INDIAN ECONOMY

2003-2007
Period of Growth and Investment

Submitted by Group 4

MACRO-ECONOMIC OVERVIEW OF INDIA

2003-2007

Assignment - Macro-economics

REPORT SUBMITTED BY GROUP 4

Malay Nigam
Lavanya Murthy
Saurav Mohanty
Prabhpreet Kaur
Shilpam Rajput
Narendra Kulkarni
Submitted to
Dr. Vikas Prakash Singh
Director
PGPME Programme
Great Lakes Institute of Management, Gurgaon

Acknowledgement

We would like to express our gratitude towards our teacher Dr Vikas Prakash
Singh for providing us with such an opportunity to study in detail the economic
developments of the county. The project made us read extensively, research
new topics and broaden our knowledge and thinking. This project was possible
only because of the encouragement and mentoring provide by the faculty.

Table of Content

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Introduction
The 10th Five Year Plan
Year 2003-2004
Year 2004-2005
Year 2005-2006
Year 2006-2007
Review and Analysis
Reference

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6
7
13
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30
37
41

Introduction
The period of 2003-04 to 2006-07
This period witnessed some of the highest growth rate in the Indian Economy peaking
at 9.2. During this period the efforts of the NDA government (1999-2003) started
showing the effects of the groundwork done. This followed the INDIA SHINING period,
but the NDA Government failed to align itself with the public opinion and lost to UPA
in the 14the general elections held in 2004.
With the new government at place and high expectations from the much learned
Prime Minister Mr. Manmohan Singh the economic outlook was upbeat. The
government introduced a multitude of schemes which further helped the country
achieve some of the highest growth rates in Indian context. The period although
witnessed the ever increasing international crude oil prices but for most part of the
year stayed aloof with a fairly stable inflation.
This period also saw the growth of the service sector and industrial sector in a fashion
unheard of. The two sectors were called as the Twin Engine of Growth aptly.
This followed by the policy of fiscal consolidation created confidence in the investors
resulting in higher FII inflows than ever. The confidence in the NDA government also
created an environment of financial investment in multiple sectors including services,
industrial, agricultural and infrastructure.
This period also saw the implementation of VAT, with the aim to simplify the taxation
system and further improve investments and economic growth in total.
Towards the end the signs of global recession started to appear.
Overall this growth in the period surpassed all expectations and the indicators will
serve for long as benchmarks for Indian economy.

The 10Th Five Year Plan

The National Development Council (NDC), headed by Prime Minister Atal Behari
Vajpayee, approved unanimously in December 2002 the Tenth Five-year Plan,
envisaging an 8 percent annual GDP growth.
The NDC decided to constitute four sub-committees to remove trade and investment
barriers and improve governance. One to deal with governance reforms as the best
policies and programmes can flounder on the rocks of poor governance and
implementation; the second to consider all barriers to internal trade on merits and to
decide what would be the most appropriate steps that could be taken; the third to look
into the wide range of controls and restriction from the past which hindered the
creation of an investor-friendly climate and work out ways to dismantle such barriers,
and the fourth to look into problems faced in transferring functions and resources to
the Panchayati raj institutions. The NDC also accepted the proposal of Prime Minister
to formulate a priority agenda for action is the coming years.
The 10th Five Year Plan (2002-2007) targets at a Gross Domestic Product (GDP) growth
rate of 8% per annum. Taking note of the inabilities of the earlier Five Years Plans,
especially that of the 9th Five Year Plan, the Tenth Five Year Plan decides to take up a
resolution for immediate implementation of all the policies formulated in the past.
This amounts to making appeals to the higher government authorities, for successful
completion of their campaigns associated with the rapid implementation of all past
policies.
The primary aim of the 10th Five Year Plan is to renovate the nation extensively,
making it competent enough with some of the fastest growing economies across the
globe. It also intends to initiate an Economic growth of 10% on an annual basis. In fact,
this decision was taken only after the nation recorded a consistent 7% GDP growth,
throughout the past decade.
The 7% growth in the Indian GDP is considered to be considerably higher that the
average growth rate of GDP in the world. This enabled the Planning Commission of
India to extend the GDP limit further and set goals, which will drive India to become
one of the best industrial countries in the world, to be clubbed and recognized with
the worlds best industrialized nations.

Macro-economic overview 2003-2004

The economy appeared to be in a resilient mode in terms of growth, inflation and
balance of payments, a combination that offers large scope for consolidation of the
growth momentum with continued macroeconomic stability. GDP is estimated to have
grown by a sharp 8.2 per cent in the year to March 2004, beating government
forecasts as the country recovered from the impact of a severe drought to join the
ranks of the world's fastest growing economies.
The achievement was possible due to one of the most bountiful monsoons in years in
India, where two-thirds of the billion-plus population work in agriculture.
A benign world economic environment provided conducive backdrop to the robust
performance of the Indian economy in 2003-04. World output growth is estimated to
have accelerated from 3.0 per cent in 2002 to 3.9 per cent in 2003. Strong performance
by the US, China, and Russia, and a strong turnaround in Japan helped to brighten the
world economic outlook in 2003. Volume of world trade in goods and services also
grew rapidly by 4.5 per cent, compared to only 3.1 per cent in the previous year. The
robust performance of India and the emerging market economies also contributed to
the good performance of the world economy.
Growth in 2002-2003 (4%) had been hampered by a withering drought which had
reduced farm output. The state-run meteorological department had forecasted
another healthy monsoon, in welcome news for the economy.
The surging growth in 2003-2004 rivals the strong gross domestic product figures of
the mid-1990s after India opened up sectors of its inward-looking economy to foreign
and private investors.

Trends in GDP:
The quarterly GDP data released by the CSO indicate GDP growth rates at 5.7 per
cent, 8.4 per cent, and 10.4 per cent respectively in the first three quarters of 2003-04.
The GDP growth rate of 10.4 per cent in the 3rd quarter of 2003-04 was the highest in
any quarter since at least 1997-98, when CSO started compiling quarterly estimates,
and was supported by a growth of 16.9 per cent in agriculture, forestry and fishing,
6.5 per cent in industry and 9.0 per cent in the services sectors.
The growth recovery in 2003-04 was accompanied by continued maintenance of
relative stability of prices. Inflation, as measured by the wholesale price index (WPI),
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was 4.6 per cent at end-March 2004 over end-March 2003, and 5.5 per cent on
average. The manufacturing sector was the major contributor accounting for nearly
80 per cent of the inflation. Within the manufacturing sector, the prime movers were
sugar, edible oils, textiles, leather and leather products, basic metal and alloys and
iron and steel.

Fiscal policies:
The Union budget of 2003-04 laid considerable emphasis in fiscal consolidation, one
of the five priorities enunciated in the budget speech. In the budget, gross tax revenue
was budgeted to increase by a modest 13.3 % over revised estimates for 2002-03. The
growth envisaged for the Union excise duties and customs was even lower at 10.8%
and 8.5%. Revenue expenditure was budgeted to grow over 7.2% over 2002-03 to
Rs.3,66,227 crores. Total expenditure was budgeted to grow at 8.6%. Fiscal and
revenue deficits were budgeted 5.6% and 4.1% of GDP
Revenue deficit increased from Rs.107880 to Rs.112292.
Fiscal deficit increased from Rs.131306 to Rs.153637.
Aggregate expenditure of the Central government increased by Rs.33141 on account
of higher expenditure under capital amount.
Direct taxes:
The guiding philosophy in the tax measures was a harmonious mix of stability and
continuity. Rates of income tax and corporation tax were left unchanged. Surcharge
on income tax was withdrawn for individuals and Hindu undivided families (HUF),
except for those with an annual income of Rs.8.5 lakh and above. For corporate
assesses and certain other categories of institutions, the rate of surcharge was halved
from 5 per cent to 2.5 per cent. Other important direct tax measures included
incentives for housing and infrastructure and rationalisation of provisions relating to
amalgamations and demergers. A number of measures aimed at reforming tax
administration were announced. These included outsourcing non-core activities,
abolition of discretion based selection of returns for scrutiny, simplification of tax
returns, abolition of tax clearance certificates for persons leaving India and
simplification of procedures to be followed during search and seizure.

Excise duty:
Excise duties were rationalised with the introduction of a three-tier duty structure of 8
per cent, 16 per cent and 24 per cent (except for petroleum products, tobacco
products, pan masala, textiles and specific rated products. In the case of excise duties,
other important measures included an incentive package for the textile industry and
extension of maximum retail price (MRP) based levy to chewing tobacco and
insecticides.
Customs duty:
The peak rate of customs duty was reduced to 25 per cent, excluding agriculture and
dairy products. Customs duty included reduction in the customs duty on project
imports with a certain threshold investment and reduction in customs duty on
specified items for promoting the information technology sector.

Inflation:
Inflation is the rate at which the general level of prices for goods and services is rising
and, consequently, the purchasing power of currency is falling.
Inflation is measured at WPI or CPI.
Inflation occurs due to an imbalance between demand and supply of money, changes
in production and distribution cost or increase in taxes on products. When economy
experiences inflation, i.e. when the price level of goods and services rises, the value
of currency reduces. This means now each unit of currency buys fewer goods and
services.
It has its worst impact on consumers. High prices of day-to-day goods make it difficult
for consumers to afford even the basic commodities in life. This leaves them with no
choice but to ask for higher incomes. Hence the government tries to keep inflation
under control.
The growth recovery in 2003-04 was accompanied by continued maintenance of
relative stability of prices. Inflation, as measured by the wholesale price index (WPI),
was 4.6 per cent at end-March 2004 over end-March 2003, and 5.5 per cent on
average. The manufacturing sector was the major contributor accounting for nearly
80 per cent of the inflation. Within the manufacturing sector, the prime movers were

sugar, edible oils, textiles, leather and leather products, basic metal and alloys and
iron and steel.
A firming of energy and primary product prices had resulted in the inflation rate
crossing 6 per cent in January 2004. However, the inflation rate softened considerably
during March 2004. The high point-to-point inflation through much of 2003-04 and its
sharp deceleration in March 2004 were partly because of the carryover of the price
increase that took place in the last quarter of 2002-03, especially in March 2003. Retail
price inflation, as measured by the Consumer Price Index for Industrial Workers (CPIIW), touched a peak of 5.1 per cent in April 2003 followed by a declining trend and
reached 3.5 per cent in March 2004. CPI inflation declined further to 2.2 per cent in
April 2004, compared to 5.1 per cent in April 2003, and abundant food grain stocks
helped in maintaining stability in food prices.

Monetary policy:
In 2003-2004 the conduct of the monetary policy in India had to address the issue of
surge in capital flows leading to increased purchase of foreign currency by the RBI,
and consequent expansion of reserve exchange assets of the RBI (adjusted for
revaluation) increased by Rs.1,41,428 crores as compared with an assertion of
Rs.82090 crores in 2002-03, resulting in excess liquidity. The liquidity was contained
through open market sale of Government securities held by the RBI and repos under
the LAF.
Bank rate reduced by 25 basis points to 6 % effective from the close of business on
April 29, 2003.
CRR reduced by 25 basis points from 4.75 % to 4.5 % effective from June 14, 2003
Banks free to extend direct finance to the housing sector up to Rs.10 lakh I rural areas
and semi-urban areas as part of priority sector lending.
Banks were advised by the RBI to increase the loan limit without collateral to small
scale industries with good track record and financial position from Rs.15 lakhs to Rs.25
lakhs.

Balance of payments:
A strong balance of payments (BOP) position in recent years has resulted in a steady
accumulation of foreign exchange reserves. After a robust growth of US$21.3 billion
in 2002-03, foreign exchange reserves (including gold, SDRs and Reserve position in
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IMF) increased by an unprecedented US$36.9 billion in 2003-04. The level of reserves

crossed the US$100 billion mark on December 19, 2004 and stood at US$119.3 billion
as of May 31, 2004. This accretion to reserves is attributed not only to capital inflows
and current account surplus, but also to valuation gains arising from a steady
appreciation of the major non-US dollar global currencies (the Euro and the Pound
Sterling in particular) against the US dollar.
Current Account:
In the period up to 2003-04, exports and imports followed a similar rising trajectory.
Though there was a deficit in merchandise trade, software exports and remittances
from Indian workers - essentially a form of export of labour services - compensated
for it, leaving an overall surplus on the current account. 2004-05 onwards, even robust
growth in software exports has been unable to compensate for the rapidly climbing
merchandise trade deficit.
Imports have been growing at a compounded annual average growth rate (CAGR)
that is 4 per cent higher than that of exports over the same period. This is the cause of
Indias burgeoning current account deficit. Clearly, this is not a problem that has
arisen overnight, but has been building up for nearly a decade.
Capital Account:
The capital account has also continued to strengthen. The size of the capital account
surplus during April-December 2003-04 was far more than that for the full year 200203. Earlier, the capital account surplus in Indias balance of payments used to be
partially offset by current account deficits, leading to lower overall surpluses.
However, since 2001-02, surpluses in both, the current and capital accounts have
resulted in larger overall surpluses, which have led to accumulation in the foreign
exchange reserves of the country.
Fiscal deficit:
Fiscal deficit represents shortfall in government's revenues compared to
expenditures. It is expressed as a percentage of GDP.
The combined fiscal deficit of the Centre and the States, which had been decreasing
in the early nineties, worsened subsequently to reach a level of 10.1 per cent in the
revised estimates (RE) for 2002-03. The combined revenue deficit as a proportion of
GDP, after declining from 4.2 in 1990-91 to 3.6 per cent in 1996-97, increased to 7.0
per cent in 2001-02, to decline again to 6.7 per cent in 2002-03 (RE) and further to a
budget estimate (BE) of 5.8 per cent in 2003-04. For 2003-04, the combined fiscal
deficit was budgeted at Rs.2,59,265 crores, constituting 9.4 per cent of GDP.
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Exchange rate:
The weakening of the US dollar, caused mainly by widening US deficits, has affected
the rupee-dollar exchange rate. The Indian rupee, which started strengthening from
June 2002 onwards, had appreciated, on a monthly average basis, by 8.8 per cent
against the US dollar by March 2004. On annual average basis, the rupee, after
depreciating by 1.5 per cent in 2002-03, appreciated by 5.3 per cent in 2003-04 vis-vis the US dollar. The movements in the rupee value were smooth and orderly,
avoiding undue adjustment costs. Furthermore, while the rupee appreciated against
the US dollar in 2003-04, it depreciated against the currencies of major non-dollar
trading partners. Given the inflation differential, the appreciation has been less
pronounced in trade weighted effective terms, with the Real Effective Exchange Rate
(REER) of the rupee (5-country index with base 1993-94) appreciating by around 2 per
cent on an annual basis in 2003-04.
Year average: Rs. 45.747

Extraneous factors:
Global Factors:
Mar 19, 2003- Invasion of Iraq by American and British led coalition begins without
United Nations support and in defiance of world opinion
May 14, 2003- 2003 invasion of Iraq: In what becomes known as the "Mission
Accomplished" speech, U.S. President George W. Bush declares that "major combat
operations in Iraq have ended" on board the USS Abraham Lincoln off the coast of
California.
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Macro-economic overview- 2004-2005

The performance of the Indian economy in 2004-05 so far has exceeded expectations
formed at the beginning of the year. Buoyed by a rebound in the agriculture and allied
sector, and strongly helped by improved performance in industry and services, the
economy had registered a growth rate of 8.5 per cent in 2003-04, the highest ever
except in 1975-76 and 1988-89. Normally, strong growth is expected after anaemic
growth, and vice versa. Following the bumper growth in 2003-04, initial growth
projections for 2004-05 were placed in the range of 6.2 per cent to 7.4 per cent. Modest
expectations were further pared down to around 6.1 per cent when rainfall, after
remaining normal in June, 2004, became deficient in the crucial sowing month of July
and the shortfall in the south-west monsoon turned out to be 13 per cent. Deterioration
in the benign world inflation environment, particularly of petroleum, coal and steel,
led to further apprehensions about growth and inflation.
The long-term growth prospective of the Indian economy is moderately positive due
to its young population, corresponding low dependency ratio, healthy savings and
investment rates, and increasing integration into the global economy. The Indian
economy has the potential to become the world's 3rd-largest economy by the next
decade, and one of the largest economies by mid-century. And the outlook for shortterm growth is also good as according to the IMF, the Indian economy is the "bright
spot" in the global landscape. India also topped the World Banks growth outlook for
2015-16 for the first time with the economy having grown 7.3% in 2014-15 and
expected to grow 7.5-8.3% in 2015-16.
India has the one of fastest growing service sectors in the world with annual growth
rate of above 9% since 2001, which contributed to 57% of GDP in 2012-13. India has
capitalized its economy based on its large educated English-speaking population to
become a major exporter of IT services, BPO services, and software services with
$167.0 billion worth of service exports in 2013-14. It is also the fastest-growing part of
the economy. The IT industry continues to be the largest private sector employer in
India. India is also the fourth largest start-up hub in the world with over 3,100
technology start-ups in 2014-15. The agricultural sector is the largest employer in
India's economy but contributes to a declining share of its GDP (17% in 2013-14).
India ranks second worldwide in farm output. The Industry sector has held a constant
share of its economic contribution (26% of GDP in 2013-14). The Indian auto mobile
industry is one of the largest in the world with an annual production of 21.48 million
vehicles (mostly two and three wheelers) in FY 2013-14. India has $600 billion worth
of retail market in 2015 and one of world's fastest growing E-Commerce markets.
India's two major stock exchanges, Bombay Stock Exchange and National Stock
Exchange of India, had a market capitalization of US$1.71 trillion and US$1.68 trillion
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respectively as of Feb 2015, which ranks 11th & 12 largest in the world respectively
according to the World Federation of Exchanges. India also home to world's third
largest Billionaires pool with 97 billionaires in 2014 and fourth largest number of ultrahigh-net-worth households that have more than 100 million dollars.

Trends in GDP:
With a normal monsoon, the growth in agriculture can be assumed to be at the trend
growth rate of about 3 per cent and further assuming that industry and services sectors
maintain their current growth momentum, the real GDP growth during 2004-05, in the
normal course, could be 6.5 per cent.
The real GDP growth during 2004-05 could well be higher at around 7.0 per cent.
For the present, for the purpose of monetary policy formulation, real GDP growth for
2004-05 may be placed in the range of 6.5 to 7.0 per cent, assuming sustained growth
in the industrial sector, normal monsoon and good performance of exports.
Macroeconomic performance in 2004-05 turned out to be stronger than anticipated.
Although beset by an uneven and deficient South-West monsoon, below normal
North-East monsoon and the base effect of a seven-year peak growth of 9.6 per cent
achieved in 2003-04, real GDP originating from 'agricultural and allied activities' rose
by 1.1 per cent in 2004-05.
The industrial recovery firmed up and broadened during the year, led by
manufacturing and 'electricity, gas and water supply', considerably mitigating the
setback to agriculture.
In the second and third quarters, the uneven spread of the South-West monsoon from
mid-July, despite the early onset, led to an absolute decline in agricultural growth.
Deceleration in growth rates of financing, insurance, real estate, business services,
community, social and personal services in relation to the corresponding quarter of
the previous year dampened the buoyancy of the overall services sector in the second
quarter of 2004-05 with the slowing down becoming more pronounced in the third
quarter of 2004-05 due to deceleration in trade, hotels, restaurants, transport and
communication.
A significant feature of the macroeconomic developments in 2004-05 was the
resurgence of the industrial sector, propelled by buoyant exports and a brightening
of the domestic investment climate in an environment of rising business optimism and
consumer confidence. Industry contributed 26 per cent to overall growth of the
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economy, up from 17 per cent in 2003-04, in spite of a secular decline in its share in
GDP.
'Agriculture and allied activities', on the other hand, exhibited considerable volatility
in terms of contribution to real GDP growth. In 2004-05, agriculture and allied
activities contributed 3 per cent of real GDP growth as against 24 per cent in 2003-04.
The services sector remained the main engine of growth of the economy during 200405. Recent gains in growth momentum under 'trade, hotels, transport and
communication' were consolidated during the year, benefiting from a sharp rise in net
tonne kilometres (8.2 per cent) and passenger kilometres (6.9 per cent) in respect of
railways, a surge in the production of commercial vehicles (30.4 per cent), expansion
in cargo handled at major ports (11.1 per cent), increase in the gross trading index
(8.6 per cent) and rising tele-density a result of a 30.3 per cent increase in the stock
of telephone connection, during April-December, 2004-05. The growth of community,
social and personal services remained stable at the previous year's level, reflecting
the commitment to fiscal consolidation and expenditure containment.

FISCAL POLICY:
Direct taxes
The budget estimates for 2004-05 reveal an endeavour of the State Governments to
carry forward fiscal reforms.
A number of States have underscored the need to increase the magnitude and
efficiency of tax revenue mobilisation. The general approach is to rationalise and
simplify the tax structure, broaden the tax base and have moderate rates of taxation.
Most of the State Governments have reiterated the need to contain unproductive
expenditures and reorient spending towards developmental purposes. Several State
Governments have already enacted Fiscal Responsibility legislation (FRL) and
formulated medium-term fiscal plans to bring about an orderly correction of their
financial positions.
The recent implementation of the Value Added Tax (VAT) by a number of States, with
effect from April 1, 2005, is an important milestone in the area of tax reforms.

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Indirect taxes
Customs duty

Customs duty, non-alloy steel, to be reduced from 15 per cent to 10 per cent. While
retaining customs duty on palm oil at 65 per cent.
Customs duty of 5 per cent on some items of plantation machinery to be extended to
more items pertaining to tea and coffee plantation sector.
Excise duty
Revenue receipts of the Centre were lower by 2.7 per cent than their budgeted level
for 2004-05 due to decline in both tax and non-tax revenues. The gross tax revenue
was 3.7 per cent lower than the budget estimates (BE) mainly on account of lower
corporation tax collections and union excise duties .The lower collections from excise
duties reflected the post-budget reduction of duties in respect of certain petroleum
products and non-alloy steel to contain inflationary pressures.

Inflation:
The unseasonal rains in producing areas had an unfavourable impact on production
and a subsequent supply to markets. Again the price hike in Diesel led to increase in
transportation cost of vegetables. This led to a high inflation.
The inflation rate during 2004-05 is likely to be influenced to a significant extent by
international oil prices and trends in commodity prices.In addition, the lagged effect
of persistence of excess liquidity on aggregate demand cannot be ignored as it could
have some potential inflationary impact. In view of the current trends, assuming no
significant supply shocks and appropriate management of liquidity, the inflation rate
in 2004-05, on a point-to-point basis, may be placed at around 5.0 per cent.
Wholesale price index (WPI):
Headline inflation, measured by year-on-year (y-o-y) changes in the wholesale price
index (WPI), moved in two distinct phases during 2004-05.The first phase, i.e., AprilAugust 2004 was marked by a hardening of domestic prices of coal, petroleum
products, iron and steel and other metals, reflecting lagged adjustments to the
increase in international prices. Prices of petroleum products were revised upwards
effective June 16 and August 1, 2004. Coal prices were also raised in June 2004. The
inadequate and uneven South-West monsoon began to push up prices of food items
and non-food agricultural commodities such as cotton and oilseeds by July 2004.
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As a result, headline inflation rose sharply to a peak of 8.7 per cent by end-August
2004.
Consumer price index (CPI):
Retail price inflation, measured by y-o-y variation in the consumer price index for
industrial workers (CPI-IW), accelerated to 4.8 per cent in September 2004 from 2.2
per cent in the beginning of the financial year and 2.9 per cent a year ago.
The food group (weight of 57 per cent) accounted for as much as 45 per cent of the
overall retail inflation (y-o-y) in September 2004.
Consumer price inflation decelerated thereafter to 3.8 per cent by December 2004
reflecting the easing of the impact of the monsoon on food prices.
Consumer price inflation firmed up to 4.4 per cent in January 2005 mainly due to
increase in the prices of fish, meat, sugar, kerosene oil and housing, before
decelerating to 4.2 per cent in February 2005. On an annual average basis, CPI
inflation at 3.8 per cent in February 2005 remained broadly at the level of the
previous year.

Monetary policy:
As regard the global developments, recovery appears more sustainable now and
there is greater resilience in emerging economies. It is essential to recognise that
interest rates in major economies are likely to harden while the adjustments in
currency imbalances would continue to take place.
Oil prices seem to persist at the current high level though they could move sharply
in either direction. The geopolitical uncertainties impacting the international oil
economy do not show any signs of waning.
Thus, while there are significant positive indications of economic recovery, there
are noticeable uncertainties and risks that should be reckoned with while designing
the stance of monetary policy..
Consistent with the real growth of GDP and inflation, the projected expansion of
money supply (M3) for 2004-05 is placed at 14.0 per cent. In tune with this order of
growth in M3, increase in aggregate deposits of scheduled commercial banks is set
at Rs.2, 18,000 crores which is higher by 14.5 per cent over its level in the previous
year.
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This magnitude of credit expansion is expected to meet adequately the credit needs
of all the productive sectors of the economy.
However, such an increase may have an adverse impact on investment demand which
has shown signs of pick-up after prolonged sluggishness.
An assessment of domestic factors, points to stability but in the leading economies of
the world, there is a greater potential for tightening rather than easing of monetary
policies.
Monetary policy would continue to enhance the integration of various segments of the
financial market, improve credit delivery system, nurture the conducive credit culture
and improve the quality of financial services.
While the economy has the resources and resilience to withstand supply shocks, the
possible consequences of continued abundance of liquidity need to be monitored
carefully. As such, the inflationary situation needs to be watched closely and there
could be no room for complacency on this count.
With the development of market repo and CBLO segments, the call money market has
been transformed into a pure inter-bank market, including primary dealers, since
August 2005.

Balance of payments:
Current Account:
Surpluses on account of invisible transactions have financed a significant portion of
the merchandise trade deficit that has traditionally characterised India's balance of
payments.
Through 2001-04, sizeable invisible surpluses comfortably financed the merchandise
trade gap and spilled over into current account surpluses. Invisible receipts increased
by 37.5 per cent during April-December 2004 over the corresponding period of the
previous year.
Software exports, in which India is a world leader, continued to be buoyant on the
back of sustained growth in industrial countries.
The current account turned into a deficit of US$5.4 billion in 2004-05.
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The deficit was caused by a burgeoning excess of merchandise imports over exports,
which was left uncompensated by the net surplus in invisibles.
Compared with 2003-04, when loan inflows had turned into net outflows, such inflows
shot up rapidly during 2004-05 and bolstered the size of the capital account surplus
with good support from robust foreign investment inflows.
The current account continues to be in deficit with the size of the deficit during the first
half of the current year (April-September 2005) almost twenty seven times that of the
deficit in the corresponding previous period.
The rapidly enlarging trade deficit, buoyed by remarkable import growth, has been
pushing the current account deficit. During the period 2001-02 to 2003-04, the
invisibles (net) always overcame the trade deficit to maintain the current account in
surplus. However, the trend was reversed in 2004-05 and appears to be continuing in
2005-06.
The current account, after being in surplus during 2001-02 to 2003-04, reverted to a
deficit in 2004-05. This was despite a robust growth in net invisibles account fuelled
by software exports and private transfers. The current account deficit (CAD) is
attributable to the widening trade deficit, driven primarily by the rise in international
prices of petroleum products and gold. Thus large merchandise trade deficit coexists
with a lower deficit on the goods and services account because of the surplus on nonfactor services. Even in the years when there were some surpluses on the current
account, India had deficit on goods and services account and a relatively larger trade
deficit.
Capital Account:
Net capital flows during 2004-05 were dominated by foreign investment. Portfolio
flows brought in by foreign institutional investors (FIIs) went through significant shifts
in the early part of the year before cumulating into a surge that was interrupted only
briefly in the early part of January 2005.
The appetite for investing in India was also shared by foreign direct investors who
responded positively to the on-going liberalisation.
Drawing strength from the strong investor enthusiasm and credit rating upgrades,
Indian entities expanded their access to international capital markets through foreign
currency convertible bonds, trade credits and external commercial borrowings.

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Even as net outflows continued under non-resident Indian (NRI) deposits, banks
compensated for the shrinkage in foreign currency funds by borrowing overseas and
drawing down nostro balances.

Exchange Rate:
The excess supply conditions that prevailed in the foreign exchange market during
the major part of 2003-04 persisted at the beginning of 2004-05.
Pressures began to emerge by mid-May 2004 due to a shift in market sentiment
driven by turbulence in the equity market and rising global oil prices.
The ebbing of capital flows, the rising demand for imports and the surge in
international oil prices drained away the excess supplies, leading the Indian rupee to
depreciate against the US dollar by 4.5 per cent during May-July 2004.
With the resumption in portfolio flows in August, the rupee started gaining strength
against the US dollar.
The US dollars weakness against the major international currencies and a decline in
international crude oil prices helped the rupee to recover lost ground and appreciate
against the US dollar by 6.6 per cent during August-December 2004.
During 2004-05, the rupee moved in the range of Rs.43.36-46.46 per US dollar,
depreciating by only 0.7 per cent over its end-March 2004 level.
On the other hand, the rupee depreciated against the Pound Sterling and the Euro by
3.0 per cent and 6.0 per cent, respectively, and appreciated by 2.1 per cent against
the Japanese Yen (Chart 46).
Although the five-country (trade-weighted) nominal effective exchange rate (NEER)
of rupee depreciated by 3.3 per cent during April-January 2004-05, the real effective
exchange rate (REER) fell marginally by 0.4 per cent, indicating fair valuation.

20

Extraneous factors:
Global environment:
Globally, inflation began to rise in early 2004, driven up by strong input demand from
the global recovery and the continued expansion of the Chinese economy. Demandside pressures on global inflation remained relatively weak, despite concerns about
easy monetary conditions fuelling asset prices. Reflecting the supply-side character
of inflation, producer prices tended to lead consumer prices in most economies. As
commodity costs represent only a small share of the overall costs, the increase in
commodity prices was initially absorbed by firms in their profit margins, creating a
wedge between producer and consumer prices.
A number of central banks, most notably the US Federal Reserve, began to signal a
reversal of their accommodative monetary policy stance in order to stabilise inflation
expectations. The US Federal Reserve raised its target Federal Funds Rate in seven
equal stages by 175 basis points to 2.75 per cent between June 2004 and March 2005.
Commodity prices, which had risen sharply in the first half of 2004, stabilised at
elevated levels by the end of the year. Fuel prices surged up by 30.9 per cent, on an
average, in 2004 on top of an increase of 16.7 per cent in the previous year. Non-fuel
commodity prices (covering prices of food, beverages, agricultural raw materials and
metals) rose on an average by 18. 6 per cent in 2004, led by metals (36.4 per cent).
The increase in commodity prices in the international markets in US dollar terms was
much higher than in terms of the Euro or the Japanese Yen. This reflected the
depreciation of the US dollar by 9.4 per cent against the Euro and 6.7 per cent against
the Yen in 2004.
The global economy continued to expand at a robust pace during 2004, although the
rate of growth moderated from the exceptionally high levels observed at the
beginning of the year.
Domestic environment:
The financial year started with the 14th Lok Sabha election during April 20 and May
10, 2004. Over 670 million people were eligible to vote, electing 543 members of the
14th Lok Sabha. The ruling Bharatiya Janata Party (BJP) and its alliance National
Democratic Alliance conceded defeat.
Initiatives taken by the previous government, in a number of sectors like telecom,
roads, ports and civil aviation have begun to yield results and made a good impact on
21

economic growth. The Survey stressing the role of higher foreign investment both FDI
and FII for accelerated economic growth, said trade liberalization, introduction of
greater competition and open foreign investment policies have been successful in
transforming several sectors of the Indian manufacturing industry into globally
competitive entities.
The major programmes initiated under the new government during the year include,
launching of the National Food for Work programme in 150 most backward districts,
introduction of National Rural Employment Guarantee Scheme, additional budgetary
support for planned programmes like food for work, Sarva Shiksha Abhiyan, mid-day
meal, basic health care, accelerated irrigation benefit programme, drinking water
and roads, imposition of a cess of 2 per cent on Central taxes for universal education
and a new universal health insurance scheme for the poor.

The December 26, 2004 Indian Ocean tsunami was caused by an earthquake that is thought
to have had the energy of 23,000 Hiroshima-type atomic bombs.

The wave killed people in 14 different countries around the Indian Ocean totalling over
250,000 and death toll in India around 9675.

Government of India announced a special rehabilitation of Rs. 3,644 cr. & Indian officials
estimate that it will cost 125 million dollars to repair the ships and replace fishing equipment

22

Macro-economic overview - 2005-2006

Demonstrating strengths, the Indian economy, after growing at 8.5 per cent and 7.5
per cent in the two previous years, was projected to grow at 8.1 per cent in the year
2005-06.
After dipping below 1.0 per cent in 2004-05, mostly on account of erratic rainfall,
agricultural and allied sectors growth in 2005-06 was projected at 2.3 per cent
Significant dimensions of the dynamic growth in recent years were: a new industrial
resurgence; a pick-up in investment; modest inflation in spite of spiralling global
crude prices; rapid growth in exports and imports with a widening of the current
account deficit; laying of some institutional foundations for faster development of
physical infrastructure; progress in fiscal consolidation; and the launching of the
National Rural Employment Guarantee (NREG) Scheme for inclusive growth and social
security.
Against the annual average growth rate of 8.0 per cent envisaged in the Tenth Five
Year Plan (2002-03 to 2006-07), the average rate is estimated to have been 7.0 per cent
in the first four years ending in 2005-06.
Industry and services continued to expand steadily. Since the beginning of the Tenth
Plan in 2002-03, with annual growth of 7.0 per cent or more, industry and services
acted as the twin engines propelling overall growth of the economy.
Growth in financial services (comprising banking, insurance and real estate services),
which after dipping in 2003-04 had bounced back in the year, maintained the
momentum with progressive maturing of Indian financial markets and the ongoing
construction boom. However, community, social and personal services, which include
public administration and defence, reflecting the process of fiscal consolidation and
increasing efficiency of fiscal expenditure management, experienced a growth
deceleration of more than a percentage point.
Pick-up in investment, reflecting the high business optimism, not only strengthened
industrial performance but also reinforced the growth outlook itself. The rally in gross
domestic capital formation (GDCF) that had commenced in 2002-03 continued.
Stock market index returns of 11 per cent in 2004 followed by 36 per cent in 2005
provide a good measure of investor sentiments. The bell-weather BSE Sensex crossed
the 10,000 mark on February 6, 2006.

23

Trends in GDP:
According to the national income data released by the Central Statistical Organisation
(CSO) on February 7, 2006, the advance estimate (AE) for growth of GDP at factor cost
at constant (1999-2000) prices in 2005-06 at 8.1 per cent was up 0.6 percentage points
over the 7.5 per cent growth recorded in 2004-05
The CSO has changed the base year for calculation of national income aggregates at
constant prices from 1993-94 to 1999-2000. The revised growth rate with base 19992000 is the same as or less than the rate with base 1993-94 for each of the four earlier
years ending in 2003-04.
Growth trend for the last three years appears to indicate the beginning of a new phase
of cyclical upswing in the economy from 2003-04. The initial momentum to this new
phase of expansion, in 2003-04, was provided by agriculture. After a somewhat
subdued impetus from the farm sector in 2004-05, there is a moderate recovery in
agricultural growth in 2005-06

Fiscal Policies:
Continuing with the process set in motion in the previous year, the Budget for 2005-06
sought to further the NCMP objectives of growth, stability and equity in a calibrated
manner. Maintaining a growth rate of 7-8 per cent per annum, promoting investment,
generating employment, accelerating fiscal consolidation, ensuring higher fiscal
devolution and focusing on agriculture, manufacturing and infrastructure were the
key objectives.
Budget 2005-06 sought to achieve these objectives through a series of initiatives,
which included: hike in gross budgetary support (GBS) for the plan by 16.9 per cent
on a like-to-like basis from Rs.1,45,590 crore in 2004-05(BE) to Rs.1,72,500 crore in
2005-06 (BE); provision of livelihood security for crores of poor families through the
National Rural Employment Guarantee Scheme (NREGS), the legislation for which was
passed by the Parliament on August 24, 2005; a visionary development proposal
Bharat Nirman for building infrastructure, especially in rural areas; an outlay of
Rs.1,100 crore for covering 1.25 lakh villages in five years under a massive
programme of rural electrification; creation of an SPV to overcome the infrastructure
deficit and provision of guarantees to the extent of the borrowing limit of Rs. 10,000
crore; enhanced outlay on NHDP from Rs. 6,514 crore in BE 2004-05 to Rs. 9,320 crore
to speed it up; provision of Rs. 5,500 crore for National Urban Renewal Mission
(NURM); and a focus on outcomes rather than outlays.
Direct Taxes:
In the area of direct taxes, the Budget for 2005-06 carried forward the process initiated
in the previous Budget. In personal income tax, the tax rates were revised for various
tax brackets conferring gain to all taxpayers through higher exemption limits and
24

scaling up, even as standard deduction was withdrawn. In another significant move,
neutrality of taxes between forms of savings was achieved through a general rebate
on savings in any approved instrument up to Rs.1lakh.

Budget for 2005-06 introduced two new taxes: a fringe benefit tax targeted at those
benefits enjoyed collectively by the employees and not attributable to individual
employees, which are to be taxed in the hands of employer; and a tax on banking cash
transactions (withdrawals) over a certain threshold in a single day. Taking a leaf out
of the international best practices, corporate income tax was reduced to 30 per cent,
albeit with a higher surcharge of 10 percent and reduced depreciation allowance that
is a better approximation to the replacement life-value.
Indirect taxes:
Customs Duty:
Budget for 2005-06 reduced peak customs duty on non-agricultural products to 15 per
cent with steeper reductions for capital goods and raw materials and corrections for
inverted duty structures.
As a part of oil prices management, in an era of unprecedented rise in international
prices, customs duty on crude petroleum was halved from 10 per cent to 5 per cent;
customs duty on petroleum products reduced to 10 percent from 20 percent and 15
per cent; customs duty on subsidised products, namely domestic LPG and PDS
kerosene, made nil; and excise duties on motor spirit and high speed diesel
converted to specific duties together with an 8 percent ad valorem component.
In excise, Government intends to bring as many goods as possible to the median
CENVAT rate of 16 percent. Towards this, the Budget for 2005- 06 reduced duties on
polyester filament yarn, tyres and air-conditioners from 24 per cent to 16 per cent.
Excise Duty:
Excise duties on MS or petrol, and HSD fixed as a combination of ad valorem and
specific duties: at 8 per cent plus Rs.13 per litre for MS, and 8 percent plus Rs.3.25 per
litre for HSD. Duty on Liquefied Petroleum Gas (LPG) for supply to domestic
households and kerosene for ultimate sale through public distribution system
reduced from 8 per cent to nil.
Duty on iron and steel raised from 12 per cent to 16 per cent. Duty on cement clinkers
per MT increased from Rs.250 to Rs.350 as an anti-avoidance measure.

25

Inflation:
WPI:
Inflation, measured by a point-to-point increase in the Wholesale Price Index (WPI)
declined from 5.7 per cent on April 2, 2005, to a low of 3.3 per cent on August 27, 2005.
Despite increasing thereafter, prices have remained at comfortable levels with the
WPI-inflation at 4.1 per cent on February 4, 2006 vis--vis 5.0 per cent on February 5,
2005. As on February 4, 2006, the fuel group, with an inflation rate of 7.6 per cent,
contributed 40.5 per cent to the overall inflation, which was marginally lower than 42.8
per cent a year ago. Much of the inflation in the fuel group is attributable to the pass
through effected in June and September 2005,in the form of enhanced retail prices of
petrol and diesel, precipitated by the flare-up in global oil prices.
Decelerating trend in inflation relating to manufactured products group observed
since the last quarter of 2004-05 continued as the inflation rate for this group dropped
from 4.5 per cent a year ago to 2.4 per cent on February 4, 2006. This deceleration in
both wholesale and retail prices, in the aftermath of the introduction of value added
tax (VAT) in most of the States with effect from April 1, 2005, helped to mobilise
popular support behind a fundamental reform of State-level sales taxes a reform
termed by some as the most important tax reform in post-independent India.
CPI:
Inflation, year on year, in terms of consumer price index for agricultural labourers
(CPI-AL) and of consumer price index for industrial workers (CPI-IW) was 3 per cent
and 5 per cent, respectively. Data indicated that inflation in CPI-AL remained below
that in CPI-IW for each of the months of the current financial year including December
2005. Furthermore, with inflation rate for food group (with a higher weight in CPI than
in WPI) lower than that of overall inflation, CPI inflation (measured in terms of both
CPI-AL and CPI-IW) remained below WPI-inflation until October 2005.Inflation in both
CPI-AL and CPI-IW, after declining to 3.2 per cent and 3.4 per cent respectively with
some minor fluctuations between April and August, 2005, revealed an upward trend.
In December, 2005, inflation in CPI-IW was 5.6 per cent. The upward trend in
consumer prices was primarily on account of hardening of retail prices of vegetables
and pulses.

Monetary Policy:
Maintaining price stability continued to be one of the main objectives of monetary
policy. For achieving this the policy variables were recalibrated appropriately. While
the Bank Rate and the cash reserve ratio (CRR) were kept unchanged during the
current year at 6.0 per cent and 5.0 per cent, respectively, the fixed reverse rate under
the Liquidity Adjustment Facility (LAF) of the Reserve Bank of India (RBI) was raised
three times, by 25 basis points each, to reach 5.50 per cent on January 24, 2006.With
26

the given spread of 100 basis points vis--vis the reverse rate, the rate is pegged at
6.50 per cent since January 24, 2006.
RBIs policy response was in line with the cautious approach in many other countries
of moving policy interest rates in a measured way in the face of the threat of
inflationary expectations firming up with high crude oil prices.
The year-on-year growth of broad money (M) at 16.4 per cent on January 20, 2006 was
not only higher than the projected14.5 per cent in RBIs Annual Policy Statement for
2005-06, but also higher than the rate observed a year ago.
Price stability despite a rapid increase in money supply during the current year
testified to the investment-driven nature of the credit growth and stability of inflation
expectations based on confidence in the appropriate stance of monetary and fiscal
policies.

Balance of Payments:
Current Account:
There was a deficit in the current account of the BOP, which emerged in 2004-05 after
three consecutive years of surpluses, and has assumed much larger dimensions
during the current year. During April-September 2005-06, the current account deficit
enlarged to around US$13.0 billion, which was more than twice the deficit (US$5.4
billion) in the whole of 2004-05. While net invisibles continued to rise, it was not
enough to neutralize the rapidly expanding trade deficit, which at US$31.6 billion
during April-September 2005-06 was only around US$5.0 billion less than that
recorded in twelve months of 2004-05.
Trade Deficit:
The sharp rise in current account deficit reflects the burgeoning trade deficit during
the year. Although, net invisibles increased, but was not enough to neutralize the
expanding trade deficit.
While the surge ahead in merchandise exports observed since 2002-03 continued,
such growth was surpassed by an even faster rise in merchandise imports.
Merchandise imports have been rising more rapidly than exports since 2003-04,
reflecting perhaps the overall industrial recovery that commenced from the second
quarter of 2002-03. The heavy demand for imports arising from increasing buoyancy
and robustness of Indian industry may have led to a sustained rise in growth of
merchandise imports.
Capital Account:
With robust inflows, during 2004-05, the surplus of US$31.6 billion recorded in the
capital account more than compensated the current account deficit and resulted in an
addition of more than US$26 billion, on BOP basis, to the existing stock of foreign
exchange reserves. In April-September 2005, while the capital account surplus at
US$19.5 billion remained higher than the current account deficit of US$13.0 billion,
27

there was a slowdown in reserve accretion on BOP basis. The dominance of non-debt
creating flows in the capital account continued.
Within foreign investment, portfolio flows, comprising mainly foreign institutional
investor (FII) investment, were the dominant variety. At US$4.2 billion during AprilSeptember 2005, FII flows (net) were higher than not only the FDI flows of US$2.3
billion, but also the FII flows of US$339 million in April-September 2004. FDI flows
(net) during April-September 2005 were US$2.3 billion up by only US$0.3 billion
from such flows of US$2.0 billion in the first half of 2004-05.

Exchange Rate:
The weakening of the US dollar vis--vis other major global currencies, which resulted
in valuation losses of US$5.0 billion in reserves in the first half of 2005-06, also got
reflected in the movements of the Rupee vis--vis the US dollar. During 2004-05, the
Rupee had appreciated against the US dollar (2.2 per cent) in nominal terms, while
depreciating against the Euro (-4.5 per cent), Pound (-6.3 per cent), and the Japanese
Yen (-2.6 per cent). However, in the first ten months of 2005-06, on average, the Rupee
has strengthened against all major currencies. The appreciation was the strongest vis-vis the Japanese Yen (6.4 per cent) followed by Pound (4.5 per cent), the Euro (4.3
per cent), and the US dollar (2.1 per cent). In 2005-06, in 5-country export-weighted
nominal effective exchange rate (NEER) terms (base year 2000), the Rupee
appreciated in all months until July 2005, and depreciated in subsequent months until
December 2005. In 5-country export-weighted real effective exchange rate (REER)
terms (base year 2000), the same pattern was observed, with the exception of
November 2005, which witnessed a mild appreciation.

Extraneous Factors:
International Environment:
Following a temporary slowdown in mid-2004, global GDP growth picked up through
the first quarter of 2005, with robust services sector output more than offsetting
slowing global growth in manufacturing and, latterly, trade. In the second quarter,
however, in part reflecting the impact of higher oil prices, signs of a renewed soft
patch emerged, with leading indicators turning downward and business confidence
weakening in most major countries (Figure 1.2). While global manufacturing and
trade are now strengthening, and leading indicators have picked up, the continuing
rise in crude oil and refined product priceslatterly exacerbated by the catastrophic
effects of Hurricane Katrinais an increasingly important offset.

28

Domestic Environment:
Growth of 9.0 per cent in 2005-06, surpassed expectations. While the up-and-down
pattern in agriculture continued with growth in the two recent years, and services
maintained its vigorous growth performance, there were distinct signs of sustained
improvements on the industrial front.
Entrenchment of the higher growth trends, particularly in manufacturing, has boosted
sentiments, both within the country and abroad.
Introduction of VAT in 21 states in April 2005 resulted in an increase in inflation in
terms of WPI.

Further, following the targets of five year plans much work was done
towards social betterment pinnacling in launch of NREGA.
The overall macroeconomic fundamentals are robust, particularly with
tangible progress towards fiscal consolidation and a strong balance of
payments position. With an upsurge in investment, the outlook was
distinctly upbeat.

29

Macro-economic overview 2006-2007

The economy averaged growth of 8.1% in the past three fiscal years (2003/04 through
2005/06). Growth during this period was driven largely by the acceleration in industry
and services save in 2003/04 when agriculture, recovering from the severe drought
in the previous year, had a role to play. The sub-sectors that were key drivers of
growth were manufacturing, construction, communication, and financial & business
services. The impressive showing was also reflected in improvement in per capital
income, which increased to Rs 29,642 from Rs 25,956 during 2005-06.
The overall improvement in the performance could also be attributed to an impressive
35.9 per cent growth in capital formation that stood at Rs 14,87,786 crore (Rs 14.87786
trillion) during 2006-07.
Such higher level of investment was made possible by a significant 34.3 per cent
increase in domestic savings that were estimated at Rs 14,41,423 crore (Rs 14.41423
trillion) during 2006-07 at current prices.
The share of financing, insurance and real estate in the GDP also increased to 14.3 per
cent in 2006-07, compared to 13.8 per cent in the previous year.

Trends in GDP
The economy grew by 9.6 per cent during 2006-07, leading to over 14 per cent
increase in the per capital income, the government announced on Thursday.
The improved growth in the GDP, up from 9.4 per cent in 2005-06, has been achieved
due to all around improvement in mining, manufacturing and services sectors, which
helped to offset the slower growth in agriculture sector, according to the quick
estimates released by the Central Statistical Organisation (CSO).
While manufacturing grew 12.3 per cent in 2006-07 as compared to 9.1 per cent in
the previous fiscal, trade, hotels, transport and communication services grew 13 per
cent as compared to 10.4 per cent a year earlier.
Mining and quarrying also grew 5.1 per cent during the year as against 3.6 per cent
a year ago.
In absolute terms, the country's GDP stood at Rs 28,48,157 crore during 2006-07 as
against the earlier estimate of Rs 28,44,022 crore. The per capita income stood at Rs
22,483 during 2006-07 as compared to Rs 20,734 in the previous fiscal.
The government has set a target of an average annual GDP growth of 9 per cent for
the Eleventh Five Year Plan.
30

Fiscal Policies
The Union Budget has placed the fiscal deficit at 3.8 per cent of GDP for the year
2006-07 as against 4.1 per cent in the previous year in the spirit of the FRBM Act,
2003.
The net market borrowing programme of the Centre for 2006-07 is budgeted at
Rs.1,13,778 crore as against Rs.95,370 crore in the previous year. While the size of
the Government borrowing programme is relatively larger than in the previous
year, this has to be viewed in the backdrop of the buoyant growth of the economy,
growing appetite of non-banks for government securities and the need for many
banks to strengthen their SLR portfolio for statutory as also for liquidity management
purposes.

Tax proposals
In Budget 2006-07, P. Chidambaram, Minister of Finance of the UPA II proposed
implementation of Goods and Services Tax (GST) by April 1, 2010.
Indirect Taxes:
Customs
Peak rate for non-agricultural products reduced from 15 per cent to 12.5 per cent.
Reduction of customs duty on 10 anti-AIDS and 14 anti-cancer drugs to 5 per cent; on
certain lifesaving drugs, kits and equipment from 15 per cent to 5 per cent; these
drugs also exempt from excise duty and CVD.
Concessional project rate of 10 per cent to be extended to pipeline projects for
transportation of natural gas, crude petroleum and petroleum products.
Rates on clearances by EOUs to the Domestic Tariff Area (DTA) adjusted at 50 per
cent of basic customs duty plus excise duty on like goods.
Direct Taxes
No change in rates of personal income tax or corporate income tax;
No new taxes are being imposed.
Marginal revision in certain tax rates in the quest for equity-Minimum Alternate Tax
(MAT) rate increased from 7.5 per cent of book profits to 10 per cent which is only
one-third of the normal rate; long-term capital gains arising out of securities included
in calculating book profits; period to take credit for MAT increased from five years to
seven years.
Fringe Benefit Tax (FBT) introduced last year as a revenue raising measure; justified
on the principles of horizontal equity and vertical equity.
31

Service tax
New services to be covered including ATM operations, maintenance and
management; registrars, share transfer agents and bankers to an issue; sale of space
or time, other than in the print media, for advertisements; sponsorship of events, other
than sports events, by companies; international air travel excluding economy class
passengers; container services on rail, excluding the railway freight charges;
business support services; auctioneering; recovery agents; ship management
services; travel on cruise ships; and public relations management services.
Coverage of certain services now subject to service tax to be expanded.
Leasing and hire purchase to be treated on par with loan transactions, interest and
instalment of principal amount to be abated in calculating value of the service.
Proposal to set April 1, 2010 as the date for introducing national level
Goods and Service Tax (GST); service tax rate increased from 10 percent to 12 per
cent as another step towards converge between service tax rate and the CENVAT rate;
net impact likely to be very small in view of credit available for service tax or excise
duty payable.

Inflation
Headline inflation for 2005-06 was lower than anticipated. While increased
competition and productivity gains in several sectors have also contributed to some
moderation in inflation in the recent period, policy measures have ensured low and
stable inflation expectations. The pass-through of international oil price increase has
been only partial and the second round effects in India have so far turned out to be
lower than anticipated earlier. Taking into account the real, monetary and global
factors having a bearing on domestic prices, containing inflationary expectations
would continue to pose a challenge to monetary management. The policy endeavour
would be to contain the year-on-year inflation rate for 2006-07 in the range of 5.0-5.5
per cent.

Consumer Price Index (CPI)

Consumer price inflation measured both by the CPI-UNME (Urban Non-Manual
Employee) and CPI-IW (Industrial Worker), which had stabilized around 4% in 2005,
started to move up beginning November 2005, when both the above indices reported
inflation of 5% or higher. An analysis of the CPI-IW by component indicates that the
principal contributor to inflation has been food. The rate of inflation in the CPI-IW
index of food (weight of 46% in the new series)went up from an average of 2.5%
during the 10-month period Jan-Oct 2005 to 5.8% during the next 6-month period of
Nov 05-Apr 06. In May 2006 this went up further to 8.0%. Thus, of the total CPI-IW
inflation rate of 6.3% in May 2006,as much as 58% (higher than its weight in the index)
32

was on account of food items alone. The other important contributor to CPI-IW inflation
was housing which had averaged a rate of 6.6% in the first 6 months of 2006. In June
2006, the CPI-IW had risen to 7.6% and the CPI-UNME to 6.5%.
Wholesale Price Index
As per the latest data available, inflation as measured by the Wholesale Price Index
(WPI) was recorded at 4.6% for the week ending 29 July 2006. WPI inflation for
primary food had touched 8.3% in the first week of June 2006, a sharp step-up from
the beginning of April when it was 5.9%. This has since declined to 4.4% by the end
of July 2006.
Food grain prices were higher by 9.5% at the end of the second week of June, but
have since declined to 7.3% by end-July 2006.
Wheat prices rose by 12.9% at the end of March just before the rabi harvesting season.
The inflation rate has since declined, but remained over 10% in early June, and
reached 7.9% by July 29.
The prices of pulses have risen sharply and continuously from 18-20% in January 2006
to over 25% in March and to 33% between April and June.
Although there has been some moderation in recent weeks, this has been modest with
the inflation rate in end-July still as high as 28%.
The WPI price index for fruits & vegetables remained subdued till the end of May and
rose to 6.3% by the first week of June. Much of the agitation on this front came from
retail prices which skyrocketed in certain markets in May and June. In the most recent
week, the index for fruit & vegetables has declined by as much as 6.8% from its peak
value in the third week of June.

Monetary Policy
The Third Quarter Review of January 24, 2006 noted that risks to growth and stability
are high from rising domestic demand, the incomplete pass-through of crude prices
into domestic prices and from global developments. Emphasising the need to shore
up the gains of recent high growth, the monetary policy stance was articulated in
favour of a greater emphasis on price stability through measured but timely and even
pre-emptive policy action to anchor inflation expectations.
Developments in the ensuing months vindicate this pro-active monetary policy
stance. With inflation contained and inflationary expectations evolving consistent
with the policy stance, real growth has quickened in an environment of price and
financial stability, raising expectations of a structural shift in the medium-term
growth path of the economy. Monetary policy has been particularly effective in
ensuring that the cost-push impulses from oil prices have not fed through into
aggregate demand conditions. In the external sector, the current account deficit has
remained within manageable proportions, comfortably financed by buoyant capital

33

flows. Monetary management during 2005-06 was conducted broadly in conformity

with the stance of the policy set out in the policy statements during the year.

Trade and balance of payments

During the current year 2006-07 exports are expected to reach the target of US $ 125
billion if the present rate of growth of exports is maintained during the last quarter of
the year. The sustained growth of merchandise exports at more than 20 per cent
during the last few years is more than twice the growth of Gross Domestic Product
(GDP).
India's trade deficit widened 40.5 percent in the fiscal year that ended in March to
$56.74 billion, and analysts said a strong rupee would hit exports further in months to
come.
Current Account:
Exports of goods increased by 21 % during 2006-07 compared to 23 % in 2005-06.
Exports grew mainly on account of tea, spices, and engineering and petro goods.
Imports growth at 22 per cent in 2006-07 (32 per cent in 2005-06). Imports grew mainly
on account of non-oil imports and not oil-imports as it has generally been the case.
Non-oil imports increased by 25% in 2006-07 (21.8% in 2005-06). The major non-oil
import items were capital goods, metalliferrous ores, metal scrap and gold and silver.
Crude oil imports during 2006-07 recorded some moderation in growth at 30.4 %
(47.3 % in 2005-06). The slowdown in oil imports was largely because of a moderation
in crude oil prices. The average price of the Indian basket of international crude (a
mix of Dubai and Brent varieties) stood at $ 62.4 per barrel during 2006-07 as
compared with US $ 55.4 per barrel during 2005-06. This implies that the prices
increased by 13% in 2006-07 much lower than 42% increase seen in 2005-06. In
volume terms, the oil import demand rose to 13% in 2006-07 from 8 % in 2005-06,
tracking the growth in industrial sector.
The service exports increased by 37% in 06-07 compared to 68% in 05-06. Software
exports increased by 29% on 06-07 compared to 35% in 05-06.
Capital account:
FDI has a larger share in foreign investments than FII, a trend last seen in 2002-03.
Outward FDI and FII have also grown sharply at 273% and 85%, showing Indians
appetite for investing abroad is increasing.
External Commercial Borrowings have grown at a shocking rate of 491% this year and
are now at about USD 16 billion. That is why RBI revised the rates corporates can pay
for ECB.
The total capital flows have increased by 92% and despite the increasing current
account deficit, we have a huge BoP surplus at USD 36.6 billion, an increase of 143%.

34

Exchange Rate
Toward the end of 2006, foreign exchange inflows, especially of dollars, into India
started rising sharply. This put upward pressure on the rupee's exchange rate against
the dollar. India's steady economic growth offered several opportunities for foreign
companies. Between April 2006 and March 2007, FDI of $ 16 billion flowed in to India.
The rupee's appreciation against the dollar was seen to be beneficial to the Indian
economy in some ways, and detrimental in other ways. The rise in the value of rupee
meant that inflation was curbed. The inflation rate in India declined from 6.73 percent
in February 2007 to 4.10 percent in August 2007.
In June, 2007, the Economist Intelligence Unit estimated that for the year 2007, the
rupee's average annual exchange rate against the dollar would be 41.3 (a 13.5 percent
real appreciation year on year), and for the year 2008, it would be 40 (6 percent)

Extraneous Factors:
Stock Market:
Since the second week of May 2006, equity markets across the world have been
negatively affected by a widespread re-rating of risk, from interest and exchange
rates to petroleum prices to intensification of conflict in West Asia.
These developments have reflected a big increase in risk perception (or premium)
which has resulted in the withdrawal of funds from some of these markets. During the
current financial year, net sales by foreign institutional investors (FII) in India
amounted to nearly US$ 1 billion (most of it in May) till the end of July 2006 although
year-to-date inflows for calendar 2006 continue to be positive at over US$ 2.9 billion.
Nevertheless the Indian market continues to enjoy fairly high price earning
(historical) multiples.
The sharp weakening of equity markets after 10 May 2006 was due to mounting
disquiet with regard to the aggressive pricing of risk that had characterised a long
period of robust growth, high levels of business confidence and strong recovery in
corporate profitability. Other global factors fuelled this concern further.
Broadly emerging markets lost between 5% (e.g. Poland, Czech Republic and
Mexico) and 15% (India, Indonesia, Thailand, Taiwan and Russia). Amongst industrial
economies, losses were somewhat lower from 2% in Britain and Switzerland to 7% in
Germany and 10% in Japan, Sweden and the US (NASDAQ). China (Shanghai) has
been an outlier in 2006, but that is partly due to its poor performance in 2005 and in
2004.
Industrial Sector
Indian Industries have entered in to an atmosphere of higher competition in the era of
globalization.
The resilience shown by the industrial sector against the hardening of global oil prices
is reflective of inherent strengths and capabilities that the industrial sector has built
up over the years since the initiation of economic reforms in the country.

35

Besides higher levels of investment, issues of governance and management including

policies relating to appropriate pricing and user charges would need to be addressed
to achieve satisfactory results. Given the rising international crude oil prices and
stagnant domestic crude oil production, an integrated approach to efficient use of
energy - both oil and non-oil energy resources - assumes importance.
Services Sector
India's services sector has grown very fast as it holds a larger portion of young
peoples. The educated young masses in India have brought tremendous success for
the country in the recent years. The services sector in the country has benefited from
the availability of vast skilled labour. In the coming years, India is expected to benefit
further from the demographic dividend emanating from a higher proportion of
younger population. There is need to improve the availability of educational facilities
at all levels - primary, secondary and tertiary - to equip the labour with the necessary
skills to maintain current competitive advantage.
External Sector
The external sector of the Indian economy is also performing better. India is in a path
to capture 1% of the global trade in the near future. Merchandise export growth of 24
per cent per annum, on average, in the past four years points to the growing
competitiveness of Indian manufacturing. Improvements in infrastructure assume
critical importance for maintaining and improving our competitiveness as also
encouraging investment in export production and sustaining the pace of export
growth in the longer term.
For the full potential of earnings from exports of services to be realised, issues relating
to skill enhancement and quality of education assume greater importance. Demand
for education, especially higher education, is expected to grow immensely in the
coming years in view of the demand emanating from knowledge intensive nature of
the services sector as well as demands from the manufacturing sector.

36

Review and Analysis (2003-2007)

Tenth 5 year plan: (2002-2007)
The primary aim of the 10th Five Year Plan is to renovate the nation extensively,
making it competent enough with some of the fastest growing economies across the
globe.
Targeted GDP growth rate of 8% per annum.

Increasing the mobility of all the available financial resources of India, and
optimizing them as well.
Setting up of a state-of-the-art infrastructure for all the existing industries in
India.
Encourage the initiative of capacity building within the Indian industrial sector.
Creating a friendly, amiable and pleasant investment environment in India.
Encouraging sufficient transparency in the corporate sectors of India.
Introduction of reforms in the industrial sectors, which are more investorfriendly in nature.

Fiscal deficit(% of GDP)

4.73

2003-04

4.4

2004-05

4.1

2005-06

3.8

2006-07

2003-04 the fiscal deficit was pegged at 4.73%, the growth envisaged for the Union
excise duties and customs was even lower revenue expenditure was budgeted to
grow over 7.2% over 2002-03 to Rs. 3,66,227 crores. Fiscal and revenue deficits were
budgeted 5.6% and 4.1% of GDP. From 2004 to 2007 there was a decline in the fiscal
deficit from 4.4 to 3.8 in the backdrop of the buoyant growth of the economy, growing
appetite of non-banks for government securities and the need for many banks to
strengthen their SLR portfolio for statutory as also for liquidity management purposes.

37

Exchange rate
46.57
45.12
43.92
41.48

2003-04

2004-05

2005-06

2006-07

In 2003-04 the rupee appreciated by 5.3 per cent in 2003-04 vis--vis the US dollar,
this weakening of the US dollar was caused mainly by widening US deficits. In 200405 the ebbing of capital flows, the rising demand for imports and the surge in
international oil prices drained away the excess supplies, leading the Indian rupee to
depreciate against the US dollar by 4.5%
Toward the end of 2006, foreign exchange inflows, especially of dollars, into India
started rising sharply. This put upward pressure on the rupee's exchange rate against
the dollar. India's steady economic growth offered several opportunities for foreign
companies.

CAD(% of GDP)
2.3

2003-04

2004-05
-0.8

2005-06
-1.3

2006-07
-1.1

IN 2003-04 Imports have been growing at a compounded annual average growth rate
(CAGR) that is 4 per cent higher than that of exports over the same period. This is the
cause of Indias burgeoning current account deficit. In 2004-05 the deficit was caused
by a burgeoning excess of merchandise imports over exports. In 2005-06 the heavy
demand for imports arising from increasing buoyancy and robustness of Indian
38

industry may have led to a sustained rise in growth of merchandise imports. In 200607 the current account deficit has remained within manageable proportions,
comfortably financed by buoyant capital flows.

GDP
8.4

8.3

9.2

6.2

2003-04

2004-05

2005-06

2006-07

2003-04 GDP is estimated to have grown by a sharp 8.2 per which was possible due
to one of the most bountiful monsoons in years in India, however in 2004-05 modest
expectations were further pared down to around 6.1 per cent when rainfall, became
deficient in the crucial sowing month of July and the shortfall in the south-west
monsoon turned out to be 13 per cent. 2005-06 saw moderate recovery in agricultural
sector thus increasing the GDP.T was in 2006-07 GDP growth of 9.2% was achieved
due to all around improvement in mining, manufacturing and services sectors, which
helped to offset the slower growth in agriculture sector

Inflation Trends
6.4
5.4
3.8

2003-04

5.3
4.2

4.4
4.2

2004-05

2005-06

Inflation(WPI)

2006-07

Inflation(CPI)

WPI
In 2003-04 WPI was 5.4 per cent on average. The manufacturing sector was the major
contributor accounting for nearly 80 per cent of the inflation. In 2004-05 was marked
by a hardening of domestic prices of coal, petroleum products, iron and steel and
other metals, reflecting lagged adjustments. In 2005-06 the deceleration in both
39

wholesale and retail prices, in the aftermath of the introduction of value added tax
(VAT) in most of the States. In 2006-07 food grain prices, pulses and fruits and
vegetable, etc. led the WPI to increase to 5.3%
CPI
In 2003-04 the high point-to-point inflation through much of 2003-04 and its sharp
deceleration in March 2004 were partly because of the carryover of the price increase
that took place in the last quarter of 2002-03.In 2004-05 Consumer price inflation
firmed up to 4.4 per cent in January 2005 mainly due to increase in the prices of fish,
meat, sugar, kerosene oil and housing. In 2005-06 The upward trend in consumer
prices was primarily on account of hardening of retail prices of vegetables and pulses.
During the year 2006-07 the increase in CPI can be attributed to increase in the prices
of food and housing.

Economic indicators
46.57

5.4 3.8 2.3

45.12

4.73

2003-04
Inflation(WPI)

6.4 4.2

43.92

4.4

4.4 4.2

-0.8
2004-05
Inflation(CPI)

CAD(% of GDP)

41.48

4.1

-1.3
2005-06
Exchange rate

5.3 5.3

3.8

-1.1
2006-07
Fiscal deficit(% of GDP)

Starting from 2003-04 the Fiscal deficit saw a steady decline from 4.73% to 3.8% in the
backdrop of the buoyant growth of the economy. Talking about the WPI, it treaded
upwards initially from 5.4% to 6.4% due to increase in the prices of food items but it
came down again to 5.3% due to the introduction of VAT across various states.
However, the CPI seems to be increasing due to the increase in food prices. The deficit
in Current account was caused by a burgeoning excess of merchandise imports over
exports. In 2005-06 The heavy demand for imports arising from increasing buoyancy
and robustness of Indian industry may have led to a sustained rise in growth of
merchandise imports. The trends in exchange rates from 2003 to 2007 showed a
robust economic growth and the widening of US deficits.

40

References:

indiabudget.nic.in
timesofindia.indiatimes.com
thehindu.com
Case: India on the move HBS case study
Video: Political and economic views of contemporary India

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