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Recent Macroeconomic Developments in India

There are several noteworthy features of India's recent macroeconomic performance. First, the investment climate has improved and industrial and service sector activity has picked up. Second, buoyant exports have emerged as the driver of demand for a broad spectrum of industries. Third, there has been a modest attempt at and a commitment to achieve fiscal consolidation. Fourth, the trend inflation has declined over the years and inflation expectations stabilised. Fifth, India has been successful in managing liquidity against the backdrop of continuing capital flows. Sixth, India has emerged as a preferred destination for foreign investors and received about a quarter of the global portfolio flows to the EMEs in 2004. Seventh, India's foreign exchange reserves are in excess of the total outstanding external debt of the country. Eighth, the performance of the corporate sector has improved and some corporates are now listed on the international stock exchanges. Ninth, India's financial markets have deepened, widened and become vibrant over the years with a robust institutional framework and market infrastructure in place. Tenth, the profitability and soundness indicators of the banking sector have improved.

Finally, India has been adopting international benchmarks for financial standards and best practices with suitable adaptations for Indian conditions.

The Indian economy today is characterised by an environment of confidence, positive business expectations, a renewal of rule-based fiscal consolidation, stable and orderly financial markets and institutions and progressive integration with the global economy. Real GDP growth for 2005-06 (April-March) has been conservatively projected at around 7.0 per cent, and more recently, revised upwards to a range of 7.0 to 7.5 per cent. Despite the sustained strength of export performance, the merchandise trade deficit is expected to be somewhat higher in 2005-06 than in the previous year, mainly on account of substantially higher oil prices and non-oil import demand for investment.

For the year as a whole, while invisibles may finance a large part of the enlarged trade deficit, the current account deficit is expected to widen during 2005-06 but to remain within acceptable limits that can be financed by normal capital flows. The headline inflation is expected to lie in the range of 5.0-5.5 per cent.
Consolidation of Central Government finances is the goal of fiscal policy at the Centre - the targets are: the gross fiscal deficit (GFD) of 3.0 per cent of GDP and the elimination of the revenue deficit by 2008-09. The fiscal position of State Governments also continues to undergo slight correction in terms of key deficit indicators.

Against this background, it may be useful to analyse the implications of global financial imbalances for India in terms of the likely impact on four separate balance sheets - of the government, of the Reserve Bank of India, of the corporate sector and of the banking sector.

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