Rakesh Mohan: State of the Indian economy
Inaugural address by Dr Rakesh Mohan, Deputy Governor of the Reserve Bank of India, at the 2nd
Annual Indian Securities Infrastructure & Operations Forum 2006, Mumbai, 7 November 2006.
* * *
It is my great pleasure to be here at the 2nd Annual Indian Securities Infrastructure & Operations
Forum 2006. The recent growth momentum of the Indian economy is leading to renewed interest in
India's growth prospects. As the mid-year review of the annual policy is just over I thought instead of
giving just a run-down of the current state of the Indian economy let me put the current trends into a
broader perspective - both with respect to the longer term trend and as well as the global scenario.
Thus, I will proceed as follows:
•
In order to draw appropriate perspectives for the future of the Indian economy, I will first
present an overview of India's economic progress over the past three decades.
•
Given the growing integration of the Indian economy with the rest of the world, I will then
discuss the prospects of the global economy.
• This will be followed by an assessment of the current economic situation in India.
•
Finally, I will discuss some of the issues necessary to accelerate the current growth
momentum.
I. Overview of longer-term trends
Growth, savings and investment
Following the initiation of structural reforms in the early 1990s, the Indian economy has grown at an
annual average rate of over 6 per cent per annum. While the 1980s had also witnessed high growth
(5.8 per cent per annum), this growth was associated with widening macroeconomic imbalances -
growing fiscal deficits, growing current account deficits, falling international reserves and higher
inflation - culminating in the balance of payments crisis of 1990-91. In contrast, not only has been
there an acceleration in growth from 5.8 per cent during the 1980s to 6.4 per cent between 1992-93
and 2005-06, it has also been achieved in an environment of macroeconomic and financial stability,
despite large exogenous shocks, both internal and external, over this period (Table 1).
Table 1 : India's Real GDP Growth
Period Average Annual Coefficient
Growth (%) of Variation
1 2 3
1970s 2.9 1.42
1980s 5.8 0.39
1990s 5.8 0.32
2000-2006 6.4 0.32
Memo:
1992-93 to 2005-06 6.4 0.24
More recently, real GDP growth has averaged more than 8 per cent per annum in the three-year
period ended 2005-06. Taking into account the sharp deceleration in population growth over the past
two decades, per capita real GDP growth has recorded a more impressive increase from 3.4 per cent
per annum during the 1980s to around 6.5 per cent per annum in the recent three years.
Developments in the current year so far suggest that the economy is on course to sustain the recent
growth momentum in 2006-07.
The Indian economy is today the world's second fastest growing economy after China. In terms of
purchasing power parity (PPP) GDP, India is the world's fourth largest economy after the US, China
and Japan. India's share in world GDP (PPP basis) has increased from 4.3 per cent in 1991 to almost
6.0 per cent in 2005 (Chart 1).
The step-up in the growth rate of the economy has been facilitated by increase in domestic investment
to over 30 per cent of GDP, financed predominantly by domestic savings. Domestic savings increased
to over 29 per cent of GDP by 2004-05 after some stagnation in the second half of the 1990s. The
improvement in overall savings in recent years has particularly benefited from the turnaround in public
sector savings. After turning negative between 1998-99 and 2002-03 owing to sharp deterioration in
the savings of Government administration, public sector savings have turned positive again from
200304 onwards, mainly reflecting the ongoing fiscal consolidation. In 2004-05, the public sector savings
rate was 2.2 per cent, but it was still less than a half of the peak of almost five per cent touched in
1976-77. Improvement in corporate profitability since 2002-03 has also contributed to increase in
domestic savings in the recent years. Household savings remain the predominant component of
domestic savings, contributing almost three-fourths of overall domestic savings in 2004-05. For the
Indian economy to achieve higher growth on a sustained basis, further improvement in overall savings
is necessary and, in this context, public sector savings will have to play a significant role (Table 2).
Table 2: Domestic Savings in India
(Per cent to GDP)
Period/Year Household Private Public Total
Sector Corporate Sector
Sector
1 2 3 4 5
1970s 12.2 1.6 3.7 17.5
1980s 14.6 1.8 3.0 19.4
1990s 18.5 3.7 1.0 23.2
2000-2005 22.4 4.2 -0.2 26.3
Memo: 22.0 4.8 2.2 29.1
2004-05
Inflation
A notable macroeconomic achievement is in regard to inflation, which has seen a significant fall since
the mid-1990s to an average of around 5 per cent per annum (from around 8 per cent per annum
during the 1970s and 1980s) (Chart 2). The success with inflation management reflects largely
preemptive monetary policy actions, in turn, facilitated by an improved monetary-fiscal interface. The
forces of competition unleashed by growing openness and deregulation of the economy have also
helped to contain the increase in domestic prices. Overall, the success with maintaining price stability
has led to low and stable inflation expectations in the country. As cross-country experience tells us,
inflation expectations play a key role in determining actual inflation movements. The success with
maintaining price and financial stability in India has raised expectations of a structural shift in the
medium-term growth path of the economy. Although inflation in India has indeed been significantly
lower since the mid-1990s compared to the 1970s and 1980s, it needs to be stressed that inflation in
India still remains higher than that of 2-3 per cent prevailing in major advanced economies.
It is interesting to note that inflation in the country in the recent past has remained relatively benign
despite large shocks from record high oil and other commodity prices. The Indian experience in this
context is consistent with the recent experience in other countries; in the current episode of the oil
shock, globally, inflation, has remained relatively modest compared to the kind of increase in inflation
that took place due to the previous oil shocks. This is attributable to a number of factors such as
declining intensity of oil usage, incomplete pass-through in some cases, higher competition and finally
stable inflation expectations in view of pre-emptive monetary policy tightening. These issues are
explored further in the next section.
Industrial growth
A welcome feature of the strengthening of economic activity since 2003-04 has been the resurgence
of manufacturing activity in the country (Charts 3 and 4). After recording high growth in the mid-1990s,
the manufacturing sector exhibited stagnation till 2001-02. Since then, manufacturing has registered a
gradual pick-up and this growth has been sustained in the current year so far. Notwithstanding the
rebound in manufacturing activity, employment growth in manufacturing activity remains low (Table 3).
Table 3: Employment in Industry
(Per cent of total employment)
Country/Year 1980 2000
1 2 3
India 13.9 18.2
Brazil 24.7 19.3
China 18.2 23.0
Indonesia 13.2 17.3
South Korea 29.0 28.0
Malaysia 24.1 32.2
Mexico 26.5 26.9
Thailand 10.3 19.0
Turkey 34.9 24.5
Source: Kalpana Kochhar, Utsav Kumar, Raghuram Rajan, Arvind Subramanian and
Ioannis Tokatlidis (2006), 'India's Pattern of Development: What Happened,
What Follows?', Journal of Monetary Economics, Vol. 53.
Growth in bank credit
The upturn in economic activity is mirrored in the sustained growth in demand for bank credit. Bank
credit has increased sharply from 30 per cent of GDP at end-March 2000 to 48 per cent by end-March
2006 (Chart 5). Non-food credit extended by scheduled commercial banks (SCBs) recorded an
average annual growth of 26.1 per cent between 2002-03 and 2005-06, notably higher than that of
14.5 per cent recorded during the preceding four-year period (1998-99 to 2001-02) as well as the
longrun average of 17.8 per cent (1970-2006). The stagnation in credit flow observed during the late
1990s, in retrospect, was partly caused by reduction in demand on account of increase in real interest
rates, turn down in the business cycle, and the significant business restructuring that occurred during
that period. Apart from the revival of economic activity, the sharp growth in bank credit in the recent
years can be attributed to factors such as financial deepening from a low base, structural shifts in
supply elasticities, rising efficiency of credit markets and policy initiatives to improve flow of credit to
sectors like the agriculture and small scale units. Increasingly, retail credit led by demand for housing
as well as other retail loans is emerging as a major driver of growth in bank credit. This is reflected in
the sharp increase in the share of housing credit in overall credit extended by SCBs from 2.4 per cent
at end-March 1990 to 11.0 per cent at end-March 2005. Growth in retail credit has also emanated from
increased use of credit cards, loans for consumer durables and demand for education loans. The
share of non-housing retail credit in total bank credit has increased from four per cent at end-March
1990 to around 11 per cent at end-March 2005. Thus, the share of total retail credit in bank credit has
increased from 6.4 per cent to over 22 per cent in the past 15 years (Chart 6). As a result of these
trends, the share of industry in total credit has been falling since the late 1990s (Chart 7).
External sector
The external sector has witnessed dramatic transformation over the past 15 years. There is growing
integration of the Indian economy with the rest of the world. In contrast to the constant stress
experienced with respect to the external sector during the period till the early 1990s, the balance of
payments position since then has remained comfortable. A summary indicator of the strength of the
external sector is provided by India's foreign currency assets which are now close to US $ 160 billion
(as on October 27, 2006) in contrast to a mere US $ 1 billion in June 1991. This significant
improvement can be attributed to the combination of policies related to the external sector such as
reduction in tariff and non-tariff barriers, current account convertibility, prudential approach to capital
account liberalisation, preference for foreign investment flows, especially direct investment flows,
constraints imposed on debt flows and a market-determined exchange rate system. These policies
have enhanced access to external markets while promoting productivity gains and ensuring financial
stability. This is mirrored in strong growth in merchandise exports and, more strikingly, growth in
exports of services and remittances. As a result, the country has been able to finance its increasing
import demand while keeping current account deficits quite modest - an average of only 0.5 per cent
of GDP since 1991-92 as against a deficit of 1.8 per cent of GDP during the 1980s (Charts 8 and 9).
The growth in services receipts has been led by the significant expansion in software exports, and
other professional and business services. Reflecting the sustained growth since the early 1990s, gross
invisible receipts (i.e., services, transfers and income taken together) have expanded sharply from 2.4
per cent of GDP in 1990-91 to 11.5 per cent in 2005-06, outpacing the growth in merchandise exports
(which increased from 5.8 per cent of GDP to 13.1 per cent over the same period). This has led to a
rise in the share of invisibles in the current receipts (exports and invisibles combined) from 29 per cent
in 1990-91 to 47 per cent in 2005-06 (Table 4). As a result, the ratio of current receipts to GDP has
nearly trebled from 8.2 per cent in 1990-91 to 24.5 per cent in 2005-06. Reflecting the continued
buoyancy of India's services exports, the share of India's services exports in world exports has trebled
in the course of just a decade - from 0.6 per cent in 1995 to 1.8 per cent in 2004 (Chart 10). India was
the 18th largest service exporter in the world in 2004. The gains recorded by the exports of services
have far exceeded those recorded by exports of goods.
Table 4: India's Invisible Receipts
(US $ billion)
Year Services Transfers Income Invisibles Receipts/
Current Receipts
(per cent)
1 2 3 4 5
1990-91 4.6 2.5 0.4 29
1995-96 7.3 8.9 1.4 35
2000-01 16.3 13.3 2.7 42
2001-02 17.1 16.2 3.4 45
2002-03 20.8 17.6 3.5 44
2003-04 26.9 22.7 3.9 45
2004-05 46.0 21.3 4.5 47
2005-06 60.6 25.2 5.7 47
Foreign investment has increased from negligible levels till the early 1990s to 2.5 per cent of GDP by
2005-06 (Chart 11). Both direct and portfolio investment flows have recorded significant increases,
although the inflows under direct investment remain relatively low compared to other recipient
countries. The volume of FDI inflows into India is, however, growing on the back of growing interest by
many of the world's leading multinationals. India has improved its rank from fifteenth (in 2002) to
become the second most likely FDI destination after China in 2005. Net capital flows received by India
amounted to US $ 25 billion in 2005-06; gross capital inflows and outflows were much higher at US $
139 billion and US $ 115 billion, respectively, pointing towards growing openness and integration of
the Indian economy with the global economy. Consequently, global economic developments are likely
to have more pronounced effects on the Indian economy than hitherto. Policies that take advantage of
the growing openness while minimising the adverse consequences have been followed since early
1990s and these have served the country well so far. Indeed, not only is India a recipient of FDI
inflows, but Indian companies are also increasingly investing abroad to take advantage of
opportunities available in the global market. Outward FDI investment was as high as US $ 2.7 billion in
2005-06 and cumulative FDI investment abroad is estimated at US $ 12 billion at end-March 2006.
Public finance
Public finances have exhibited a mixed trend in the reforms period. After witnessing some correction
till 1996-97, public finances witnessed a deterioration, reflecting a variety of factors such as the decline
in tax revenues (as per cent to GDP) in consonance with the cyclical downturn of economic activity, as
well as the effects of the 5th Pay Commission award. Indeed, the combined fiscal deficit of the Centre
and States was higher in 2001-02 than that in 1990-91 (Chart 12). Since 2002-03 onwards, public
finances have witnessed a significant improvement, reflecting both policy efforts at fiscal consolidation
as well as the upturn in economic activity. Notwithstanding this recent correction, combined public debt
remains high (almost 79 per cent of GDP). Furthermore, capital expenditure remains low (Table 5) and
the tax-GDP ratio, despite recent improvement, also remains low (Table 6 and Chart 13).
Table 5: Central Government's Expenditure
(Per cent to GDP)
Year Revenue Expenditure Capital Outlay
1 2 3
1970-71 6.9 2.1
1980-81 10.0 2.1
1990-91 12.9 2.1
1995-96 11.8 1.2
2000-01 13.2 1.2
2005-06 RE 12.5 1.6
2006-07 BE 12.4 1.7
Table 6: Gross Tax Revenues of the Centre
(Per cent to GDP)
Year Direct Tax Indirect Tax Total
1 2 3 4
1990-91 1.9 8.2 10.1
1991-92 2.3 8 10.3
1992-93 2.4 7.5 10
1993-94 2.4 6.5 8.8
1994-95 2.7 6.5 9.1
1995-96 2.8 6.5 9.4
1996-97 2.8 6.6 9.4
1997-98 3.2 6.0 9.1
1998-99 2.7 5.6 8.3
1999-2000 3.0 5.8 8.8
2000-01 3.2 5.7 8.9
2001-02 3.0 5.2 8.2
2002-03 3.4 5.4 8.8
2003-04 3.8 5.4 9.2
2004-05 4.2 5.5 9.8
2005-06 (RE) 4.8 5.7 10.5
2006-07 (BE) 5.3 5.9 11.2
RE : Revised Estimates. BE: Budget Estimates.
Financial sector
The financial system in India, through a measured, gradual, cautious, and steady process, has
undergone substantial transformation. It has been transformed into a reasonably sophisticated,
diverse and resilient system through well-sequenced and coordinated policy measures aimed at
making the Indian financial sector more competitive, efficient, and stable. It is noteworthy that despite
a series of exogenous shocks such as the Asian crisis, sanctions due to nuclear explosions, the sharp
rise in oil prices to record highs, large corrections in stock markets, financial stability has been
maintained. The asset quality of the banking sector has recorded a significant improvement: the ratio
of net non-performing assets to net advances has declined from 8.1 per cent at end-March 1997 to 2.0
per cent at end-March 2006 despite tightening of prudential norms. There is growing competition in the
banking sector, as indicated by the rising share of private sector banks in total banking assets. The
overall capital adequacy ratio of the banking sector as a whole has increased from 10.4 per at
endMarch 1997 to 12.8 per cent at end-March 2006. Operating expenses of scheduled commercial banks
have declined from 2.1 per cent of total assets in 1992 to 1.8 per cent in 2004 indicative of
improvements in efficiency. Intermediation cost of banks has declined from 2.9 per cent in 1995-96 to
2.1 per cent by 2005-06. The financial system is now robust and resilient, and is enabling accelerated
economic growth in an environment of stability (Charts 14-17).
BIS Review 106/2006
II. World economic situation
As noted earlier, the openness of the Indian economy has nearly trebled between 1990-91 and
200506. The Indian economy is thus now much more intertwined with the global economy. In order to
assess the prospects for the domestic economy, it would, therefore, be relevant to review the
prospects of the global economy.
According to the latest assessment of the IMF in its World Economic Outlook (September 2006), the
global economy (using exchange rates based on purchasing power parities) is expected to record an
accelerated growth of 5.1 per cent in 2006, higher than that of 4.9 per cent in 2005. This is the fourth
successive year of strong, above trend, growth despite continuous headwinds form record high oil
prices and elevated non-commodity prices. Global growth is expected to average 4.9 per cent per
annum between 2003 and 2006, significantly higher than growth of 3.9 per cent registered between
1996 and 2000 and 2.8 per cent between 1991 and 1995. Headwinds from higher commodity prices
have been offset by productivity gains across the world, in both developed and emerging economies,
emanating from forces of globalisation, the ICT revolution, creation of global supply chains, greater
efficiency in financial markets and better macroeconomic policies. Global growth has been led by the
US and emerging economies led by China and India. A positive feature is that global economic activity
is now becoming more balanced, with the euro area gaining momentum, along with sustained
expansion in Japan. Economic activity in the US, on the other hand, is slowing down mainly on the
back of a cooling housing market. Global economic growth is expected to maintain its recent
abovetrend growth in 2007; the IMF projects growth to be 4.9 per cent in 2007 (in PPP terms) (Charts 18
and 19). Concomitantly, growth in world trade has remained buoyant. World trade in goods and
services in volume terms has increased by an average of 9 per cent per annum during 2004 and 2005
and is expected to grow by another 9 per cent in 2006.
While global growth has remained strong, it faces a number of downside risks. One such risk
emanates from high oil prices and commodity inflation. Globally, inflation has edged up reflecting
higher oil and other commodity prices, but surprisingly, the impact has remained relatively muted
compared to previous oil shocks. It is also worth stressing that since 2003 onwards, real interest rates
are at very low levels in many countries and monetary and credit aggregates have been recording
above trend growth. Yet, consumer price inflation has been relatively benign, even in the face of
sharply higher oil and other commodity prices (Charts 20 and 21). This phenomenon has been aptly
described as the "Great Liquidity Expansion Puzzle".
A number of factors explain as to why consumer price inflation has remained relatively modest despite
higher oil and other commodity prices and abundant liquidity. Lower trade barriers, increased
deregulation, innovation and competition and efficiency gains arising from global supply chains all over
the world helped in containing inflationary pressures. With the rapid expansion in tradables, domestic
economies are, therefore, increasingly exposed to the rigours of international competition and
comparative advantage, reducing unwarranted price mark-ups. Productivity growth in a number of
sectors, partly due to IT investments combined with restructuring, has also enabled absorption of
higher costs. Fall in intensity of oil usage, and, in case of many emerging market economies,
lessthan-complete pass-through of oil prices have also helped to contain headline inflation. Finally,
changes in the conduct of monetary policy frameworks such as inflation targeting regimes with greater
focus on price stability and increased central bank credibility have contributed to keeping inflationary
expectations largely stable and anchored at low levels.
Nonetheless, the cumulative impact of the past increases in oil and other commodity prices has led to
headline inflation in many economies marginally exceeding their respective targets. Central banks
have, therefore, been tightening their monetary policies to stabilise inflation expectations, especially
since demand conditions have been strong and output gaps are closing in most of the economies
(Chart 22). While the Federal Reserve in the US has paused since end-June 2006 after 17 successive
hikes of 25 basis points each between June 2004 and June 2006, it has indicated that further
tightening would depend upon the incoming information. The European Central Bank is anticipated to
continue to tighten further, despite a pause in its latest meeting. Thus, global interest rates, which had
eased significantly during 2002-2003, are likely to remain relatively higher in the short-term. Although
in recent weeks, international crude oil prices have eased substantially to below US $ 60 a barrel, they
still remain quite high and furthermore, the outlook remains uncertain. Moreover, although headline
inflation in major advanced economies has indeed exhibited significant moderation during September
2006, core inflation continues to remain firm.
In brief, globally, both output growth and consumer price inflation are relatively more stable despite a
series of supply shocks. On the other hand, commodity prices, exchange rates and other asset prices
have exhibited heightened volatility. When inflation and interest rates are low, as is the case now,
small changes in inflation expectations or interest rate expectations can lead to repricing of risks which
can be quite large. In turn, this repricing of risks can lead to elevated volatility in asset prices, as was
witnessed during May-June 2006.
III. Current economic situation: India
Against this backdrop of external outlook, it would be useful to have an assessment of the Indian
economy for 2006-07, based on developments during 2006-07 so far. A review of the developments
suggests that the Indian economy is on its way of achieving growth close to that witnessed during the
past three years (Table 7).
Table 7 : India's Real GDP Growth
(Per cent)
Sector Full Year April-June
(Base: 1999-2000)
2004-05 2005-06 2005 2006
200304 (QE) (RE)
1 2 3 4 5 6 7
1 Agriculture and Allied Activities 10.0 0.7 3.9 3.4 3.4
2 Industry 6.6 7.4 7.6 9.5 9.7
2.1 Mining and Quarrying 5.3 5.8 0.9 3.1 3.4
2.2 Manufacturing 7.1 8.1 9.0 10.7 11.3
2.3 Electricity, Gas and Water Supply 4.8 4.3 5.3 7.4 5.4
3 Services 8.5 10.2 10.3 10.1 10.5
3.1 Construction 10.9 12.5 12.1 12.4 9.5
3.2 Trade, Hotels and Restaurants, Transport, Storage 12.0 10.6 11.5 11.7 13.2
and Communication
3.3 Financing, Insurance, Real Estate and Business 4.5 9.2 9.7 8.8 8.9
Services
3.4 Community, Social and Personal Services 5.4 9.2 7.8 7.3 9.5
4 Gross Domestic Product 8.5 7.5 8.4 8.5 8.9
Agriculture
Assuming trend growth in agriculture under normal monsoon conditions and barring domestic or
external shocks, the Reserve Bank in its Annual Policy Statement for 2006-07 (April 2006) placed real
GDP growth, for policy purposes, in the range of 7.5-8.0 per cent during 2006-07. The Reserve Bank
reaffirmed its forecast for GDP growth in July 2006 in its First Quarter Review of the Annual Statement
on Monetary Policy. The Reserve Bank revised upwards its forecast for GDP growth to around 8.0 per
cent in October 2006 in its Mid-Term Review on the back of improvement in industrial outlook and
expected sustenance of growth momentum in services. Other agencies have also placed their growth
estimates close to 8 per cent.
Industry and infrastructure
Led by manufacturing, the upturn in the industrial sector is entering its fifth year of expansion in
200607. Manufacturing activity has remained stronger than expected in the current fiscal year so far. Based
on movements in the index of industrial production (IIP), growth in manufacturing activity accelerated
to 11.8 per cent during April-August 2006 from 9.6 per cent in the corresponding period of 2005. In
terms of use-based classification, all sectors, excepting consumer non-durables have exhibited
acceleration. Notably, growth in capital goods production accelerated to nearly 19 per cent, even on a
high base, reflective of strong investment activity in the economy (Table 8).
Table 8: Index of Industrial Production
Sector Weights in IIP Growth Rate (Per cent)
April-March April-August
2004-05 2005-06 2005 2006
1 2 3 4 5 6
IIP 100.0 8.4 8.1 8.7 10.6
Basic Goods 35.6 5.5 6.6 6.9 8.3
Capital Goods 9.3 13.9 15.8 13.8 18.6
Intermediate Goods 26.5 6.1 2.4 3.5 9.5
Consumer Goods 28.7 11.7 12.0 13.7 11.3
i) Consumer Durables 5.4 14.4 14.9 13.0 16.6
ii) Consumer Non-Durables 23.3 10.8 11.1 13.9 9.5
On the other hand, the six infrastructure industries have recorded only modest improvement to 7.3 per
cent during April-September 2006 from 6.1 per cent in the corresponding period of 2005. This
improvement was helped by a turnaround in the production of crude oil and petroleum refinery
products - these two sectors had registered negative growth a year ago. Electricity generation, coal,
and oil production, however, remained subdued (Table 9).
Table 9 : Infrastructure Activity
Weight in IIP Growth in
(per cent) per cent (y-o-y)
April-March April-September
Sector 2004-05 2005-06 2005 2006
1 2 3 4 5 6
Electricity 10.2 5.2 4.9 4.7 6.7
Coal 3.2 6.2 7.0 6.0 5.3
Finished Steel 5.1 8.4 8.0 13.7 7.2
Cement 2.0 6.6 12.3 11.4 10.0
Crude Petroleum 4.2 1.8 -5.3 -5.0 4.1
Petroleum Refinery Products 2.0 4.3 2.1 -0.7 12.3
Composite Infrastructure Index 26.7 5.8 5.3 6.1 7.3
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. There is evidence of growing competitiveness in respect
of sectors such as automobiles and pharmaceuticals, with potential to emerge as a manufacturing
base for global production. At the same time, in the face of challenges from infrastructural bottlenecks,
elevated input costs from higher oil and other commodity prices, likely imports from China and the
possibility of emerging shortages of domestic skilled labour, the domestic manufacturing sector will
have to continuously improve its productivity and competitiveness in order to sustain the current
growth momentum.
Corporate profitability
In recent years, a striking feature of the Indian corporate sector is its growing engagement with the
global economy. Apart from merchandise trade in goods and services, this growing integration has
taken the form of large scale cross-border merger and acquisition activities. Thus, not only India is a
recipient of foreign direct investment, but the corporate sector is also exploring opportunities to invest
abroad. Following the phased liberalisation in the regime for Indian investments overseas, investments
in joint ventures (JV) and wholly owned subsidiaries (WOS) abroad have emerged as important
avenues for promoting global business by Indian companies. Indian firms are acquiring firms abroad to
leverage comparative advantage of foreign locations, to acquire appropriate technologies and to have
a marketing and distribution base with the ultimate objective of attaining economies of scale and
productivity gains. As noted earlier, India's direct investment overseas amounted to US $ 2.7 billion
during the year (Chart 23). The value of acquisitions is, however, much higher since these data only
capture the cross-border remittance of outward FDI from India. The number of Indian companies listed
on stock exchanges abroad has seen a consistent increase. The growing integration of the Indian
corporate sector is also visible from the trends in their exports and imports. The ratio of merchandise
exports to sales trebled from 6.2 per cent in 1990-91 to 18.6 per cent by 2004-05 while the ratio of
imports to sales has increased from 7.9 per cent to 21.6 per cent over the same period (Chart 24).
Corporate profitability has recorded strong growth for over three years now. Profits after tax of a
sample non-financial non-Government companies recorded a growth of more than 40 per cent for 11
successive quarters from October-December 2002 to April-June 2005. Subsequently, growth in
profitability decelerated over the next three quarters of 2005-06 on the back of rising input costs as
well as higher debt servicing costs. Available information for 2006-07 suggests a reversal of the
deceleration trend; growth in profits after tax accelerated to 35 per cent during April-June 2006 from
around 15 per cent in the preceding quarter (Table 10). It is interesting that corporate profitability has
remained strong, despite sharp rise in input costs. Perhaps, the strong profitability can be partly
attributed to productivity gains. Looking ahead, a critical question is: how long can corporate
profitability and productivity continue to exhibit buoyancy?
Table 10: Corporate Sector Performance
(Growth rates, per cent)
Item 2003-04 2004-05 2005-06 2005-06 2006-07
Q1 Q2 Q3 Q4 Q1
1 2 3 4 9 10 11 12 13
Sales 16 24.1 16.9 18.5 16.4 13.2 19.5 25.6
Expenditure 13.2 21.9 16.4 18 16.3 12.7 18.9 24.6
Gross Profit 25 32.5 20.3 32 19.1 21.2 16.6 33.9
Interest Cost -11.9 -5.8 1.9 -13.5 -8 4.6 3.8 19.9
Profit After Tax 59.8 51.2 24.2 54.2 27.5 27 15.1 34.7
Note : 1. Growth rates are percentage change in the level for the period under reference over the corresponding period of the
previous year.
2. Data are based on the audited / unaudited abridged results of the non-financial non-Government companies except column
(2) and column (3) which are based on audited balance sheets for 2003-04 and 2004-05, respectively.
*: Provisional.
Recovery in domestic stock markets, buoyant corporate performance and business confidence all
suggest that investment climate remains upbeat and this should support economic activity. There has
been a large increase in investment intentions: the value of investment intentions registered in
Industrial Entrepreneurs Memoranda have more than doubled from Rs.1,54,954 crore in 2003-04 to
Rs. 3,82,743 crore in 2005-06. However, it remains to be seen as to how much of these investments
fructify? Issues of financing of investments will also assume importance in this context as these
investment intentions move towards fructification.
Banking developments
Bank deposits as well as credit have recorded strong growth during the fiscal year 2006-07 indicative
of strong demand conditions. Bank credit has continued to record year-on-year growth of over 30 per
cent for more than a year. Bank credit has been largely broad-based, although some of the sectors
such as housing and other retail and commercial real estate have expanded more rapidly. In this
context, it would be relevant to note that the credit-GDP ratio in India - notwithstanding the sharp rise
since 2000 - remains lower than in many Asian economies as well as in advanced economies. Deposit
growth has accelerated, which could be attributed partly to higher interest rates on time deposits as
well as extension of tax benefits for deposits above 5-year maturity. Concomitantly, growth in broad
money (M3), y-o-y, at 19.0 per cent as on October 13,