Macro-economic overview of India
INDIA CAN DO IT
the first time in history, India has recorded a growth
rate in excess of 8% for four years in a row. I see a new dynamism
in our entrepreneurial class. I see a new energy, a new creativity,
a new urge to show that India can do it.
-- Prime Minister Manmohan Singh at The Economic Times Awards for Corporate Excellence (2005-06) on October 9, 2006
THE Indian economy exhibited strong performance during 2005-06, led by sustained growth in the industry and the services sectors. According to the advance estimates of the Central Statistical Organisation (CSO), the real GDP growth accelerated from 7.5 per cent in 2004-05 to 8.1 per cent in 2005-06.
Monetary and Liquidity Conditions
Monetary and liquidity conditions remained largely comfortable during 2005-06 although there was some tightness in liquidity conditions during the last four months of 2005-06 reflecting partly the impact of the redemption of India Millennium Deposits (IMDs). The Reserve Bank injected liquidity through unwinding of the Market Stabilisation Scheme (MSS) and repo operations under the liquidity adjustment facility (LAF) along with some private placement of the Central Government securities. As a result, the banking system was able to meet the sustained pick-up in credit demand from the commercial sector.
In the face of the rising demand for commercial credit, banks restricted their incremental investments in Government paper. Strong growth in deposits as well as access to non-deposit sources also enabled the banking system to meet the enhanced demand for commercial credit. Scheduled commercial banks’ non-food credit, on a year-on-year basis, registered a growth of 30.8 per cent as on March 31, 2006 on top of 28.8 per cent a year ago.
Money supply (M3) expanded by 16.2 per cent on a year-on-year basis as on March 31, 2006 as compared with 13.9 per cent a year ago. On a fiscal year basis, M3 expanded by 20.4 per cent during 2005-06 as compared with 12.1 per cent a year ago. In this context, it may be noted that data on fiscal year variation for 2005-06 are not comparable with those of the previous years as the data for 2005-06 include 27 fortnights while usually the data for a year include 26 fortnights. Moreover, the last reporting Friday of 2005-06 coincided with March 31, the closing day for banks’ accounts, thereby giving rise to the phenomenon of year-end bulge in aggregate deposits and credit.
Reserve money expanded by 16.9 per cent on a year-on-year basis as on April 7, 2006 as compared with 15.1 per cent a year ago.
Headline inflation firmed up in a number of economies during 2005-06 on account of international crude oil prices reaching a record high and remaining at elevated levels. Accordingly, many central banks tightened monetary policy during 2005-06 in order to contain inflation and inflationary expectations, especially in view of the fact that a significant part of the increase in international crude oil prices is increasingly viewed as somewhat permanent.
In India, headline inflation and inflation expectations remained well-contained during 2005-06, despite continued dominance of supply-side factors. Fiscal and monetary measures undertaken since mid-2004 to reduce the impact of imported price pressures on domestic inflation and to stabilise inflationary expectations were successful in containing inflation towards the desired trajectory during 2005-06.
In India, year-on-year wholesale price inflation was 3.5 per cent on April 1, 2006 as compared with 5.7 per cent a year ago.
Inflation Conditions in India
Headline inflation, based on movement in the wholesale price index (WPI), was 4.0 per cent as at end-March 2006 as compared with 5.1 per cent a year ago. Inflation initially increased during 2005-06 to an intra-year high of 6.0 per cent on April 23, 2005 reflecting increases in prices of fruits and vegetables, iron and steel and select petroleum products such as furnace oil and naphtha. Subsequently, with the base effect coming into play and the revival of the monsoon, inflation began to ease reaching an intra-year low of 3.3 per cent on August 27, 2005. Inflation again edged up during the third quarter of 2005-06 - but remaining below 5.0 per cent – under the impact of the hike in petrol and diesel prices in
early September 2005 as also a rise in vegetables and cotton prices. Vegetable prices remained high for most part of the third quarter of 2005-06 due to damage to the standing crops from excessive rains/floods in various parts of the country. With the easing of vegetables prices from early December 2005 as well as reduction in domestic iron and steel prices in January 2006, inflation moderated to 3.9 per cent on January 7, 2006. It edged marginally higher to reach 4.3 per cent on March 11, 2006 on the back of higher non-ferrous metal, furnace oil and electricity prices before easing to 4.0 per cent as on March 25, 2006. The average WPI inflation rate eased to 4.5 per cent during 2005-06 from 6.4 per cent a year ago. WPI inflation (y-o-y) was 3.5 per cent as on April 1, 2006.
The inflation outcome during 2005-06 was influenced mainly by the price movements of petroleum products. Mineral oils inflation alone contributed about 41 per cent to the headline inflation. Accordingly, the y-o-y WPI inflation excluding the fuel group at 2.6 per cent remained well below the headline rate.
Although fuel prices were the key driver of domestic inflation during 2005-06, domestic petroleum products prices still lag the increase in international crude oil prices. The pass-through of higher international oil prices has been restricted mainly to petrol and diesel (hike of 7-8 per cent each in June and September 2005). Domestic prices of liquefied petroleum gas (LPG) and kerosene oil remained unchanged during 2005-06. As compared with an increase of about 87 per cent from US $ 31.9 a barrel to US $ 59.6 a barrel in international crude oil prices (the Indian basket) between March 2004 and March 2006, domestic mineral oil prices in the WPI basket have increased by about 31 per cent over the same period – petrol by 28.4 per cent and high-speed diesel by 40.1 per cent.
Apart from fuel prices, prices of primary food articles posed some upward pressures on inflation during 2005-06. Wheat prices firmed up during the second half of 2005-06 on reports of fall in stocks. Prices of pulses, eggs, fish and meat also edged higher during 2005-06. Raw cotton prices after remaining flat during the first half of the year increased marginally during November-December 2005 in tandem with international trends. Oilseeds prices have moderated since November 2005 on account of improved crop prospects. The prices had hardened somewhat during the first half of 2005-06, reflecting last year’s shortfall in domestic kharif production and worries about a poor ensuing crop due to the unsatisfactory progress of the South-West monsoon. On the whole, primary articles inflation increased from 1.3 per cent at end-March 2005 to 5.3 per cent at end-March 2006.
Manufactured products inflation remained modest, falling from 4.6 per cent at end-March 2005 to 1.5 per cent at end-March 2006 reflecting stable inflation expectations, productivity gains as well as increased competition. Strong corporate profitability also provided firms the flexibility to absorb higher input prices into their profit margins. Upward pressures from sugar and other food products, cement and non-ferrous metals were offset by easing of prices of manmade fibres, edible oils, oil cakes and iron and steel. Domestic sugar prices remained firm during the year in line with international trends, notwithstanding higher sugarcane output in the country. Domestic metal prices during 2005-06 moved in tandem with trends in international prices. Iron and steel prices in India declined by 7.5 per cent during 2005-06 as against a sharp increase of 21.3 per cent during the previous year. In contrast, non-ferrous metal prices rose sharply. Prices of copper and zinc increased by 40.8 per cent and 39.6 per cent, respectively, during 2005-06.
In brief, domestic WPI inflation during 2005-06 was dominated by a few items, especially mineral oil prices, which alone contributed almost 41 per cent of the headline inflation. Accordingly, the contribution of the fuel group to y-o-y overall WPI inflation as at end-March 2006 was 49.1 per cent (higher than that of 42.7 per cent a year ago). Manufactured products contribution fell to 22.1 per cent (52.0 per cent), largely on account of a decline in iron and steel prices. On the other hand, primary articles’ contribution to the overall inflation increased to 28.5 per cent (5.5 per cent) mainly due to higher prices of wheat, pulses, vegetables and eggs, meat and fish.
Consumer price inflation for industrial workers (CPI-IW) was 5.0 per cent during February 2006 as compared with 4.2 per cent during March 2005 (Table 34). Disaggregated information on CPI-IW available up to December 2005 shows that food prices firmed up from the March 2005 level. Services inflation – proxied by the miscellaneous group in the CPI-IW – edged up mainly reflecting increase in the prices of medical care and ‘education, recreation and amusement’. On the other hand, increase in the housing index – which includes rent paid for rented, self-owned and rent free houses – in the CPI-IW basket decelerated from its March 2005 level.
Equity and gold prices recorded sharp increases during 2005-06. Buoyancy in equity markets continued on the back of better prospects for economic activity, strong corporate performance and liquidity support by FIIs and mutual funds. Domestic gold prices remained firm in line with international trends. International gold prices have risen sharply since mid-2005, crossing US $ 600 per ounce in April 2006. Gilt prices fell marginally during the year, with intra-year movements influenced by trends in domestic inflation and liquidity conditions.
Source: Reserve Bank of India report Macroeconomic and Monetary Developments, April 17, 2006