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>> FEBRUARY 27, 2006
Economic Survey: Nothing extraordinary!
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It is yet another year of robust growth for the Indian economy, which is riding strong on the back of robust growth of the manufacturing and services sector and also some recovery witnessed in agricultural sector. With the above three engines running smooth for the Indian economy, India's GDP is projected to clock a growth rate of 8.1% for FY06. It must be noted here that GDP growth at constant prices in excess of 8% has been achieved by the Indian economy in only 5 years of India's recorded history. Of this, it has come about twice in the last 3 years, as can be seen in the chart below.
Services show the way...
It must be noted that an annual average growth rate of 8% had been envisaged in the Tenth Five Year Plan (FY03-FY07). While this target is unlikely to be achieved, considering that the average growth in the first four years of the plan has been 7% (owing to the mere 3.8% GDP growth in FY03), and if India has to achieve the 8% average, it would have to grow at 12% in FY07, the fact that India's GDP has indeed averaged 8% in the last three years is encouraging. In fact, India would have had managed to achieve the targeted growth rate, but for the erratic monsoons, which has adversely affected the agricultural output. Despite this, the growth in GDP is commendable and this, to an extent, indicates the decreasing dependence on agriculture as the key growth engine of the Indian economy.
On the manufacturing front, the growth momentum has only gathered steam over the last few years from 7% in FY03 to a projected 9% in FY06 (see chart above). Within this, it has been the manufacturing and construction segments that have been at the leading end of this growth. While the manufacturing growth has steadily accelerated from 6.8% in FY03 to 9.4% (projected) in FY06, the average growth of the construction sector has been a strong 10.8% in the last four years (over 12% in the last couple of years). Substantive commercial bank credit flows to the housing, real estate and retail sectors continue to provide support to the boom in construction and consumer durables.
On the services front, the growth continues to be broad-based. While 'trade, hotels, transport and communication' as a segment registered double-digit growth rates (averaging 10.7% in the last four years), financial services also did its bit by clocking in an average growth of 7.8% in the said period.
Not a 'pricey' growth...
Despite record global crude oil prices during FY06, the effect of which was visible in terms of an upward bias in inflation in most parts of the world, the Indian economy displayed relative resilience. In India, inflation, measured by a point-to-point increase in wholesale price index declined from 5.7% on 2nd April 2005, to a low of 3.3% on 27th August 2005. Despite increasing thereafter, prices have remained at comfortable levels with wholesale price index (WPI) inflation at 4.1% in February 2006 vis-à-vis 5.0% same time last year.
This performance is indeed credible, considering that India imports 70% of its crude oil requirements. Further, since a part of this was passed onto the consumer in terms of increased prices of petroleum products, the 'fuel, power, light and lubricants' group contributed the most to price rises in the economy. It must however, be noted that retail prices of kerosene and LPG remained unchanged during the year to soften the burden on consumers, this subsidy has had a telling effect on the finances of Indian oil marketing companies as yet during FY06.
In contrast to the above, the decelerating inflation trend witnessed in the manufactured products group has continued in FY06, which could be attributed to the implementation of value added tax (VAT) system in most of the Indian states since the beginning of FY06. Inflation in manufactured products was under tight control with heightened competition in increasingly liberalised markets for such products.
Healthy forex reserves...
A reversal of trend has been witnessed here so far in FY06 with India's forex reserves having reduced by US$ 1.1 bn. This is in sharp contrast to the accretion witnessed in forex reserves in FY05 of US$ 28.5 bn to US$ 141.5 bn. The economic survey has attributed three key factors for this turnaround: an outgo of US$ 7.1 bn on account of IMD redemption, valuation losses from a weakened dollar vis-à-vis other major currencies and a widening deficit in the current account of the balance of payments (BOP).
Interest rates - Heading northwards!
The bank rate and the cash reserve ratio (CRR) were kept unchanged during the current year at 6.0% and 5.0% respectively. However, the fixed reverse repo rate under the Liquidity Adjustment Facility (LAF) of the Reserve Bank of India (RBI) was raised three times, by 25 basis points each, to reach 5.5% on January 24th 2006. RBI's policy response has been in line with the cautious approach in many other countries of moving policy interest rates in a measured way in the face of the threat of inflationary expectations firming up with high crude oil prices.
Fiscal deficit - Not a worry...
As per the economic survey, the consolidated fiscal deficit of the centre and the states is budgeted to come down from 8.4% of GDP in 2004-05 (RE) to 7.7% in 2005-06 (BE), which is heartening. Buoyant revenues in the states indicate that the process of deepening of the fiscal reforms and restructuring of public finances as envisaged by the Twelfth Finance Commission (TFC) have had a head start. While the decline in deficit is a commendable fact, for a developing economy like that is starved for basic amenities, it is high time the government allocates a greater share towards infrastructure development, even if it means higher fiscal deficit. Given the fact that the private sector may not be in a position to garner significant funds towards public development, the government should not distance itself from the same. Deficit is not a problem, but channelising the utilisation of funds i.e. administration is the key issue.
The economic survey states 'while in many other countries, the experience of fiscal adjustment process has essentially been achieved through expenditure compression, the fiscal correction in the country (India) since FY04 has been achieved on the strength of higher revenue'. Further, though the outlook issued does indicate that there is room for some expenditure compression in the event of revenues not matching up, we reckon that rather than waiting for possible lower revenues, reduction in expenditure should be implemented without much delay.
It must be noted that the growth in gross tax revenues has been projected at 22% going forward (18.8% in 9mFY06) on the basis of higher real GDP growth and tax reforms.
To conclude, going forward, while the increased contribution from the industry and services sectors in India's GDP growth instills faith in the growth of the Indian economy, the fact that a large population of the Indian economy continues to be dependent on monsoons for a good living cannot be overlooked. Further, although large power projects being lined up are good for the infrastructure development of the economy along with the development of railways, roads and airports, the country is going a step backward as far as protectionism is concerned.
All in all, we believe that the government will continue to have to take some harsh measures in the time to come in order to see longer-term sustainable economic growth at the cost of short-term benefits. It has taken almost fifty years for the policy makers to target GDP growth in excess of 8% GDP on a sustainable basis without any major price escalation. One wonder how long will it take for the policy makers to start thinking about 10% growth! As it is said "Indians are easily satisfied"
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