2.33 The aggregate expenditure in the revised estimates for 2002-03 was lower by 1.5 per cent from the budget estimates. The expenditure reduction was solely in the non-Plan expenditure while the Plan expenditure showed a marginal rise. The reduction in the non-Plan expenditure was on account of reduced grants and loans to States and Union Territories (UTs) due to non-utilisation of funds under the Fiscal Incentive Fund (Rs.2,184 crore), defence (Rs.9,000 crore) on account of lower capital expenditure, interest payments (Rs.1,727 crore) due to reductions in interest rates on Government securities and pensions (Rs.804 crore). However, the expenditure on subsidies increased by Rs.4,817 crore over the budget estimates with almost 83 per cent of the rise accounted for by food and indigenous fertiliser subsidies.

2.34 The Union Budget for 2003-04 accorded priority to fiscal consolidation and debt restructuring as it is essential for sustainable growth. The fiscal policy measures proposed in the Union Budget underscore the Government’s commitment to totally eliminate budgetary drags and achieve fiscal consolidation through revenue enhancement under a modern tax administration and expenditure rationalisation. An important element in tax reforms is the switching over to a Value Added Tax (VAT) by States with effect from April 1, 2003; others include strengthening of tax administration through greater application of IT and rationalisation of the tax structure with a view to improving the competitiveness of Indian industry in international markets. The expenditure management envisaged in the Union Budget mainly focuses on better cash management and debt restructuring taking advantage of comfortable foreign exchange reserves and lower domestic interest rates. As part of debt restructuring, a buy back of a large proportion of the banks’ holding of Central Government domestic debt contracted under the high interest regime is expected to improve banks’ balance sheets. The Government’s objective towards fiscal consolidation is, thus, endeavoured through expenditure reprioritisation and revenue augmentation.

2.35 The Union Budget for 2003-04 projects moderate growth rates of 7.2 per cent in revenue receipts and 8.6 per cent in aggregate expenditure. With a relatively higher growth in expenditure, all the major deficit indicators would show increases in absolute terms during 2003-04 from the levels in the revised estimates for 2002-03. However, in terms of GDP, all the deficit indicators would be lower during 2003-04 than the levels in the revised estimates for 2002-03. As proportion of GDP, the GFD for 2003-04 is placed lower at 5.6 per cent than 5.9 per cent in the revised estimates for 2002-03.

2.36 The Centre’s ways and means advances (WMA) from the Reserve Bank for the first and second halves of 2002-03 were fixed at Rs.10,000 crore (April-September) and Rs.6,000 crore (October-March), the same as in the previous year. The average utilisation of WMA, at Rs 4,433 crore during 2002-03 (up to March 14, 2003), was lower than the previous year’s level. The net Reserve Bank credit to the Centre declined by Rs.24,098 crore during 2002-03 (up to March 14, 2003) reflecting active open market operations by the Reserve Bank (Chart II.18).

2.37 The gross market borrowings of the Central Government were budgeted at Rs.1,42,867 crore and net market borrowings at Rs.95,859 crore for 2002-03. The outcome in the revised estimates for 2002-03 placed the net borrowings at Rs. 1,12,865 crore which exceeded the budget estimates by 17.7 per cent. For 2003-04, the gross and net market borrowings are budgeted at Rs. 1,66,230 crore and Rs.1,07,194 crore, respectively. Net market borrowings would finance 69.8 per cent of GFD during 2003-04 as against 77.6 per cent in the revised estimates for 2002-03. At the same time, financing through other liabilities would decline to 27.9 per cent from 28.0 per cent and external finance would contribute 2.3 per cent as against a negative share of 9.3 per cent during 2002-03 (Chart II.19).¹

2.38 The Reserve Bank continued to combine auction issues with private placements of dated securities of the Central Government consistent with market conditions. Devolvements/ private placement with the Reserve Bank amounted to Rs.36,175 crore, representing 28.9 per cent of the gross market borrowings of the Centre through dated securities during 2002-03 (up to March 21, 2003). The weighted average maturity of the Government of India dated securities issued so far during 2002-03 declined to 13.83 years from 14.26 years for 2001-02 as a whole. At the same time, the cost of market borrowings of the Central Government continued to fall due to a benign inflation rate and ample liquidity conditions. The weighted average yield of GOI dated securities declined to 7.34 per cent during 2002-03 (up to March 21, 2003) from 9.44 per cent during 2001-02 reflecting the general softening of the interest rate structure. The bid-cover ratio of the primary issuance of dated securities ranged between 0.64-3.8 during the current year so far. The interest rate on the primary issue of 10-year government securities declined from 6.85 per cent on April 5, 2002 to 6.72 per cent on July 18, 2002. The yield on 15-year securities declined from 7.49 per cent on April 16, 2002 to 7.37 per cent on October 17, 2002. Similarly, the yield on 25-year primary bonds declined from 8.62 per cent on May 30, 2002 to 7.48 per cent on November 7, 2002.

2.39 The finances of State Governments during 2002-03 are budgeted to record an improvement over the previous year. In the budget estimates for 2002-03, the revenue deficit, as a percentage of GDP, is budgeted lower at 1.9 per cent as compared with 2.6 per cent in the revised estimates for 2001-02. With the compression in the revenue deficit, the GFD as a percentage of GDP is budgeted to decline from 4.6 per cent in 2001-02(RE) to 4.0 per cent in 2002-03. The primary deficit is also budgeted lower at 1.2 per cent of GDP in 2002-03 than 1.8 per cent in the previous year.

2.40 During 2002-03, revenue receipts are budgeted to rise by 13.3 per cent. States’ own revenue receipts are expected to finance 53.6 per cent of revenue expenditure and 44.2 per cent of the aggregate expenditure (49.7 per cent and 41.0 per cent, respectively, in 2001-02). The total expenditure of States is budgeted to grow by 7.3 per cent, as compared with the growth rate of 15.7 per cent in the previous year.

2.41 The States have continued to emphasise fiscal consolidation in their budgets for 2002-03 through expenditure management, revenue augmentation and reforms in public sector undertaking. The proposed measures include enhancement of revenue receipts through a revision of tax rates, broadening of the tax base and improved tax compliance. On the expenditure front, a number of States propose to contain revenue expenditure through a set of economy measures such as restrictions on fresh recruitment/ creation of new posts and controlling administrative expenditure. Some States have initiated measures to provide statutory backing to the fiscal reform process through enabling legislations. While Karnataka has already enacted fiscal responsibility legislation, Maharashtra and Punjab introduced similar bills in their respective legislatures. The Kerala Government proposes to introduce a Fiscal Accountability Bill. Several States have already finalised their Medium-Term Fiscal Reforms Programme (MTFRP). A number of States have also focused on restructuring of public sector undertakings, development of infrastructure, including encouragement to private investment in the infrastructure projects and promotion of growth enhancing sectors like information technology and agro-based industries, consolidated sinking fund, guarantee redemption fund and statutory limits on guarantees.

2.42 The likely fiscal outturn of the State Governments during 2002-03 is not yet evident. During April-July 2002, the outstanding WMA was generally higher than those in the comparable period of the previous year. From August 2002, these have generally remained lower than the outstanding WMA in the comparable period of the previous year. The outstanding WMA and overdrafts of State Governments amounted to Rs.4,060 crore as on March 14, 2003 which was lower by 38.7 per cent as compared with the outstanding amount of Rs.6,622 crore on March 15, 2002 (Chart II.20).

2.43 The gross and net market borrowings allocated to States for 2002-03 (including additional allocation of Rs.10,000 crore under a debt-swap scheme) amounted to Rs.30,933 crore and Rs.29,144 crore, respectively. During 2002-03 (up to March 20, 2003), the States have raised Rs.30,853 crore. Of this, Rs.27,880 crore (90.4 per cent) was raised through tap-issues at interest rates ranging between 6.6-7.8 per cent and Rs.2,973 crore (9.6 per cent) through auctions at coupon rates ranging between 6.7 per cent and 8.0 per cent. The States that raised funds through the auction route were Andhra Pradesh (Rs.545 crore), Gujarat (Rs.445 crore), Jammu and Kashmir (Rs.70 crore), Karnataka (Rs.200 crore), Kerala (Rs.445 crore), Madhya Pradesh (Rs.247 crore), Maharashtra (Rs.509 crore), Punjab (Rs.85 crore), Tamil Nadu (Rs.275 crore) and West Bengal (Rs.153 crore). The range of coupon rates, at 6.6-8.0 per cent during 2002-03 so far, worked out substantially lower than that of 7.8-10.5 per cent during 2001-02 and 10.5-12.0 per cent during 2000-01 as well as 11.5 per cent in case of loans from the Centre (Plan loans) and 10.5 per cent for loans arising from small saving collections. The decline in the interest rate on States’ market borrowings reflected the general softening of interest rates. The coupon rate for the tap tranche held in August 2002 was fixed 50 basis points over the then prevailing yield of Government of India 10-year security. However, in the tranche conducted in December 2002, the spread was lower at 37 basis points over the then prevailing yield of a Government of India ten-year security.

2.44 The high order of borrowings by the Central and State Governments continue to raise concerns about the sustainability of the public debt. The combined debt-GDP ratio of the Centre and States increased to 70.0 per cent in the revised estimates for 2001-02 and is budgeted to rise further to 71.6 per cent in 2002-03.

2.45 The monetary policy stance of the Reserve Bank during 2002-03 continued to focus on the provision of adequate liquidity to meet credit growth and support investment demand in the economy with a policy preference for soft interest rates while continuing a vigil on movements in the price level. The Reserve Bank also reiterated its commitment to impart greater flexibility to the interest rate structure in the medium term. In April 2002, the monetary and credit policy for 2002-03 was framed on the basis of a real GDP growth rate of 6.0-6.5 per cent and a rate of inflation of slightly lower than 4.0 per cent under the assumption of a normal monsoon. Consistent with the macroeconomic objectives, indicative projections of M₃ growth and aggregate deposit growth of scheduled commercial banks were placed at 14.0 per cent each, with non-food credit growth (inclusive of non-SLR investments) projected at about 15.0-15.5 per cent. The Mid-Term Review of Monetary and Credit Policy (October 2002) lowered the projection of real GDP growth to 5.0-5.5 per cent in view of the drought conditions in several parts of the country.

2.46 Monetary conditions remained stable during 2002-03. Notwithstanding a higher non-food credit off- take, easy liquidity conditions prevailed during the year on account of strong capital flows, CRR cuts and a decline in food credit. This enabled a smooth absorption of the Centre’s market borrowing as well as a softening of interest rates with varying sensitivity across the spectrum. The Reserve Bank continued to steer liquidity conditions by modulating market liquidity with an array of discretionary operations in the form of changes in reserve requirements, open market (including repo) operations and standing facilities, reinforced by interest rate signals, in the form of changes in the Bank Rate and the repo rate. In the backdrop of large and persistent capital inflows, the Reserve Bank absorbed excess liquidity through a policy mix of outright open market operations (OMO) sales and repos under the Liquidity Adjustment Facility (LAF) (Chart II.21 and Table 2.11). This enabled the Reserve Bank to contain primary money creation, on the one hand, and at the same time, ease interest rates by simultaneously cutting the price of discretionary liquidity, on the other.

2.47 During 2002-03, monetary conditions remained easy facilitated by stable foreign exchange market conditions leading to a favourable interest rate environment conducive to investment. A temporary tightening of liquidity resulting from pressures of the government borrowing programme, seasonal cash demand and a revival of credit off-taken in end-May 2002 was mitigated by a policy mix of private placements and a CRR cut of 50 basis points effective fortnight beginning June 1, 2002. As call rates softened in response, the repo rate was cut by 25 basis points on June 27, 2002. This was reinforced by a further cut of 25 basis points each in the Bank Rate (to 6.25 per cent, the lowest since 1973), the repo rate (both effective October 30, 2002) and the CRR (effective November 16, 2002) as announced in the Mid-Term Review of Monetary and Credit Policy. At the same time, the Mid-Term Review stated that no useful purpose would be served by a further reduction in the Bank Rate in view of the prevailing easy liquidity conditions and the structural downward stickiness in interest rates, and the policy bias would be to keep it stable at least until the end of the financial year. The repo rate was cut by 50 basis points to 5.0 per cent by March 2003.

2.48 In order to tackle the problem of downward rigidities in the interest rate structure, the Reserve Bank encouraged banks to introduce a flexible interest rate system (together with the fixed rate option) for all fresh deposits. To increase the interest rate flexibility, banks were advised to review both their prime lending rates (PLRs) and spreads. The Reserve Bank initiated the process of deregulation of ceiling rates on export credit in rupee terms in a phased manner to encourage greater competition among banks and to extend such credit at lower rates to exporters with good track records.

2.49 The Liquidity Adjustment Facility (LAF) emerged as the principal operating instrument of monetary policy to adjust liquidity on a day-to-day basis as well as transmit interest rate signals especially through periodic fixed rate auctions during the year. Since the LAF was able to provide an effective cushion to the market and with a view to phasing out sector-specific standing facilities, other windows of liquidity support continued to be gradually withdrawn. The collateralised lending facility (CLF), for instance, was phased out effective October 5, 2002. In case of export credit refinance, which is now the only remaining standing facility, the apportionment of normal (at a rate linked to the Bank Rate) and backstop (at a rate linked to LAF operations or NSE-MIBOR) facilities was changed to one-half each effective November 16, 2002, from the earlier ratio of two-third and one-third.

2.50 The Reserve Bank continued with structural reforms with the objective of widening and deepening the financial markets. Non-bank participants are being gradually phased out of the call/notice money markets which is expected to facilitate the development of other segments, such as the repo market and the term-money market. Besides, with effect from November 16, 2002, banks were required to maintain a minimum of 80 per cent of the required CRR balances on a daily basis as against the earlier requirement of a minimum daily maintenance of 50 per cent of required CRR balances during the first week and 65 per cent during the second week of the reporting fortnight. Subsequently, with effect from December 28, 2002, the required minimum daily CRR balance was brought down to 70 per cent.

2.51 Reserve money increased by 7.5 per cent during 2002-03 (up to March 14, 2003) as compared with 8.8 per cent during the corresponding period of last year, notwithstanding the steady accretion to the Reserve Bank’s foreign currency assets by Rs.75,730 crore (net of revaluation) during 2002-03 so far, as compared with Rs.45,740 crore last year. The net domestic assets (NDA) underwent a compensating decline of Rs.50,534 crore, as the Reserve Bank continued to counterbalance domestic and external sources of monetisation as well as neutralise the liquidity released by CRR cuts (Chart II.22).

2.52 Due to a steady rise in net foreign assets led by capital inflows, the ratio of net foreign assets to currency climbed to 123.3 per cent by March 14, 2003, far in excess of 70 per cent as recommended by the Committee on Capital Account Convertibility (Chairman: S. S. Tarapore) (Chart II.23).

2.53 The Reserve Bank’s subscription to the Centre’s fresh dated securities, at Rs.36,175 crore (at face value, inclusive of Rs.13,000 crore towards pre-payment loans drawn from multi-lateral agencies) during 2002-03 so far, was swamped by net open market sales amounting to Rs.53,772 crore. Reflecting the increased market appetite for government paper in the wake sustained easy liquidity conditions emanating from capital flows and reductions in reserve requirements, the Reserve Bank was, thus, able to more than offset the monetary impact of deficit financing through secondary market operations (Chart II.24).

2.54 The net Reserve Bank credit to the Central Government declined by Rs.24,098 crore as compared with a decline of Rs.936 crore during the corresponding period of 2001-02 (Table 2.12). In view of the market demand for government paper, the Reserve Bank converted annuities in the form of 4.6 per cent special securities of Rs.40,000 crore into marketable securities This enhances the quality of the Reserve Bank’s balance sheet, not only by reducing the non-marketable portion of the public debt but also by valuing central bank assets at market-determined rates. Furthermore, commercial banks and PDs redeemed their refinance drawals in view of CRR cuts.