The Hindu Business Line : The economy's balance-sheet

More than any concrete developments in specific markets, it is the fairly widespread acceptance of the continuing revamp of the economic structure that provides the brightest ray of hope. The most concrete measures have been and are still continually being taken in the financial sector.

THE positives for the Indian economy outweigh the negatives. With elections to the Lok Sabha already on, a look at the encouraging and pessimistic aspects of India's macroeconomic balance-sheet. More than any concrete developments in specific markets that could be rooted for, it is the fairly widespread acceptance of the continuing revamp of the economic structure and global stance that provides the brightest ray of hope. The most concrete measures have been and are still continually being taken in the financial sector.

The price levels have held fairly steady in FY2004. The Wholesale Price Index (WPI)-based inflation is likely to be below 5 per cent and and the various Consumer Price Indices reflect the cost of living of the rural and urban white and blue-collar population.

There is a core rate of inflation that is usually defined in developed countries that excludes volatile fuel and energy prices. In India, a core rate of inflation would accordingly comprise the WPI without its most volatile components, prices of cereals and pulses. With the prices of "primary articles" on an average remaining subdued in FY2004, variations in the core inflation rate have been muted than in the overall WPI.

In FY2005, with the India Meteorological Department predicting a normal monsoon, foodgrain prices are likely to remain in control. As for fuel prices, the prospects of an increase will depend on the whether the widespread expectations of a fuel price rise after the elections actually becomes a reality.

The big news is that the National Accounts Statistics Gross Domestic Product (GDP) data show that there has been a sharp increase in GDP growth rate in FY2004.

GDP growth in FY2004 moved up progressively from 5.7 per cent in Q1, to 8.4 per cent in Q2 and finally to a sharp 10.4 per cent in Q3. Even after factoring in the base effect (agriculture growth in Q3FY2003 was a negative 9.8 per cent against a 16.9 per cent growth in Q3FY2004), estimates based on the growth rates in FY2004 reveal that the overall GDP growth (based on April-December GDP numbers) currently exceeds even the CSO projections for the year at 8.1 per cent.

There is also the question of how, as a nation, the resources are being used. The Incremental Capital Output Ratio (ICOR) is an aggregate measure of efficiency of capital use, indicating how many units of capital are needed to produce one unit of output. Estimates show that there has been a sharp decline in ICOR over the years from the high levels in mid-1990s (3.45 in FY1995). This shows that the efficiency of the economy as a whole has improved over the years.

A major source of satisfaction is the $35 billion accretion to the foreign exchange reserves of the RBI in FY2004. This large amount of foreign exchange reserves is likely to act as a cushion against any possible speculative disturbances in the foreign exchange market, apart from investor confidence.

However, on the downside, a little introspection on the plight of the central banks of the South-East Asian nations in the 1990s reveal that even large foreign exchange reserves may not be a sufficient condition to ward of foreign exchange market turmoil.

The implications of the huge bulge in foreign exchange reserves has also resulted in the RBI going the full circle to neutralise the excess liquidity injected in lieu of the RBI intervention in the foreign exchange market to mop up dollar supplies. For instance, the recently introduced Market Stabilisation Fund will supplement the RBI's open market operations in mopping up the surplus liquidity from the banking system.

The RBI has also been successful in shifting the interest rate yield curve downwards. In effect, the Monetary and Credit Policy over the years has been successful in creating an atmosphere conducive to a lower interest rate regime by broadening, deepening and liquefying the debt and money markets. Additionally, the RBI has been conscious enough to contain the money supply growth within a very conservative estimate of 14 per cent, so asnot to take chances with increased inflationary expectations, which push long and medium term rates up. So far, this ploy has worked successfully to the RBI'sadvantage.

The total flow of funds to the commercial sector, which includes banks' investments in bonds/debentures/shares issued by the public sector undertakings and private corporate sector, commercial paper, rose 15.1 per cent in FY2004 (till March 19, 2004) — as against a targeted resource flow of 15-15.5 per cent by the RBI.

However, even though the targeted resource flow is likely to be met, the 15.1 per cent growth is much lower than the 24.9 per cent in the like period the previous year. On an average, the banks' investments in corporate debentures, bonds and preference shares have taken a hit in FY2004.

A pleasant surprise in FY2004 is the improvement in fiscal health of the Government. In particular, and in all probability (the recently released figures for tax collections are close or even higher than the revised FY2004 estimates), the government will be able manage to adhere to the revised fiscal deficit for FY2004 at 4.8 per cent of GDP, significantly lower than the budgeted 5.6 per cent.

Over the next fiscal year (FY2005), this figure is budgeted to be reduced to 4.4 per cent of GDP. The implication is that an overall tax collection and expenditure reduction effort amounting to 0.4 per cent of GDP would have to be made in FY2005.

However, the much lower level of fiscal deficit in FY2004 is attributed mainly to a surge in non-debt capital receipts. In particular, recoveries of loans from States (including receipts from States on account of the debt swap scheme are estimated at Rs 64,630 crore), as against the budgeted Rs 18,020 crore. Additionally, the disinvestment proceeds for FY2004 are at Rs14,500 crore against the budgeted Rs 13,200 crore, and significantly higher than the revised estimate for FY2003 at Rs 3,150 crore. However, given that the debt swap scheme was a one-time phenomenon, the government needs to tread with caution in FY2005.

On the external front, the country's export growth zoomed to 17.3 per cent during FY2004, as against the targeted 12 per cent. The strong performance in exports is to be viewed against the current trend of appreciation of rupee vis-a-vis the dollar. Probably, reflecting the appreciation of the rupee against the US dollar), India's exports to the US (a share of over 20 per cent) fell by close to 3 per cent in the first eight months of the FY2004.

This reinforces the contention that the fall in the real value of the rupee against a basket of currencies (the rupee depreciated against the euro) may have helped in pushing up the exports.

Indian markets are still among the better-regulated ones among the emerging countries. This will be a crucial factor in the ongoing process of liberalisation insofar as a facilitator of greater transparency in the financial system, thereby reducing risk.

(The author is with ICRA Limited. The views expressed are personal.)