2.1 The Indian economy continued to exhibit strong growth during 2004-05 with a noticeable improvement in macroeconomic fundamentals. Industrial growth gathered momentum, led by the manufacturing sector. A noteworthy aspect is the momentum gained in the growth of the capital goods sector signalling building up of capacity which should augur well for future growth prospects. Merchandise export growth has been quite robust, indicative of the growing global competitiveness of the Indian economy. Corporate results continue to be good and various business expectation surveys point to a reasonable optimism regarding growth. Non-food credit has recorded a strong and a fairly broad-based growth, indicative of a revival in the investment activity. Services sector continued its high growth path. An encouraging sign within the favourable macroeconomic environment is the incipient improvement in the Government finances. Notwithstanding the setback emanating from a less than satisfactory South-West monsoon, the Indian economy is poised for strong growth during the fiscal 2004-05 and is expected to remain one of the fastest growing economies in the world.

2.2 Although there has been an increase in the headline inflation in recent months, it is largely supply induced, driven mainly by external factors. More recently, the pressure of high international oil prices seems to have eased somewhat, although the problem of overhang of liquidity remains. Despite a large order of increase in oil imports, the balance of payments position remained comfortable. The current account is expected to remain in surplus for the fourth consecutive year enabled by continued strong inflows from private remittances. Capital flows remained buoyant, reflecting mainly foreign investors' growing confidence in the Indian economy. Foreign exchange reserves recorded a substantial increase on top of last year's record accretion. Financial markets have generally exhibited orderly conditions, notwithstanding some hardening of yields across the spectrum.

2.3 Against this brief overview, this Chapter provides an analytical account of macroeconomic developments during 2004-05 so far. Section I covers the developments in the real sector while Section II covers the Central and State Governments finances. Section III dwells on monetar y and credit developments and the behaviour of inflation. Developments in the financial markets and the external sector are discussed in Sections IV and V, respectively. Concluding observations are presented in Section VI.

2.4 The Indian economy recorded a strong growth performance during 2003-04. The recovery in agriculture from the previous year's drought was the main driver of the overall growth of the economy. This was supported by simultaneous and well-distributed firming-up of activity in industry and services. Industrial production benefited from buoyant external demand. Accordingly, the real GDP growth accelerated to 8.2 per cent during 2003-04 from 4.0 per cent in 2002-03. The growth in the industrial sector was led by manufacturing and 'electricity, gas and water supply'. The services sector also experienced an acceleration in growth rate mainly driven by the sub-sectors, namely, 'trade, hotels, transpor t and communication' and 'community, social and personal services' (Table 2.1 and Chart II.1).

2.5 The Indian economy entered the fiscal year 2004-05 on an optimistic note. The India Meteorological Department (IMD) forecasted a normal South-West monsoon during the year. The SouthWest monsoon had in fact set in ahead of schedule. Based on the assumption of a normal monsoon, sustained growth of the industrial sector and good performance of exports, the Reserve Bank (RBI) had, in its Annual Policy Statement for the year 2004-05 (May 2004), projected a real Gross Domestic Product (GDP) growth rate of 6.5 to 7.0 per cent. A number of other institutions also projected growth rates close to this range. However, the erratic behaviour of the South-West monsoon (temporally as well as spatially) and the uncertain global oil price movements prompted most of these institutions to revise downward their growth forecasts over the course of the year. The Reserve Bank, in its Mid-Term Review of Annual Policy Statement (October 2004), also revised downward its projection of the economy's growth rate to 6.0 to 6.5 per cent (Table 2.2).

2.6 Notwithstanding this downward revision, as noted before, India will continue to be one of the fastest growing economies among the major emerging market economies during 2004-05 (Table 2.3).

2.7 Real GDP growth at 7.4 per cent in the first quarter of 2004-05 was along expected lines. The growth was driven by the buoyancy in industry and services. The prime movers were manufacturing, 'trade, hotels, transport and communication' and 'community, social and personal services' (Table 2.4).

2.8 The savings rate improved marginally to 24.2 per cent in 2002-03 although it still remains below the peak of 25.1 per cent achieved in 1995-96, a year coterminous with the phase of high growth in the Indian economy (Table 2.5 and Chart II.2). The improvement in savings rate during 2002-03 was entirely due to the reduced public sector dis-savings, reflecting improved Government finances. There was a marginal decline in the household financial savings

rate primarily on account of a sharp decline in deposits with non-banking companies. The savings rate of the private corporate sector continued its declining trend.

2.9 There was also an improvement in the investment rate in 2002-03, mainly due to an increase in the household sector investment (Chart II.3). The increase in the investment rate, however, was lower than that in the savings rate. Consequently, the overall saving-investment surplus increased further during 2002-03 and this was mirrored in the current account surplus of the balance of payments. The surplus of the private corporate sector continued to finance the resource gap of the public sector, although the resource gap of public sector declined marginally during the year (Table 2.6).

2.10 Prospects for agriculture were bright in the beginning of the year in view of an optimistic forecast of a normal South-West monsoon by the IMD coupled with an ahead-of-schedule onset of the South-West monsoon. Thereafter, however, the monsoon was erratic with prolonged weakness/break over different parts of the country during late June, most of July (the main sowing month), late August and early September. The impact of deficient rainfall was acute during June 1 to July 28, 2004, when the deviation of the actual from the normal turned out to be 15 per cent. There was, however, a turnaround in rainfall during August and to some extent in September 2004. This provided respite from the moisture stress for late sown crops, besides replenishing the reservoirs.

2.11 The spatial distribution of rainfall during the South-West monsoon was uneven with 23 out of 36 meteorological sub-divisions recording normal rainfall and 13 receiving deficient/scanty rainfall. While none of the sub-divisions experienced severe drought conditions (wherein the seasonal rainfall deficiency exceeds 50 per cent), Himachal Pradesh, West Uttar Pradesh, Punjab, West Rajasthan, Vidarbha and Telengana experienced moderate drought conditions (with the seasonal rainfall deficiency between 25 and 50 per cent). Among the broad regions, North-West India was the worst affected with a seasonal rainfall deficiency of 22 per cent. Seasonal rainfall deficiency in Central India, North-East India and South Peninsula was 11 per cent, 6 per cent and 15 per cent, respectively. Of the 524 meteorological districts, 25 per cent of the districts experienced moderate drought, while 7 per cent of the districts experienced severe drought conditions during the season.

2.12 The cumulative area-weighted rainfall during the South-West monsoon (June 1 to September 30, 2004) was 13 per cent below the Long Period Average (LPA) as compared with two per cent above the LPA during the last season. However, as the total area of the sub-divisions experiencing drought conditions was only 18 per cent, the year was not declared as an all-India drought year. This is also evident from the fact that the number of sub-divisions experiencing deficient/scanty rainfall during the South-West monsoon 2004 was 13 as compared with 21 during 2002, which was declared as a drought year. A positive development has been the satisfactory progress of the North-East monsoon so far (Table 2.7).

2.13 The crop production prospects during the kharif season, as a consequence, have been somewhat subdued. Given the fact that there is little scope for increasing the area under crops and any increase in production has to come through only by way of increasing the productivity levels, strategies were drawn for kharif 2004. These included: promotion of cropping system approach for augmenting the productivity of field crops as a whole as against the individual crop approach; ensuring timely pre-positioning of inputs like seeds, fertilisers, pesticides and improved implements in adequate quantities; adoption of timely and adequate weed control measures; and encouraging the cultivation of pulses and oilseeds as inter-crop in rainfed farming systems.

2.14 According to the First Advance Estimates of the Ministry of Agriculture (September 18, 2004), the production of foodgrains during kharif 2004-05 is placed at 100.3 million tonnes, a decline of around 10 per cent over that achieved in the preceding year. This decline is mainly due to the slippage in the production of coarse cereals. Among non-foodgrains, while the production of sugarcane and cotton is expected to remain closer to the previous year's level, the output of oilseeds is likely to receive a setback (Table 2.8).

2.15 The revival of the South-West monsoon towards the end of the season and the satisfactory progress of the North-East monsoon together with a rabi strategy announced by the Government are expected to lead to a recovery in rabi production. The total live water storage as on December 10, 2004 in the 71 major reservoirs¹ was 54 per cent of the Full Reservoir Level (FRL), higher than that in the corresponding period of preceding year. This is expected to recoup the losses in kharif production to some extent (Table 2.9). Incidentally, the contribution of kharif crops in the overall production has been coming down in the recent years. The Ministry of Agriculture has set the target for foodgrains production during the rabi 2004-05 at 111.3 million tonnes. A series of measures have been announced to increase rabi production, which include: launching of a nation-wide campaign to provide seeds of new varieties of crops, other inputs, and timely information so that farmers are able to make best use of moisture present in the soil; crop-specific strategies with a renewed emphasis on ensuring timely and adequate availability of inputs; propagation of soil ameliorants; promotion of water saving devices; promotion of zero-till seed drills, seed-cum-fertiliser drills, strip drills and raised bed planter in rice-wheat cropping system; promotion of integrated weed, pest, and disease management system; monitoring the progress of States in their work plans under Macro-Management Scheme; and promotion of Technology Missions on various crops. Reinvigorating the flow of credit to agriculture continues to be an important constituent of the overall strategy to

augment the agricultural production. The initiatives in this direction included: announcing a package to double the flow of credit to agriculture; advising the States to closely monitor credit disbursements and the progress of the recently announced debt-restructuring package; deputing teams to States to take stock of availability of inputs including credit distribution; rewarding the States achieving the targets with additional plan outlay; and, honouring the officials showing good results with cash and office facilities. Furthermore, States were advised to enhance the coverage under Kisan Credit Card (KCC) Scheme, besides allowing them to expand the scope of KCC to include the component of consumption credit and term loans for investment purposes in agriculture and allied activities.

2.16 The procurement of foodgrains (mainly rice, wheat and some coarse cereals) during 2004-05 (upto end-November 2004) was higher by around three million tonnes over the comparable period of the previous year. The off-take during April-September 2004, however, was lower by eight million tonnes over the preceding year. The decline was mainly due to a sharp fall in the off-take under Open Market Sales (OMS) which could be attributed to the comfortable supply situation in different parts of the country. Although the total stocks of foodgrains with the Food Corporation of India and other Government agencies as on October 1, 2004 were lower than the previous year, they continued to be higher than the buffer stock norms (Table 2.10).

2.17 Industrial growth has strengthened further during 2004-05 so far (up to October 2004) (Chart II.4 and Table 2.11). The growth was led by all the three sectors, namely manufacturing, mining and electricity. The electricity sector showed an impressive growth mainly due to higher generation in thermal and hydro power plants on the back of higher demand emanating both from agriculture and industrial sectors. Higher growth in mining was largely contributed by the coal sector, which, in turn, was due to higher demand from the industrial sector and lesser interruption in mining activities during the monsoon.

2.18 During April-October 2004, 14 manufacturing industry groups (according to 2-digit level classification) recorded positive growth (Table 2.12). Notably, two industries, machinery and equipment, and chemicals and chemical products, constituting around 24 per cent of weight in the Index of Industrial Production (IIP) recorded more than 17 per cent growth up to October 2004.

2.19 In terms of the use-based classification, all sectors, viz., basic, capital, intermediate and consumer goods registered higher growth during April-October 2004 as compared with the corresponding period of the previous year. However, consumer non-durables sector slowed down due to a decline in production mainly of food products and some industries in the basic chemicals and chemical products sector. On the other hand, consumer durables sector exhibited strong performance on account of increased demand both from rural and urban segments enabled by a significant increase in the retail credit. The improved growth performance of intermediate goods sector can be attributed to the surge in imports and higher capacity utilisation. The performance of the basic goods sector improved