RBI’s Third Quarter Review of Macroeconomic and Monetary Developments

WHILE ‘AGRICULTURE and allied activities’ recorded higher growth during the first half of 2007-08 over the corresponding period of the previous year, the growth of industrial and services sectors was somewhat lower than that during the first half of the previous year. But the review admits that during April-November 2007, the index of industrial production (IIP) rose by 9.2 per cent compared with an increase of 10.9 per cent recorded during the corresponding period of the previous year. The manufacturing sector registered a growth of 9.8 per cent during April-November 2007 compared with 11.8 per cent during April-August 2006. This sentence provides the answer to the sentence preceding it. The manufacturing sector has suffered a setback.

Equally unfortunately, during April-November 2007, the infrastructure sector recorded a growth of 6.0 per cent as compared with 8.9 per cent a year ago, something that the country can ill afford at the moment. All the sectors have exhibited growth rates lower than a year ago. The services sector registered the now-usual double-digit growth (10.5 per cent) in April-September 2007. But leading indicators of service sector activity for April-October 2007 show that growth rates in revenue earning freight traffic of the railways, commercial vehicles production, new cell phone connections, passengers handled by civil aviation at domestic terminals, cement and steel moderated, albeit over a high base. These only testify to the sustained growth the real economy witnessed during the period, despite the qualifier ‘moderate’ used by the RBI in this connection. If the base effect is reckoned, the growth will be positive.

On the fiscal front fortunately, key deficit indicators, viz., revenue deficit and GFD, have been lower than those in the corresponding period of the previous year, in absolute terms and as percentage of the budget estimates as well. This should warm the cockles of the RBI Governor’s heart. Government of India’s net market borrowings, including the 364-day treasury bills, up to January 25, 2008, have already crossed 94 percent of the estimates for the year.

Headline inflation, was 3.8 per cent on January 12, 2008 (3.4 per cent at end-September 2007); it compares favourably with 5.9 per cent at end-March 2007 (and 6.2 per cent a year ago). The easing in inflation from a year ago, according to the RBI, was mainly led by primary food articles and some manufactured products. RBI notes with relief that primary articles-related inflation eased to 3.9 percent on Jan 12, 2008, thanks to food articles – related inflation declining. Inflation relating to manufactured products also eased to the same level of 3.9 percent on Jan 12, 2008. This is attributed to decline in the prices of non-ferrous metals, textiles and sugar. But the luck runs out here - fuel group inflation, which was negative during June-November 2007, turned positive from the beginning of December 2007 (3.7 per cent on January 12, 2008) partly reflecting the base effects of fuel (petrol and diesel) price cuts last year and increase in the prices of some petroleum products such as naphtha, furnace oil and aviation turbine fuel.

On the monetary and liquidity front, aggregate deposits of banks have grown compared to last year. Importantly, growth in bank credit moderated after the strong pace in the preceding three years. Notably, reserve money expanded by 30.6 per cent, y-o-y, as on January 18, 2008, compared with 20.0 per cent a year ago. This is understandable in the backdrop of the rather high cash reserve ratio of 7.5 percent that has been in force.

On financial markets, the RBI admits that the Indian rupee generally appreciated during the quarter vis-a-vis all major currencies (US dollar, Euro, Pound sterling and Japanese yen). Yields in the government securities market too remained range-bound but for some softening in the first week of January 2008.

On the BoP front, although the trade deficit widened to USD 42.4 billion during Apr-Sep 2007 (against USD 33.8 billion during the corresponding period of the previous year), the net surplus under invisibles was higher at USD 31.7 billion (against USD 23.4 billion during the corresponding period of the previous year). The net invisible surplus offset a large part of the trade deficit (74.7 per cent during April-September 2007 as compared with 69.4 per cent during April-September 2006).

The RBI makes two valid points here: higher net invisible surplus mainly emanated from private transfers and it contained the current account deficit at US $ 10.7 billion in the first half of 2007-08 (US $10.3 billion in April-September 2006). The current account deficit was financed by capital flows which have remained large during 2007-08 so far.

But what is going to upset those who blamed the FIIs for the recent market turmoil is the fact that during 2007-08 (up to January 11, 2008), net inflows from FIIs amounted to a whopping US $26.8 billion, compared to a meagre US $ 2.5 billion in the corresponding period of 2006-07. Some way must be devised to curb these inflows.

During the current financial year 2007-08 (April-September), inflows (net) under external commercial borrowings (ECBs) amounted to US $ 10.6 billion (US $ 5.7 billion during April-September 2006). Apparently, India Inc still finds ECBs cost-effective. Non-resident Indians’ deposits registered net outflows of US $ 433 million during April-September 2007 as against net inflows of US $ 3.0 billion during April-September 2006. NRIs did not want to park their funds in deposit accounts.

On the whole, during 2007-08 so far (April-November), merchandise exports posted a growth rate of around 22 per cent moderating from a growth rate of 26.2 per cent during April-November 2006, while growth in imports at 26.9 per cent was marginally lower than that of 27.4 per cent in April-November 2006. This obviously has been occasioned by the secular rise of the Indian rupee (INR). Non-oil imports recorded a substantial increase (mostly because of import of capital goods by India Inc) while oil imports showed a sharp deceleration in growth (only because of an appreciating INR). Overall, the merchandise trade deficit widened to US $ 52.8 billion in April-November 2007 from US $ 38.5 billion in April-November 2006. India’s foreign exchange reserves were comfortably placed at US $ 284.9 billion as on January 18, 2008.