The Hindu Business Line : RBI's Annual Report 2004-05 — Pervading optimism, major concerns

Revival of the South-West monsoon, a stronger manufacturing sector, high corporate profitability, buoyant equity market, robust merchandise exports and imports, and sustained demand for non-food credit, all point to bright prospects for the economy for 2005-06 and beyond. Yet, concerns remain in stepping up the growth rate of the agriculture, building up infrastructure, and in the soaring international oil prices. On the whole, though, the RBI is upbeat about the economy, says S. D. Naik.

THE RESERVE Bank of India's Annual Report for 2004-05 exudes pervading optimism and paints a bright near-term outlook for the Indian economy. Though the real GDP growth slowed to 6.9 per cent in 2004-05 vis-à-vis the impressive 8.5 per cent the preceding year, the Report points out that the overall macroeconomic performance remained impressive and that India remained one of the fastest growing emerging economies.

In particular, the Report highlights the firming up and spread of the upturn in industrial activity, continued buoyancy of the services sector and the positive developments in the external sector, including the continuing strong growth in the country's merchandise trade. Assuming a normal monsoon, the RBI has reaffirmed that the GDP growth in 2005-06 would be 7 per cent.

Industrial recovery

The recovery in the industrial sector, which set in during 2002-03, has steadily become entrenched and diffused. The real GDP growth originating from industry rose to 8.3 per cent in 2004-05 — the highest since 1995-96. The industrial activity during the year was largely powered by manufacturing, which grew 9.0 per cent. The buoyant performance of this sector was supported by a congenial domestic investment climate, an improvement in world output, a liberalised FDI regime and surging exports.

One of the outstanding features of industrial activity in 2004-05 was the strong growth of the capital goods sector. Expanding investing activity driven by both domestic and external demand was reflected in higher capital expenditure and capital goods imports, leading to an increase in capacity creation across a wide spectrum of industries. Going by the current trends in corporate finances, it appears that Indian industry is embarking on a new investment cycle.

The overall investment climate in 2005-05 was buoyant, as reflected in the investment intentions registered in the Industrial Entrepreneurs Memoranda and Letters of Intent and in their implementation. A significant investment revival is suggested by the substantial investment intentions registered in 2003-04, which further nearly doubled in 2004-05. This is also reflected in the strong growth in banking sector's non-food credit.

Also during 2004-05, there was a substantial growth of 75.5 per cent in the value of acquisitions in the industrial sector. Mergers and acquisitions (M&As) were concentrated mainly in such sectors as chemicals, non-metallic mineral products, computer software and mining. The telecommunications sector entered a consolidation phase with smaller players selling out to larger ones.

Industrial production gathered further strength during the first quarter of this fiscal (April-June) with growth accelerating to double-digit level. While overall industrial production registered a growth of 10.3 per cent, the pick-up in manufacturing was even higher at 11.2 per cent. During the quarter, the capital goods sector continued to maintain high growth supported by strong performance of machinery and equipment, transport equipment and commercial vehicles.

Services, the driving force

The services sector remained the key driving force of the economy in 2004-05 contributing as much as 70.5 per cent to the real GDP growth. The growth of the services sector at 8.6 per cent during the year was higher than the average growth of 7.5 per cent over the preceding five years. This sector's contribution to GDP has been more than 50 per cent since 1997-98. Its share in GDP climbed further to 57.6 per cent in 2004-05.

The most visible dimension of the sustained growth in services has been the contribution of the software sector including the information technology enabled services (ITeS) and BPO segments. The total revenues (exports and domestic) of the IT-ITeS industry grew by 32 per cent to $22 billion in 2004-05, constituting 3 per cent of GDP. Employment in the IT-ITeS sector increased from 280,000 people in 1999-2000 to 1.05 million in 2004-05 — a compound annual growth rate of 29.8 per cent.

Consistent export and import growth

As for merchandise trade, India's exports at $79.3 billion in 2004-05 registered a growth of 24.1 per cent, the highest in the last three decades and substantially higher than the annual target of 16 per cent set by the Ministry of Commerce and Industry. Incidentally, this is the third consecutive year the country's exports have grown by over 20 per cent. Exports of manufactured products maintained the growth momentum (20 per cent in 2004-05 compared with 20.5 per cent in 2003-04).

Imports at $107.1 billion grew by 37 per cent in 2004-05 — the highest since 1980-81 — on top of 27.3 per cent in 2003-04. Oil imports at $29.8 billion shot up by 45.1 per cent in 2004-05, mainly on account of the surge in international crude oil prices; in volume terms, the growth rate of oil imports slowed to 5.5 per cent during the year from 10.6 per cent in 2003-04. Non-oil imports, excluding gold and silver, increased by 30.9 per cent during the year.

In the first four months of 2005-06 (April-July) also, both exports and imports posted robust growth. Exports rose 21.3 per cent in dollar terms over this period. Non-oil imports grew 38.1 per cent while oil imports grew 32.3 per cent over the same period. Consequently, the merchandise trade deficit increased further during this period. The continuing sharp rise in non-oil imports mirrored the step up in the pace of industrial activity.

The merchandise trade deficit at $27.8 billion touched a historic peak in 2004-05 with the increase in non-oil imports ($29.8 billion) being the major contributing factor. The non-oil trade balance, which remained in surplus during 2000-01 to 2003-04, turned into a deficit of $4.8 billion in 2004-05. Going by the developments on the trade front in 2005-06 first quarter, the trade deficit is set to register a further sharp rise.

Current account deficit `manageable'

Reflecting a sharp rise in the merchandise trade deficit, the current account turned into a deficit from the second quarter of 2004-05 onwards and for the year as a whole it was minus 0.9 per cent of GDP.

The current account deficit is set to rise further in 2005-06. But the RBI is not worried on this count as yet since it is expected to remain within manageable limit and can be financed by growing receipts of invisibles and capital flows.

In fact, the RBI says that the reappearance of current account deficit after a gap of three years augurs well for the higher growth trajectory envisaged for the Indian economy over the medium term. This indicates a cessation of a brief period of export of domestic saving and resumption of the supplemental role of foreign saving in financing higher investment in the economy.

Upbeat on economy

The country's external sector presents a healthy picture thanks to growing services exports and capital inflows. Hence, the RBI thinks that the positive developments in this sector provide the environment of pursuing a further rationalisation of tariffs to move to a single, uniform rate of import tariff, say, 10 per cent.

It also favours simplifying all Customs procedures in line with the best global practices so as to help improve competition, exports and domestic consumers.

On the whole, the RBI is quite upbeat about the outlook for the economy for 2005-06 and beyond. In its view the leading indicators suggest that the economy is poised to build upon the gains in macroeconomic performance secured in 2004-05.

The revival of the South-West monsoon, robust strengthening of manufacturing activity, high corporate profitability, buoyant equity markets, robust merchandise exports and imports and sustained demand for non-food credit, all point to a brightening of the near-term prospects.

Areas of concern

There are, of course, some concerns. Among the major areas of concern, are the constraints in stepping up the growth rate of the agriculture and allied activities. The growth rate of this sector decelerated sharply to 1.1 per cent in 2004-05 from 9.6 per cent a year before.

This brings to the fore, yet again, the continuing rain-dependence of Indian agriculture and underscores the urgent need to step up public and private investment in the sector, particularly in irrigation projects.

Unless the growth rate of the farm sector is stepped up to around four per cent per annum on a long-term basis, achieving a GDP growth of 8 per cent per annum would remain a far cry.

In this context, the RBI rightly says that future agricultural growth would largely accrue from improvements in productivity of diversified farming systems with regional specialisation and sustainable management of natural resources, especially land and water.

The approach to the development of rural infrastructure would need to stress the importance of water management, criticality of assured power supply, high quality of inputs and risk management strategies.

Also there is an urgent need to establish effective linkages of production systems with marketing, agro processing and other value-added activities.

The RBI Report also expresses concern over the low and shrinking capital outlays that are constraining the expansion of infrastructure and realisation of the full potential of the economy.

In this context, the RBI is clearly unhappy with the Government's attempt to moderating the impact of spurting international oil prices by allowing only their partial pass-through to consumers. This will not only affect the performance of domestic oil companies but will curtail the revenues to the Exchequer.

Dwelling further on infrastructure constraints, the Report points out that the increasing demand-supply gap in the availability of power is becoming the most critical issue in the future of India's economic development.

Inadequate power generation capacity, lack of optimum utilisation of existing capacity, insufficient inter-regional transmission links, slow pace of rural electrification and inefficient use of electricity by the end consumer have tended to exacerbate the absolute shortages.

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