Dr Yaga Venugopal Reddy, Governor RBI, presented the First Quarter Review of the Indian economy today. The highlights are as follows.

Outlook For 2006-07:

• The RBI expects the growth momentum of the last two years to continue. The GDP is expected to be in the range of 7.5 to 8% over and above 8.4% achieved 2005-06.
• The RBI’s Industry Outlook Survey for the second quarter indicates a further improvement in overall business environment. Accordingly, production, capacity utilization, order book position, employment, foreign trade, profit margins etc are expected to show a positive trend. 
  
  

First Quarter Review:

Overall growth scenario of the economy looks healthy. This is backed by satisfactory performance  of agriculture, industry and services sectors. 

• Agriculture: South-West monsoon arrived early this year, the cumulative rainfall so far (June 1st to July 12) has been below average. Cumulative rainfall has been deficient in 9 sub-divisions (as against 8 last years). However, area coverage under kharif crops (till July 10,2006 ) was 11.9% higher than year ago. Total buffer stock at 22.8 mn. tonnes was 20% lower than its year ago level but substantially higher than standard norms of 16.2 mn. tones.
• Industry: Industry registered an encouraging performance. During April-May 2006, Index of Industrial Production increased by 9.8% mainly driven by the double digit growth of 10.9% by the manufacturing sector. However, a slowdown in the infrastructure sector (5.9% vis-à-vis 7.1%) is an area of concern.
• Services: This segment, which accounts for nearly 60% of overall GDP, has further strengthened its place as the leading sector of the Indian economy. Major lead indicators of the service segment include tourist arrivals, revenue earning freight of railways, civil aviation etc.
   
• On the Fiscal front , the Review suggests that the process of fiscal consolidation is expected to continue during the current year. The combined Fiscal Deficit Ratio is expected to be 6.5% as against 7.5% last year. A major part (52.9%) of the combined fiscal deficit is expected to be financed through market borrowings. This may result in crowding out of corporate borrowers. Rising interest rates coupled with higher market borrowings would lead to higher interest payments leaving lesser funds for development programmes.
   
• Monetary and Liquidity situation : Rationale for rate increase as given by RBI is growing inflationary expectations. However, the current inflation is driven more by supply side factors than demand factors. These supply side factors include hike in price of food items and petroleum products. Interest rate hike can not influence supply induced inflation, strangely enough true that non-food credit rose by 40.5% in 2005-06, but inflation was contained at 4.4%.  On June 8, 2006 , the RBI increased Repo rate and Reverse Repo Rate (RRR) by 25 basis points each mainly with objective of containing inflationary pressures built in the economy due to rising global crude oil prices. Since then the situation remains more or less the same, currently the crude price is ruling at $72.31 per barrel. But it is not clear why RBI has once again raised the short term rates.
  • The repo rate is increased to 7% and Reverse Repo Rate is increased to 6%.
  • Bank rate has been kept unchanged at 6%.
  • Similarly, Cash Reserve Ratio is kept unchanged at 5%.

The RBI feels that, considering the real, monetary and global factors, containing the Year-On-Year inflation rate for 206-07 in the range of 5.0-5.5% warrants appropriate priority in policy responses.

Consequently, the entire interest rate structure is expected to harden. In that case, the cost of funds will be dearer for the corporates. This could impact investment scenario in general, housing, construction segments in particular. Profit Margins of the corporate sector are likely to come under further pressure.

During the first quarter, despite sustained growth, monetary and liquidity situation improved mainly due to reduction in Central Government’s surplus balance with the RBI and injection of liquidity into the system on account of the RBI’s intervention in the forex market.

• Price situation in the last quarter was mainly impacted by the supply side factors namely, rising prices of global crude oil and primary food articles. At present although, underlying inflationary pressures continue, the overall inflationary scenario seems to be under control. Pro-active policy stance being adopted by the RBI would help in containing inflationary pressures.  During the current year, the RBI expects rate inflation to be within the range of 5.0 to 5.5%. Considering the satisfactory level of forex reserves and buffer stock supply side factors can be taken care of. Only cause for concern would be the rising crude oil prices.
   
• Financial Markets : During the first quarter of the current year, financial markets including stock market, foreign exchange markets, debt market witnessed high degree of volatility. The Sensex ranged between 8,929 and 12,612. The rupee dollar rate ranged between Rs.44.61 and 46.97. There was a net outflow of FII investment to the tune of $1.8 bn. In the debt market call rates eased during the April-May 2006 and remained close to Reverse Repo Rate thereafter. Interest in collateral segment also remained below call rate. However, deposit and credit rates hardened. Yields of Government securities also hardened.
   
• External Sector : On the external front, during April-June merchandise exports registered an increase of 16.9% to $27.7 bn. while imports increased by 17.7% to $40.3 bn thereby resulting in a trade balance of $12.6 bn. The share of oil imports to the total imports was 32.5% as against 27.5% in the corresponding period of the last year. Rising global crude prices is the major factor responsible for the higher oil bill.

Foreign Direct Investment during Apr-May 2006 was $1,199 mn as compared to $922 mn in the corresponding period of last year (a rise of 30%).

Similarly, funds mobilized through GDRs/ADRs route increased by 180% from $360 mn to $1007

As noted earlier, there was an outflow of FII investments.

In conclusion, the RBI’s Report Card indicates continuation of the current growth trend of the Indian economy.