South-west monsoon performance is highly critical for agricultural growth. The 2005 monsoon season ended with an overall rainfall deficiency of just 1% compared to normal.
However, monsoon rains were spatially and temporally not well distributed. The Ministry of Agriculture has come out with the first advance estimates of kharif crop production. Based on the estimates, production of jowar, bajra, tur, soyabean, cotton and jute is estimated to fall short of last year's output.
Total foodgrain production, however, is expected to be higher than last year by just about 2%. So, despite the excellent aggregate rainfall picture, the crop production outlook is not that good due to temporal and spatial discrepancy in rainfall patterns.
On the industrial performance, industrial growth based on Index of Industrial Production (IIP) went up from 6.2% during July 2005 to 7.4% during August 2005. Manufacturing remained the most buoyant segment, growing at 8.2%, up from 7.7% during the preceding month.
Of the other two segments, electricity improved its performance substantially compared to the preceding month, aided by the base effect. Electricity grew at 7.8% during August 2005 compared to a deceleration during July 2005. Mining, on the other hand, continued to witness negative growth during August 2005.
Among use based industries, consumer goods was the most buoyant segment, growing at 10.6%, though it had slowed down compared to the corresponding month of the previous fiscal. Capital goods followed consumer goods in terms of buoyancy during August 2005.
However, growth in capital goods slowed down, in comparison with both the preceding month and the corresponding month of the previous fiscal. After 6 months of double-digit growth rate, the growth in capital goods slipped below 10% during August 2005, with machinery and equipment the prime contributor to the slowdown. The slowdown in machinery and equipment and, hence, capital goods implies moderation in investment demand and needs to be closely monitored.
On the external front, India's exports recorded a slow growth of 7.51% in September 2005 at $7.29 billion, compared with $6.78 billion during September 2004. The slowdown during September 2005 pulled down the overall export growth during April-September 2005-06 to 20.5%.
Imports during September 2005 rose 18% to $10.48 billion, against $8.94 billion in the corresponding period last year. Imports surged 33% to $63.55 billion during April-September 2005-06, against $47.74 billion in the corresponding period last year. The surge in imports during the first six months of the fiscal was mainly because of a 43% increase in oil imports. The country's trade deficit jumped to $20.32 billion compared with $11.88 billion during April-September 2004-05.
Inflation on a high
On the inflation front, the inflation rate started moving up during September as the benefits of a low base started wearing off. Inflation based on Wholesale Price Index (WPI) for all commodities went up from 3.1% during August 2005 to 3.6% during September 2005.
For the week ended October 8, 2005, inflation rose to 4.6%. Among the three major groups, inflation in primary articles and fuel products rose during September 2005 compared to the preceding month. Inflation in manufactured products, on the other hand, continued to fall. Inflation in manufactured products slipped to as low as 1.9% during September 2005 - its lowest level since August 2002.
Inflation is expected to rise further in coming months. Apart from the falling base, international oil prices remain a critical risk to the domestic inflationary situation. Going forward, the hike in domestic oil prices may trickle down to manufacturing inflation by raising the cost of production of manufactured products.
On the fiscal front, total receipts during FY06 were budgeted to be 2% lower than last year. A receipts crunch is expected on the capital receipts front because of the shelving of the disinvestment of public sector units (PSUs) and the end of states' debt swap scheme. As the total receipts data is not comparable across years, it is more meaningful to focus on the performance of revenue receipts.
Revenue receipts were up by 18.7% during the first 5 months of the current fiscal, compared to the targeted 15% for the whole fiscal. In it, tax revenue net to Centre was higher by around 28% during the first 5 months of the current fiscal, compared with 21.6% targeted for the whole fiscal. Gross tax revenue was up by 23.2% during the first 5 months compared to the corresponding period of the previous fiscal.
On the expenditure front, both Plan and non-Plan expenditure overshot their targets during the first 5 months. Hence, an increase in expenditure has offset the gains of higher tax revenue, pushing up the overall fiscal deficit to Rs 86,328 crore till August 2005, which at 57% of the Budget estimate is much bigger than 38.2% during the corresponding period a year earlier.
Given the disproportionate dependence of tax collections on industrial performance, the revenue performance of the government critically hinges on the level of industrial activity. If the average tax/industrial GDP observed in FY05 is assumed, we get a revenue shortfall of Rs 11,429 crore for industrial growth of 7.4%, which we have projected for FY06. We expect the fiscal deficit to inch up to 4.6% of GDP in FY06 as against the budgetary target of 4.3%.
On the rupee, while the market awaited the Fed's decision on a rate hike as the US government discounted the impact of hurricanes Katrina and Rita, foreign fund inflows and the domestic stock market rally provided strength to the domestic currency amidst threats of rising and volatile global crude oil prices during the second half of September. During October, the rupee has been weakening on concerns of a sustained rise in oil prices, which is bloating India's import bill and widening the trade deficit further. Although global crude oil prices have eased from the record high of $70 per barrel during August, the prices were observed rising again, with crude trading around $65 to a barrel.
The current selling by FIIs is expected to be a temporary phenomenon as the strong macroeconomic fundamentals in the economy will continue to attract significant capital inflows to the domestic market. While the overall inflation is expected to inch up, sufficient liquidity is expected to keep the currency stable around the current levels. We expect the rupee to trade around 43.5-44 against the dollar by the year-end.
In the debt markets, the period from September 13-October 12, 2005, saw a rather bearish phase that enabled the markets to break away from the range-bound movement observed last month. While the yield on 10-year G-secs rose consistently, the yields on 1-year G-secs rose in tandem with long-term yields only till September 28. Thereafter, the short end of the G-sec spectrum saw a phase of aggressive buying, leading to a weakening of yields. In fact, India's bond yield curve flattened as tight liquidity led to a sell-off in short-dated debt instruments, while investors picked bargains at the long end .
On September 28, the spread was at its 2-month low at 118 basis points (bps). Although trading has been rather thin ahead of the quarterly review of the monetary policy, a reversal was seen after October 7, 2005, as long yields fell on account of a recovery in demand for long-term debt instruments and short yields rose on fears of a repo rate hike.
In its Monetary and Credit Policy 2005-06, announced on October 25, 2005, the Reserve Bank of India (RBI) has hiked both the repo and the reverse repo rate by 25 basis points (bps). The reverse repo rate has been hiked on the concerns of inflationary pressures created by global oil prices.
In the short run, interest rates are likely to be range-bound and flat, with the market already having factored in the reverse repo rate hike. However, an upward bias on bond yields is likely to ensue in the long run with the RBI taking a hint from escalating US rates. Since a lot of emphasis appears to have been given on the permanence of the impact of the oil price hike in September on relative prices, it is likely that the markets would factor in a higher rate of inflation in nominal bond yields.
With the India Millennium Development Bond (IMD) redemption coming up and foreign institutional investors recording net sales, liquidity is likely to be tight in the short run. We expect the 10-year G-sec rates to be in the range of 7.25-7.5% by March 2006 with an upward bias towards 7.5%.
To sum up, we project an overall GDP growth rate of 7% in FY06 a tad higher than last years' 6.9%. Agriculture, industry and services are projected to grow at 2.5, 7.4 and 8.5% respectively in FY06. Some downside risks do threaten growth prospects in future. The expenditure compression by the government in the face of fiscal pressures can reduce the fiscal stimuli to growth.
Rising interest rates in the US, repo and reverse repo rate hike announced by RBI, together with higher borrowing programme of the government imply increased pressure on domestic interest rates. Oil prices remain a critical supply side worry as its continuation at high levels will hurt industrial activity.