like tradeables. The WPI is on a 1993–94 base, and it itself has certainly become outdated, but certainly much less so, than have the CPI indices.

There is a third and useful measure of inflation, which comes a bit late on annual basis, namely the implicit GDP deflator. In 2002–03 the value of the implicit GDP deflator was 3.5 per cent and in 2003–04 it was 3.7 per cent. For non-agricultural GDP, the values of the implicit deflator was however higher. In 2002–03 it was 3.7 per cent and rose to 4.5 per cent in 2004–05.

While some caution needs to be borne in mind when dealing with the quarterly estimates of GDP, it is of course possible to compute the implicit deflator from the series. That tells us that on year-on-year basis (that is one quarter compared to the corresponding quarter of the previous year), the implicit GDP deflator in the first (April-June) quarter of 2004–05 was 4.6 per cent, up from 3.7 per cent in the Jan–Mar quarter of 2003–04. The corresponding numbers for non-agricultural GDP were unsurprisingly higher at 5.3 per cent in the first quarter of the current fiscal and 4.8 per cent in the last quarter of 2003–04.

This points to the relevance of the WPI measure of inflation, and the inappropriateness of drawing too strong a lesson from the trends indicated by the CPI, in periods when the WPI and CPI measure are at odds.

There is something else that is possible, which is to try and estimate what are the quarter-to-quarter changes. For measuring change we need a de-seasonalised series, which is not officially estimated. In computing the implicit deflator, the problem with quarter-on-quarter numbers, is principally the varying weights of different industries in terms of the GDP that arises in them in each of the four quarters. Remembering this drawback, were we to compute the quarter-on-quarter GDP implicit deflator however, what we get is a very sharp increase in the inflationary trend in the first quarter of 2004–05. The value rises to 13.5 per cent, compared to a mere 1.7 per cent in the last quarter of 2003–04. We know that the weight of agriculture varies considerably in different quarters. If we look at non-agriculture alone, what we find is that on a quarter-on-quarter basis the annualised deflator in the April-June quarter of 2004–05 is 12.3 per cent, compared to 4.9 per cent in the last quarter of 2003–04. If anything, this points to the relevance of the WPI measure of inflation, and the inappropriateness of drawing too strong a lesson from the trends indicated by the CPI, in periods when the WPI and CPI measure are at odds.

Credit & Investment

In 2004–05, for the third year running, non-food credit has continued to expand at a rising rate. In the first half of 2004–05, non-food credit has gone up by Rs. 92,000 crore—an unprecedented increase.

Credit flow from the banking system to the commercial sector has been growing at an increasing rate through 2002–03 and 2003–04. Non-food credit rose by nearly Rs. 120,000 crore in 2003–04 on top of the increase of Rs. 100,000 crore in the previous year. In 2004–05, for the third year running, non-food credit has continued to expand at a rising rate. In the first half of 2004–05, non-food credit has gone up by Rs. 92,000 crore—an unprecedented increase (see Table 7.1). Investments continue to be depressed in 2004–05, and in consequence, the increase in total accommodation at Rs. 88,000 crore has been less than that for non-food credit. Table 7.1

Changes in Major Items of Bank Accommodation to the Commercial Sector

Unit: Rs crore

	Non-food Credit				Food Credit

FY	01–02	02–03	03–04	04–05	01–02	02–03	03–04	04–05

Q-1 (June)	−2,367	19,308	3,091	34,926	10,349	7,030	586	7,100
Q-2 (Sept)*	24,454	46,834	41,034	92,443	10,211	−752	−12,107	2,677
Q-3 (Dec)	35,955	64,765	64,484		12,285	−2,031	−13,127
Q-4 (Mar)	64,302	100,356	119,684		13,987	−4,499	−13,516

	Investments^†				Total Accommodation

FY	01–02	02–03	03–04	04–05	01–02	02–03	03–04	04–05

Q-1 (June)	1,060	−5,724	−4,705	−2,440	−1,471	6,111	−1,385	32,551
Q-2 (Sept)*	2,976	−5,675	−1,838	−3,920	27,920	40,825	39,484	88,218
Q-3 (Dec)	3,025	−2,719	−3,445		39,762	61,472	61,363
Q-4 (Mar)	3,446	−339	−3,937		67,862	99,406	116.877

Note: As in Table 7.2 below.
Source: As in Table 7.2 below.

Table 7.2

Year-on-year changes in Major Items of Credit Flow to the Commercial Sector

Unit: per cent

	Non-food Credit				Food Credit

FY	01–02	02–03	03–04	04–05	01–02	02–03	03–04	04–05

Q-1 (Jun)	9.9	16.8	16.2	22.2	51.7	21.2	−17.1	−14.8
Q-2 (Sept)*	11.4	17.5	15.8	24.5	52.7	6.0	−29.8	3.4
Q-3 (Dec)	10.2	18.4	16.2		39.6	−0.6	−30.0
Q-4 (Mar)	13.6	18.7	17.6		35.0	−8.3	−27.3

	Investments†				Total Accommodation

FY	01–02	02–03	03–04	04–05	01–02	02–03	03–04	04–05

Q-1 (Jun)	17.6	−2.0	0.5	−1.7	10.8	14.3	14.1	19.4
Q-2 (Sept)*	24.3	−4.4	3.8	−6.5	12.9	14.3	14.0	21.0
Q-3 (Dec)	14.5	−0.7	1.4		11.0	15.5	14.1
Q-4 (Mar)	7.3	−0.4	−4.2		12.7	16.1	15.1

Note: Data for last reporting Friday of the week of alternate fortnights and the data used for estimating changes in the quarter is the last Friday of the month.
* For previous years since in the second quarter, the fortnight straddles the end of September and the first week of October. Hence the aggregates as at the end of the first week of October has been used, that is 1st, 3rd, 4th, 5th, and 6th October of 2004, 2003, 2002, 2001and 2000 respectively.
† Figures are with one fortnight lag in comparison with the other aggregates.
Source: Reserve Bank of India, Weekly Statistical Supplement various issues up to October 16, 2004.

The estimate of the increase in credit outstanding with respect to the last Friday of the previous working year is vulnerable to a policy effect. That is, the tendency in some years of credit to pick up sharply at the end of the fiscal year (under moral suasion of the masters of the public sector banks). Then there is the tendency of the year-end figure being revised. To that extent the year-on-year rate of expansion in the credit position is a more reliable indicator. By this measure too, the expansion in credit has been a story of gaining momentum. It was strong through 2002–03 and 2003–04 at 16–17 per cent and in the current fiscal has touched 25 per cent. The growth in total accommodation has moved up from 14 per cent in the past two years to 21 per cent in the first half of 2004–05. Chart 5Change in Main Elements of Bank Credit over end-March of Previous YearUp to October 2004

Non-bank Sources of Commercial Finance

First, the role of mutual funds in providing commercial finance through subscription to commercial paper and debentures continues to rise much faster than does the stock of bank finance. Second, there has been increasing resort to external sources by companies that have been tempted both by the lower offshore interest rates and the perceived strength of the rupee against the US dollar, accounting in part for the increased inflow of capital into the country. To the extent that these important additional financing sources have both risen on narrow bases, the rate of expansion of non-food credit (and of total accommodation) perhaps understates the real conditions of credit demand by the commercial sector. In the October 2004 Policy Statement, the RBI has estimated that the “total flow of resources to the commercial sector including capital issues, global depository receipts (GDRs)/American depository receipts (ADRs) and borrowings from banks and FIs increased by Rs. 108,510 crore up to October 1, 2004 as compared with Rs. 66,863 crore in the corresponding period of the previous year.”¹⁹ These numbers are with respect to the end-March stock and what they indicate is that the share of non-bank sources has declined sharply from 41 per cent in the first half of 2003–04, to 19 per cent in the first half of the current year, while the share of the banking system has risen from 59 per cent last year to 81 per cent in this year. That of course fits in with what we know about changes in lending practices in the banks this year.

¹⁹ Statement by Dr. Y. Venugopal Reddy, Governor, Reserve Bank of India, on Mid-term Review of Annual Policy for the year 2004–05, para 8.

External Merchandise Trade

This section has six tables that provide information on the composition and direction of India's external merchandise trade.

Imports

In the first two months of fiscal 2004–05, while overall imports have risen at the same pace as that of the previous year, oil imports have risen much faster and non-oil imports were up only by 16%, while non-oil, non-bullion imports increased by 11%.

In 2003–04, while total imports rose by 21 per cent, gold imports soared by 60 per cent. The value of crude petroleum imports rose by only 11 per cent and non-oil, non-bullion imports were up by 22 per cent. Import of capital goods and several manufacturing intermediates rose strongly—from chemicals to metals [see Table 8.1]. We have disaggregated data for the current year only up to May 2004. In the first two months of fiscal 2004–05, while overall imports have risen at the same pace as that of the previous year, oil imports have risen much faster and non-oil imports were up only by 16 per cent, while non-oil, non-bullion imports increased by 11 per cent. However, from the aggregate data availabel up to September, we do know that non-oil imports rose by 26 per cent, which is in line with the experience of 2004—namely 25 per cent. Table 8.1

Summary of Changes in the rupee value of Merchandise Imports Financial years of 2002–03, 2003–04 and April-May (2 months) of 2004–05

Unit: Rs. crore

	2002–03	2003–04			2004–05 (Apr–May)

		Amount	Change from full year of 2002–03		Amount	Change from April–May of 2003–04

			Amount	%		Amount	%

Food Products	14,279	2,748	17,027	19	1,917	−853	−31
of which: Edible oil	8,780	2,904	11,683	33	1,300	−783	−38
Other agricultural products	3,202	3,626	425	13	408	−186	∔.31
Ores & minerals	11,924	13,421	1,497	13	3,941	1,851	89
Manufactured intermediates & consumer goods	90,992	114,266	23,274	26	19,651	3,340	21
Electronic goods	27,099	34,491	7,393	27	5,977	1,144	24
Organic chemicals	9,125	12,689	3,565	39	2,206	254	13
Non ferrous metals	3,226	4,360	1,134	35	752	132	21
Wood & wood products	1,946	3,270	1,324	68	517	43	9
Manmade filament/spun yarn	1,922	1,912	−10	neg	290	15	5
Chemical material & products	2,187	2,902	715	33	495	124	34
Artificial resins, plastic material	3,784	4,972	1,188	31	855	165	24
Iron & steel	4,267	6,493	2,225	52	1,477	468	46
Inorganic chemicals	5,516	5,838	322	6	778	25	3
Fertilisers (manufactured)	1,731	2,301	571	33	86	−152	−64
“Other” commodities	11,268	11,949	681	6	2,505	849	51
Capital goods	41,358	51,987	10,629	26	7,086	471	7
All kinds of machinery*	24,291	29,739	5,448	22	4,855	508	12
Professional instruments	5,494	5,655	159	3	926	96	12
Transport equipment	9,183	14,833	5,650	62	952	−147	−13
Gold	18,608	29,946	11,338	61	9,557	3,127	49
Diamonds & gem stones	29,341	32,757	3,416	12	3,612	−1,283	−26
Crude petroleum and products	85,367	94,520	9,153	11	19,983	5,206	35
Total	297,206	359,108	61,902	21	66,516	11,641	21
Memo
Non-oil, non-bullion imports	191,086	233,082	41,996	22	36,787	3,511	11
Non-oil, non-bullion, non-diamond imports	161,745	200,324	38,580	24	33,175	4,794	17

Note:* Including all project goods.
Source: Monthly Foreign Trade Statistics of India (principal commodities& countries), Imports and Exports & Re-exports, Directorate General of Commercial Intelligence & Statistics, Government of India, March and May issues of 2004, both released in October 2004.

Exports

The relatively weaker export performance in textiles is of some concern, given that the MFA quota system is set to be phased out with effect from January 2005 and the challenge to occupy competitively additional space will be facing the Indian textile business as a current reality.

In 2003–04, exports overall in rupee terms increased by 15 per cent. During the first two months (April-May 2004) of the current fiscal year, the expansion of exports was faster at the rate of 25 per cent [see Table 8.2]. Within exports, the fastest growing items were engineering goods, metals and metal manufactures, chemicals and products thereof. This was as true of the full year, as for the first two months of 2004–05. Textiles—yarn, fabrics, apparel, made-ups and carpets—expanded by only 5 per cent in 2003–04 and contracted by a small amount in the first two months of the current year. Leather and manufactures picked up a bit in 2003–04, but have had a lacklustre performance in the first two months of 2004–05. Export of gems & jewellery showed modest growth last year, but has expanded by 42 per cent in the first two months of 2004–05. Export of refined petroleum products rose by 32 per cent in 2003–04 and by 74 per cent in the first two months of 2004–05. The relatively weaker export performance in textiles—and individually in the major categories of cotton apparel, cotton yarn, fabrics & madeups and manmade fibre yarn & apparel—is of some concern, given that the MFA quota system is set to be phased out with effect from January 2005 and the challenge to occupy competitively additional space will be facing the Indian textile business as a current reality. Table 8.2

Summary of Changes in the rupee value of Merchandise Exports Financial years of 2002–03, 2003–04 and April-May (2 months) of 2004–05

Unit: Rs. Crore

Categories	2002–03	2003–04			2004–05 (Apr–May)

		Amount	Change from full year of 2002–03		Amount	Change from April–May of 2004–05

			Amount	%		Amount	%

Agricultural Products	31,413	33,500	2,087	7	5,755	884	18
Ores & minerals	9,660	10,885	1,225	13	2,354	988	72
Leather & manufactures	8,946	9,940	994	11	1,323	−89	−6
Textiles and products	56,220	58,777	2,557	5	8,506	−142	−2
Chemicals and products	33,942	40,776	6,834	20	7,072	1,238	21
Metals and products	20,309	25,725	5,416	27	4,628	854	23
Engineering goods	17,141	22,985	5,844	34	4,299	1,214	39
Other manufactured goods	76,244	89,308	13,064	17	17,649	5,694	48
Total	255,137	293,367	38,230	15	43,540	8,771	25
Memo Items
Agricultural & mineral produce
Oil meals	1,487	3,348	1,861	125	1,090	948	667
Marine products	6,928	6,106	−822	−12	569	−263	−32
Meat & meat preparations	1,337	1,714	337	24	235	3	1
Rice-basmati & non-basmati	5,831	4,168	−1,663	−29	697	−145	−17
Tea and coffee	1,856	1,840	−16	−1	414	47	13
Wheat	1,760	2,391	631	36	447	220	97
Iron ore	4,200	5,173	973	23	1,352	814	151
Manufactured Goods
Apparel—cotton	21,510	22,009	499	2	3,282	146	5
Drugs & pharmaceuticals	12,826	15,213	2,387	22	2,302	−47	−2
Cotton yarn, fabrics & made ups	16,218	15,600	−618	−4	2,159	−187	−8
Iron and Steel	8,982	11,385	2,403	27	2,029	211	12
Machinery and instruments	9,720	12,757	3,037	31	2,120	176	9
Manufacture of metals	8,942	11,150	2,208	25	1,952	352	22
Plastic & linoleum products	5,912	8,054	2,142	36	1,946	965	98
Transport equipment	6,455	8,988	2,533	39	1,934	929	92
Manmade fibres-yarn & apparel	6,639	8,093	1,454	22	1,247	38	3
Inorganic/organic/agro-chemicals	4,930	5,293	363	7	945	88	10
Dyes &intermediates	3,440	4,710	1,270	37	945	88	10
Select items categorised under “other manufactured goods” in above
Gems & jewellery	43,701	48,586	4,885	11	8,620	2,560	42
“Other” commodities	5,770	8,640	2,870	50	2,308	1,118	94
Petroleum refinery products	12,469	16,397	3,928	32	4,131	1,751	74
Electronic goods	6,063	7,942	1,879	31	1,228	99	9
Handicrafts	3,801	2,296	−1,505	−40	135	−223	∔62

Source: As in Table 8.1.

Direction of TradeImports

In 2003–04, China became the second largest supplier of India's imports with a market share of 5.2% and 38% growth during the year.

The largest regional source of non-oil imports into India is Western Europe, followed by East Asia and South East Asia [see Table 8.3]. However, the most sizeable increases in imports have come from East and South East Asia. Imports from South Korea and Australia have nearly doubled in 2003–04 over that in 2002–03, while that from Sri Lanka, the UAE, Norway and Afghanistan have indeed more than doubled [see Table 8.5]. The USA is the origin of the largest single share of India's imports at over 6 per cent, but growth of 7–8 per cent in each of the two previous years has been relatively modest. Belgium (the source of much of the diamonds imported into India) had the second largest market share at 6 per cent in 2002–03, but growth last year was weak,²⁰ and has yielded the second spot to China. In 2003–04, China became the second largest supplier of India's imports with a market share of 5.2 per cent and 38 per cent growth during the year. Imports from Switzerland grew by 35 per cent bringing that country up to fourth place in terms of market share. Imports from Norway, Italy, Sweden, Norway, the Netherlands and Finland, all grew strongly through 2003–04. So too did imports from Spain, Greece and Ireland, though on a relatively small base. Imports from France actually fell, while that from Germany and our largest European trading partner, namely the U.K., grew at a relatively modest pace.

²⁰ Most probably because Indian gem polishers are increasingly purchasing their rough diamonds directly from producer countries.

Table 8.3

Summary of changes in the Sources of Indian Imports by Region Financial years of 2002–03 and 2003–04

	Complete financial year—12 months

	2002–03		2003–04

	Value in Rs crore	Share in total imports in %	Value in Rs crore	Change from 2002–03 in %	Share in total imports in %

Western Europe	72,596	24.5	84,565	16.5	23.5
North America	24,119	8.1	26,471	9.8	7.4
East Asia incl. Japan	37,691	12.7	54,285	44.0	15.1
West Asia	15,290	5.2	20,851	36.4	5.8
South East Asia	24,912	8.4	34,156	37.1	9.5
Africa	16,545	5.6	14,694	−11.2	4.1
South Asia	2,491	0.8	3,259	30.9	0.9
Latin America	5,068	1.7	5,480	8.1	1.5
C.I.S.	3,642	1.2	5,796	59.2	1.6
Oceania	6,869	2.3	12,623	83.8	3.5
Transitional Europe	1,090	0.4	1,409	29.2	0.4
Unspecified sources*	86,066	29.0	95,367	10.8	26.6
Grand Total	201,519	100	263,590	30.8	100

Note:* This is mostly crude petroleum which is almost invariably not identified by source in trade data. Much of India's imports of crude petroleum are sourced from the Persian Gulf region, and to a much lesser extent from South East Asia. Had the details been availabel would have been incorporated into the group “West Asia” and to some extent under the category “South East Asia”.
Source: As in Table 8.1 above.

Table 8.4

Summary of changes in the Destination of Indian Exports by Region Financial years of 2002–03 and 2003–04

	Complete financial year—12 months

	2002–03		2003–04

	Value in Rs crore	Change from 2001–02 in %	Value in Rs crore	Change from 2002–03 in %	Share in total exports in %

Western Europe	57,289	16	67,038	17	22.9
North America	55,879	29	56,306	1	19.2
West Asia	35,001	39	45,975	31	15.7
East Asia incl. Japan	37,135	34	43,140	16	14.7
South East Asia	20,418	24	26,752	31	9.1
South Asia	12,824	31	19,729	54	6.7
Africa	15,097	10	17,654	17	6.0
Latin America	6,578	35	5,491	−17	1.9
C.I.S.	4,404	−5	4,727	7	1.6
Oceania	2,929	20	3,257	11	1.1
Transitional Europe	1,501	22	2,277	52	0.8
Grand Total	255,137	22	293,367	15	100.0

Source: As in Table 8.1 above.

Table 8.5

Summary of Changes in the Sources of Indian Merchandise Imports—Selected Countries Financial years of 2002–03 and 2003–04

	Complete financial year-12 months

	2002–03		2003–04

	Value in Rs Crore	Share in total imports %	Value in Rs crore	Change from 2002–03 in %	Share in total imports %

North America
U.S.A.	21,379	7.2	23,136	8.2	6.4
Canada	2,740	0.9	3,336	21.7	0.9
Western Europe
Belgium	17,962	6.1	18,270	1.7	5.1
Switzerland	11,273	3.8	15,223	35.0	4.2
U.K.	13,446	4.5	14,862	10.5	4.1
Germany	11,504	3.9	13,411	16.6	3.7
France	5,298	1.8	5,010	−5.4	1.4
Italy	3,927	1.3	4,922	25.3	1.4
Sweden	2,504	0.8	3,211	28.2	0.9
Netherlands	1,867	0.6	2,461	31.8	0.7
Norway	347	Neg	1,392	300.9	0.4
Finland	963	0.3	1,241	28.9	0.3
East Asia
China	13,466	4.5	18,625	38.3	5.2
Hong Kong	4,706	1.6	6,859	45.8	1.9
Japan	8,852	3.0	12,258	38.5	3.4
Korea, South	7,374	2.5	13,000	76.3	3.6
Taiwan	3,206	1.1	3,533	10.2	1.0
West Asia
U.A.E	4,610	1.6	9,465	105.3	2.6
Saudi Arabia	2,442	0.8	3,390	38.8	0.9
Israel	2,945	1.0	3,078	4.5	0.9
Iran	1,249	0.4	1,226	−1.8	0.3
Jordan	1,080	0.4	1,058	−2.0	0.3
South East Asia
Indonesia	6,681	2.3	9,751	46.0	2.7
Singapore	6,937	2.3	9,583	38.1	2.7
Malaysia	7,090	2.4	9,404	32.6	2.6
Thailand	1,832	0.6	2,799	52.7	0.8
Myanmar	1,626	0.5	1,879	15.6	0.5
South Asia
Nepal	1,356	0.5	1,314	−3.1	0.4
Sri Lanka	441	0.1	895	102.7	0.2
Bangladesh	263	0.1	357	35.7	0.1
Pakistan	215	0.1	265	23.0	0.1
Bhutan	125	Neg	241	91.9	0.1
Afghanistan	88	Neg	186	111.3	0.1
Oceania, Africa, CIS and Latin America
Australia	6,453	2.2	12,174	88.7	3.4
South Africa	10,113	3.4	8,727	−13.7	2.4
Russia	2,853	1.0	4,410	54.6	1.2
Argentina	1,956	0.7	2,408	23.1	0.7
Brazil	1,532	0.5	1,441	−6.0	0.4

Source: As in Table 8.1.

Exports

If we take Hong Kong and China as a single economic entity, its share was 8.5% in 2003–04 and 9.7% in 2004–05—second only to that of the US as a market for Indian exports.

The largest regional destination of Indian exports continues to be Western Europe, but the share of this market has declined to 22.9 per cent in 2003–04 from 23.3 per cent in 2001–02 [see Table 8.4]. The USA is the single largest destination country, but export growth has slowed to 8.2 per cent in 2003–04, compared to 29.4 per cent in 2002–03, as a result of which the share of the US market in Indian goods export has declined to 18.2 per cent in 2003–04, from 20.6 per cent in 2002–03 [see Table 8.6]. In Europe, the United Kingdom continues to be largest country destination, followed by Germany. Exports to Italy have grown the fastest in 2004–05. The UAE has been the second largest destination country for Indian exports for some years and in 2004–05 its share increased further to 8 per cent. Hong Kong has moved to the third sport ahead of the U.K. in 2004–05. If we take Hong Kong and China as a single economic entity, its share was 8.5 per cent in 2003–04 and 9.7 per cent in 2004–05—second only to that of the US as a market for Indian exports. Export growth to both Japan and Taiwan was slow in 2003–04 and the trend has continued into 2004–05. Table 8.6

Summary of changes in the Destination of Indian Merchandise Exports—Selected Countries Financial years of 2002–03 and 2003–04

	Complete financial year-12 months

	2002–03		2003–04

	Value in Rs Crore	Share in total exports %	Value in Rs crore	Change from 2002–03 in %	Share in total exports %

North America
U.S.A.	52,536	20.8	52,799	0.5	18.0
Canada	3,343	1.3	3,507	4.9	1.2
Western Europe
U.K.	11,968	4.7	13,892	16.1	4.7
Germany	9,973	3.9	11,693	17.2	4.0
Belgium	7,976	3.2	8,298	4.0	2.8
Italy	6,483	2.6	7,947	22.6	2.7
Netherlands	4,960	2.0	5,924	19.4	2.0
France	5,107	2.0	5,886	15.3	2.0
Spain	3,896	1.5	4,607	18.2	1.6
Switzerland	1,722	0.7	2,067	16.6	0.7
East Asia
Hong Kong	11,829	4.7	14,989	26.7	5.1
China	9,491	3.8	13,579	43.1	4.6
Japan	8,990	3.6	7,854	−12.6	2.7
Korea, South	3,120	1.2	3,515	12.7	1.2
Taiwan	2,796	1.1	2,447	−12.5	0.8
West Asia
U.A.E.	16,037	6.3	23,553	46.9	8.0
Saudi Arabia	4,552	1.8	5,162	13.4	1.8
Iran	3,171	1.3	4,219	33.0	1.4
Israel	3,071	1.2	3,327	8.4	1.1
Turkey	1,780	0.7	2,589	45.4	0.9
Kuwait	1,212	0.5	1,466	21.0	0.5
Iraq	1,037	0.4	345	−66.7	0.1
South East Asia
Singapore	6,885	2.7	9,764	41.8	3.3
Indonesia	3,997	1.6	5,180	29.6	1.8
Malaysia	3,614	1.4	4,102	13.5	1.4
Thailand	3,440	1.4	3,822	11.1	1.
Latin America
Brazil	2,318	0.9	1,267	−45.4	0.4
Mexico	4,457	0.5	1,215	−4.1	0.4
South Asia
Bangladesh	5,297	2.1	7,999	51.0	2.7
Sri Lanka	4,457	1.8	6,062	36.0	2.1
Africa, Oceania and CIS
Russia	3,376	1.3	3,280	−2.8	1.1
Australia	2,433	1.0	2,685	10.4	0.9
South Africa	2,307	0.9	2,478	7.7	0.8
Nigeria	2,177	0.9	2,599	19.4	0.9
Egypt	1,443	0.6	1,689	17.0	0.6

Source: As in Table 8.1.

The other fast growing export destination has been Singapore to which export growth was as high as 42 per cent in 2003–04 that came on top of a 49 per cent expansion in 2002–03. In the region, export growth to Bangladesh and Sri Lanka has been strong, while that to Australia has lagged import growth. Export growth to major Latin American markets slowed in 2003–04, as well as that to Russia—which has been something of a continuing trend. In Africa, while export growth to South Africa has grown relatively slowly, that to Nigeria and Egypt has picked up some momentum.

Macro-Overview