India’s 2005 Article IV Consultation reports that the government’s medium-term fiscal strategy is broadly appropriate, and faster implementation is crucial for its economy. India’s growth spurt provides a golden opportunity to fast-forward the government’s structural reform agenda. The government is rightly focused on improving the infrastructure, opening and liberalizing further the Indian economy, and alleviating poverty. Steps to improve the business climate and regulatory environment, and reform of restrictive labor laws could have large payoffs in terms of foreign investment and job creation.
1. This statement contains information that has become available since the staff report was circulated to the Executive Board on December 23, 2005. This information does not alter the thrust of the staff appraisal.
2. Recent economic developments are broadly consistent with staff’s growth and balance of payments forecasts for 2005/06. Industrial production appears to have softened, with 8 percent growth in October-November, slightly below levels of the first half of the year. This suggests that GDP growth may be moderating somewhat from the 8 percent growth of the first half of the year, consistent with staff projections. However, domestic demand remains robust, and staff continues to see upside risks to its GDP forecast for the year. Recent data indicate that in the first half of the fiscal year (April–September) the external current account deficit reached 1¾ percent of projected annual GDP, in line with staff projections. Despite healthy export growth of more than 20 percent (y/y), import growth of almost 50 percent—more than 40 percent excluding oil—pushed the trade deficit above 4 percent of projected annual GDP. Strong capital inflows, led by portfolio investment, contributed to a small balance of payments surplus. Recent customs data indicate that the growth of exports and imports slowed significantly during October-December, which may also point to some moderation in GDP growth.
3. Foreign inflows remain strong and equity prices have continued to climb. Since mid-December, net inflows from foreign institutional investors have totaled close to US$2 billion, contributing to a 3 percent appreciation of the rupee against the dollar. After rising by more than 42 percent in 2005, the SENSEX is up about 5 percent this year. International reserves fell by $7 billion in late December, as expected, as India Millennium Deposits were redeemed on maturity, but have since recovered by more than US$2 billion to reach $139 billion on January 20.
4. Inflation is likely to remain lower than projected in the staff report. In contrast to expectations, the WPI has not risen appreciably since September and stood at 4.4 percent in mid-January. The moderation is broad based, and suggests that efficiency improvements and competition from imports may be helping to contain inflation. Staff has revised downward its projection for average WPI inflation to 4¾ percent this fiscal year and 5.5 percent next year.
5. Despite the modest rate of inflation, the Reserve Bank of India (RBI) raised its key policy interest rate by 25 bps on January 24. Citing concerns about rapid growth in domestic demand and monetary aggregates as well as potential pressures from future pass-through of oil prices, the RBI increased the reverse repo rate to 5½ percent. Market rates had begun to harden ahead of the announcement amid tightening liquidity in the face of rapid credit growth. However, the rate increase surprised markets and interest rates for government securities continued to increase subsequently, with rates on government securities rising 50 bps at the short end and 20 bps at the longer-end.
6. Budgetary developments remain broadly in line with those described in the staff report. Through December the overall central government deficit stood at 3.1 percent of projected annual GDP (72 percent of the annual budget target) and the current deficit at 2¼ percent of GDP (84 percent of budget). The government expects revenue overperformance of 0.2 percent of GDP, largely in the form of special dividends from state-owned companies. Expenditures have also been revised up by 0.2 percent of GDP, mainly due to compensation, in the form of bonds, for oil company losses arising from less than full pass-through of global oil price hikes. However, the government expects this will be more than offset by savings in other spending categories, including defense, resulting in a small fiscal overperformance.
7. Several structural measures have been implemented. Most notably:
The government has announced that it will allow FDI in the retail sector for single-brand stores, up to a maximum of 51 percent.
The government has awarded concessions for modernization of Delhi and Mumbai airports. The two winning consortiums, joint-ventures of domestic construction and foreign airport companies, will be offered a 74 percent stake in the airports.
As a means for enhancing banking penetration in rural areas, the RBI has allowed banks to appoint business correspondents to take deposits and offer loans without opening branches.
8. National accounts data for 2004/05 along with new historical series with base year 1999/2000 were released on January 31. For 2004/05, real GDP growth at constant factor prices is estimated to have reached 7.5 percent, compared to earlier estimates of 6.9 percent. Both services and industry growth were revised upward by 0.4 percentage point to 9.9 percent and 8.6 percent respectively. Growth was fueled by investment which, for the third year in a row, grew by around 16 percent. Revisions to historical nominal GDP figures and the sectoral composition of GDP have been minimal.