Mumbai: The Annual Report of the Reserve Bank of India for the year 2001-02 was released on August 30, 2002. The Report presents the Annual Accounts of the Reserve Bank and its working and operations for the year ended June 30, 2002. The Report also presents a review of the Indian economy during 2001-02 and prospects for the near- and medium-term.

In the year 2001-02, India was among the strongest growing economies in the world, notwithstanding an international environment bound down by the synchronised weakness affecting large parts of the global economy. Agriculture performance was robust with the stock of foodgrains crossing 63 million tonnes. With the posting of a modest current account surplus after 24 years and the continuing strength of the capital flows, Indias foreign exchange reserves rose to US $ 60.6 billion, placing India among the top reserve holding emerging market economies. Monetary and financial conditions remained stable in 2001-02 as well as in the first few months of the current year. There was a distinct easing of inflationary pressures.

The macroeconomic prospects for the current year 2002-03 are mixed. On the one hand, financial, liquidity and inflationary conditions and the external sector are highly favourable for higher growth. On the other hand, the agricultural outlook is sombre with likelihood of widespread drought. This may also adversely affect the incipient industrial recovery. On balance, there is a strong possibility that the growth rate of 6.0 to 6.5 per cent projected in the Annual Monetary and Credit Policy Statement (April 2002), which was based on the assumption of a normal monsoon, will not be realised. A re-assessment of the projected growth rate for the current year will be attempted in the mid-term review of the Monetary and Credit Policy in October 2002, by which time reliable information regarding the effects of drought on the agricultural and industrial output will be available.

The monetary and credit policy for 2002-03 has been reinforced by favourable developments in the form of low inflation, ample liquidity in financial markets, continuing capital inflows and a substantial build up of foreign exchange reserves. The policy stance continues to ensure that all legitimate requirements of credit are met consistent with price stability, with the outlook biased towards a soft and a more flexible interest rate structure in the medium term. Monetary policy has been imbued with a flexible approach and markets are being prepared for shifts in stance if a change in circumstances warrant a tightening.

Considerable progress has been achieved in financial sector reforms in India in terms of setting out the objectives, the framework and the timetable. Indias position on international standards and codes in respect of the financial sector has been placed in the public domain. Expert assessment, both internal and external, of the applicability of these worlds best practices to the specifics of the Indian situation has also been undertaken to enable an unbiased public assessment of the announced resolve to converge to international norms, with the speed and content modulated to the country-specific case. The focus of financial sector reforms is now on the implementation of the agenda of reforms over a wide area involving financial markets, financial intermediaries and the regulatory and supervisory function.

In sum, the Indian economy seems to have acquired a remarkable degree of resilience to withstand domestic and external shocks with minimal adverse consequences for growth, inflation and financial stability. A foundation has been laid, particularly in financial and external sectors, for acceleration of the growth rate.

Medium-term growth prospects for the Indian economy would be contingent upon a number of factors including legislative changes, fiscal empowerment, further reforms in the real sector, further liberalisation of the financial sector and of the external sector, and, solving overhang problems in various areas, such as, cost recovery in the energy sector and management of foodgrains stocks while simultaneously ensuring that such pressures do not continue in the future.

Introduction

1. Agriculture

1. Trade Policies

I THE REAL ECONOMY

I MACROECONOMIC POLICY ENVIRONMENT

Introduction
1.1 Policies for macroeconomic management in 2001-02 were geared to initiate and nurture the recovery of industrial activity and exports against the backdrop of sluggishness in several industries and the deepening of the synchronised slowdown characterising the global economy. A robust recovery in agricultural performance, comfortable food stocks, record lows in inflation, and a strong improvement in the balance of payments reflected in a large accretion to the foreign exchange reserves provided the enabling environment for the macroeconomic policy stance.

1.2 Real sector policies were guided by the objective of boosting domestic investment demand by expanding the participation of private enterprise and by promoting foreign investment. Trade policies focussed on an aggressive medium-term export strategy, both product- and market-specific, within the overall goal of raising Indias share in world exports over a five-year span. The process of removal of quantitative restrictions (QRs) and the reduction/ rationalisation of tariffs was carried forward. Foreign investment policy extended the liberalisation of extant ceilings on foreign direct investment (FDI) in various sectors. Liberalisation was also effected in respect of the participation of foreign institutional investors (FIIs) in Indian corporate entities. Norms for overseas issuances by Indian companies and Indian direct investment abroad were eased significantly along with procedural simplifications. Fiscal policies renewed the commitment to consolidation and rectitude alongside a six-pronged strategy to reinvigorate the economy and return to a growth path consistent with its potential. Monetary policy continued its stance of ensuring adequate liquidity to meet credit demand, and pursued the objective of softening of interest rates consistent with a vigil on price stability. Channels of credit delivery were refined and augmented and the operational effectiveness of monetary policy was improved as an integral part of building the institutional infrastructure of an efficient and vibrant financial system. Banking and financial sector reforms were intensified with continued emphasis on deregulating the policy environment to enhance the operational efficiency of financial intermediaries, strengthening these institutions by benchmarking prudential standards against international best practices, improving the regulatory and supervisory function, and enhanced transparency, accountability and market discipline.

Agriculture
1.3 A number of steps were undertaken to reduce foodgrain stocks that are posing problems of storage and disposal. QRs on export of several food items including wheat and wheat products, coarse grains and pulses were dismantled in March 2002. The First In First Out (FIFO) condition for export of foodgrains from the Food Corporation of India (FCI) stocks - requiring disposal of old stocks before newer arrivals could be sold - was waived in June 2001. The Central Issue Price (CIP) of wheat and rice was lowered by around 26 per cent in July 2001 for the Above Poverty Line (APL) consumers so as to increase the off-take under the Targeted Public Distribution System (TPDS). The quantum of foodgrains for the Below Poverty Line (BPL) consumers was increased to 35 kilograms per household. The Public Distribution System (PDS) was converted into a statutory entity in September 2001. The policy of dividing the country into five zones for selling subsidised wheat in the open market was removed in January 2002. Each State would be treated as a separate zone and the actual freight cost incurred by the FCI in transporting wheat to that State would be charged.

1.4 Several new initiatives under the "save grain campaign scheme" to reduce losses of foodgrains during the post-harvest period were initiated in 2001-02, including creation of additional storage capacities (estimated at 54 lakh tonnes), creation of additional capacity for bulk handling, storage and transportation facilities and creation of conventional godowns through private sector participation. Grain banks are proposed to be established in various locations of the country.

1.5 Forward trading was allowed in sugar in April 2001. A package of policy measures aimed at boosting sugar exports and forward trading was announced in November 2001. Three exchanges were given in-principle approval to carry futures trading in sugar. A consortium was given an in-principle approval to set up a multi-commodity exchange to undertake futures and spot trading in 30 commodities in July 2001.

1.6 A key objective of fiscal policy for 2002-03 is the acceleration of agricultural reforms, the removal of regulatory and procedural rigidities and an improved infrastructure in the agricultural sector. Assistance from Rural Infrastructure Development Fund (RIDF) is linked to reforms in the agriculture and rural sectors and funds for RIDF-VIII have been enhanced. The allocation for the Accelerated Irrigation Benefit Programme (AIBP) was also stepped up.

Manufacturing, Infrastructure and Services
1.7 FDI up to 100 per cent was permitted in a wide range of manufacturing activity and commerce, in special economic zones (SEZs) and in telecommunications, airports (including concessions for private sector participation in greenfield airports proposed in the Union Budget, 2002-03), courier services, drugs and pharmaceuticals, and hotel and tourism sectors. The defence sector was opened up for private participation. The Union Budget for 2002-03 put in place a tourism development package consisting of development of six tourism circuits to international standards during 2002-03 and permission for Special Purpose Vehicles (SPVs) to raise resources from both public and private sectors for infrastructure development in these circuits. Steps were also taken to address infrastructural constraints through the implementation of the National Highway Development Project, expansion in the ambit of National Telecommunication Policy (1999) through opening up of Domestic Long Distance telephony, and introduction of the Convergence Commission of India Bill (2001) in the Parliament. An Infrastructure Equity Fund of Rs.1000 crore was set up for providing equity investment for infrastructure projects.

1.8 The new policy for the automobile industry, announced in March 2002, allows foreign equity investment up to 100 per cent in this sector without any minimum capitalisation norms. It aims to promote the Indian automotive industry as globally competitive, with a balanced transition to open trade at minimal risk to the Indian economy and local industry. In the Union Budget, 2002-03 manufacturing of some auto components has been de-reserved. The Government is also planning to remove the outstanding export obligation of auto companies, given the imperatives of the Word Trade Organisation (WTO).

1.9 The Plan outlay on power, roads and national highways and railways was enhanced substantially to step up public investment in infrastructure. Measures were taken to address the issue of appropriate user charges necessary to provide adequate returns on investment. In the power sector, the focus of reforms shifted from generation to transmission and distribution. The Accelerated Power Development Programme (APDP) is being redesigned as the Accelerated Power Development and Reform Programme (APDRP) with enhanced Plan allocation. Access of the States to the fund under the Programme will be on the basis of agreed reform programmes.

Trade Policies
1.10 The Medium Term Export Strategy 2002-07 (MTES) announced in January 2002 sets out a road map for the export sector which would be co-terminus with the Tenth Five-Year Plan period. The MTES aims at increasing Indias share in world trade to one per cent by 2006-07 from the present level of 0.67 per cent. This implies doubling exports from the present level. The MTES includes product (220 commodities) and market identification for exports and indicative sector-wise strategies for identified potential sectors. Export market diversification is also a major objective of the Export and Import (EXIM) Policy with special focus on sub-Saharan Africa and the Commonwealth of Independent States (CIS).

Export and Import (EXIM) Policy (2002-2007)
1.11 The Five-Year EXIM policy for the period 2002-2007 announced on March 31, 2002 includes, inter alia, removal of all QRs on exports (except a few sensitive items reserved for exports through State Trading Enterprises), a farm-to-port approach for exports of agricultural products, special focus on cottage sector and handicrafts, and assistance to States for infrastructural development for exports (ASIDE).

1.12 28 Agri Export Zones (AEZs) were sanctioned in 14 states to promote the export of agro products and agro-based processed products. Export capabilities of the small scale sector, which accounts for about 50 per cent of Indias exports, were strengthened through a programme for "Special Focus on Cottage Sector and Handicrafts" including promotion of cottage sector exports under Khadi and Village Industries Commission (KVIC), access to funds from Market Access Initiative (MAI) for units in the handicrafts sector, exemption from maintenance of average level of exports under Export Promotion Capital Goods (EPCG) Scheme, duty-free imports of specified items up to three per cent of the Free-on-Board (FoB) value of exports and benefit of export house status at a lower average export performance (Rs.5 crore). Similar incentives would be extended to industrial cluster-towns with export potential like Tirupur (hosiery), Panipat (woollen blankets) and Ludhiana (woollen knitwear).

1.13 Several measures including reduction in customs duty on imports of rough diamonds to zero and abolition of licensing regime for rough diamonds were undertaken to enable India to emerge as a major international centre for diamonds. Important measures were taken to give a fillip to jewellery exports, including reduction in value addition norms for export of plain jewellery from 10 per cent to 7 per cent and allowing mechanised unstudded jewellery exports at a value addition of only 3 per cent.

1.14 Facilities for SEZs under the EXIM policy include income tax concessions, exemption from Central Sales Tax (CST) on supplies from the Domestic Tariff Area (DTA), drawback/ Duty Entitlement PassBook (DEPB) to DTA suppliers, exemption from external commercial borrowing restrictions, freedom to make overseas investment and carry out commodity hedging. For the first time, Overseas Banking Units (OBUs) exempt, inter alia, from CRR and SLR stipulations, would be set up in SEZs to provide access to external finance at international rates. In a post-budget announcement, 100 per cent deduction of export profits was allowed to all SEZ units commencing production on or after April 1, 2002 for a period of five years and thereafter at 50 per cent for the next two years. Supplies to SEZs from the DTA would be treated as physical exports instead of deemed exports for the purposes of duties, tariffs and central sales tax under the Income Tax Act and Customs Act.

1.15 In order to give a boost to the hardware industry, the Electronic Hardware Technology Park (EHTP) Scheme was modified to enable the sector to avail of the zero duty regime under the Information Technology Agreement (ITA-I). Net foreign exchange earning as a percentage of exports (NFEP) for these units has to be positive in five years instead of every year. There would be no other export obligation for EHTPs and supplies of ITA-I items with zero duty in the domestic market would be eligible for counting of export obligation.

1.16 Rationalisation and procedural simplification has been undertaken in respect of the Duty Free Replenishment Certificate (DFRC), DEPB, EPCG Scheme and Advance Licence Scheme (ALS). Various facilities would be extended to status holders like direct negotiation of export documents, 100 per cent retention in Exchange Earners Foreign Currency (EEFC) accounts and extension of the repatriation period for realisation of export proceeds from 180 days to 360 days. With a view to further reducing transaction costs, various procedural simplifications are being introduced in the Directorate General of Foreign Trade (DGFT) and customs procedures.

1.17 Transport subsidy was extended to units located in North Eastern States, Sikkim and Jammu & Kashmir to offset the disadvantage of being far from ports. In order to encourage re-location of industries to India, import of plant and machineries was permitted without a licence where the depreciated value of such relocating plants exceeds Rs.50 crore.

Budget Proposals Relating to Customs Duties
1.18 Major changes relating to customs duties effected in the Union Budget for 2002-03 include reduction in the peak rate of customs duty from 35 per cent to 30 per cent, increase in the customs duties of tea and coffee (from 70 per cent to 100 per cent), spices, i.e., pepper, cloves and cardamoms (from 35 per cent to 70 per cent), natural rubber and poppy seeds (from 35 per cent to 70 per cent), pulses (from 5 per cent to 10 per cent) and imposition of duty of 30 per cent on such non-edible oils that contain 20 per cent or more of free fatty acid.

1.19 The customs duty on dairy products was hiked to the WTO bound rate of 40 per cent from 30 per cent. The customs duty on imported liquors was reduced from 210 per cent to the bound rate of 182 per cent in accordance with WTO commitments; the rates of countervailing duty (CVD) applicable to liquors and wines were rationalised.

1.20 There was a reduction in customs duty on IT products. Customs duty on specified items of reeling, twisting, weaving and processing machinery for silk textile industry was reduced from 25 per cent to 10 per cent. These items were exempted from Central Value Added Tax (CENVAT) along with 28 items of processing machinery, automatic shuttle looms and specified jute machinery; these concessions would be available up to February 28, 2005.

Post-Doha Developments
1.21 The Doha Declaration of November 2001 comprising a main Declaration, a Declaration on Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement and Public Health and a decision on implementation related issues and concerns sets out the future Work Programme of the WTO. The negotiating mandate focuses on reducing or eliminating tariff peaks and escalations as well as non-tariff barriers. With regard to General Agreement on Trade in Services (GATS), members are to make requests for market access by June 30, 2002 and initial offers of market access by March 31, 2003. India continues to focus on seeking enhanced market access for developing countries in future WTO negotiations. India has urged that that the work programe on implementation issues should be given the highest priority. Greater attention needs to be given to issues concerning Sanitary and Phyto-Sanitary Standards (SPS) and Technical Barriers to Trade (TBT) so as to fully realise gains in agriculture. India has also argued that the TRIPS agenda should reflect the concerns of developing countries. In the context of the Doha declaration, India has also called for a Development Coalition of the bio-diversity rich countries of the world for the protection of traditional knowledge.

Policies for External Capital Flows
1.22 Various policy initiatives were undertaken to further liberalise the movement of cross-border capital flows especially in the area of outward foreign direct investment, inward direct and portfolio investment, non-resident deposits and external commercial borrowings.

Foreign Direct Investment
1.23 The policy framework governing inward foreign direct investment (FDI) was substantially liberalised under the automatic route. FDI up to 100 per cent was permitted under the automatic route for manufacture of drugs and pharmaceuticals, in the hotel and tourism sector and for mass rapid transport systems in all metropolitan cities (including associated commercial development of real estate). Similarly, airports, development of integrated townships, commercial premises, hotels, resorts, city and regional level urban infrastructure facilities such as roads and bridges, manufacture of building materials and courier services (subject to exclusion of activity relating to distribution of letters) were permitted 100 per cent FDI under the automatic route. FDI up to 49 per cent from all sources was permitted in the private sector banks under the automatic route.

Portfolio Investment
1.24 Indian companies were permitted in September 2001 to raise the 24 per cent limit on Foreign Institutional Investors (FIIs) investment to the sectoral cap/statutory ceiling as applicable. As announced in the Union Budget for 2002-03, FIIs portfolio investment will not be subject to sectoral limits for FDI except in specified sectors. FIIs were allowed by the Reserve Bank on February 4, 2002 to trade in exchange traded derivative contracts subject to limits prescribed by the Securities and Exchange Board of India.

Non-Resident Deposits
1.25 Continuing with the policy of progressive liberalisation of the capital account, the non-resident non-repatriable (NRNR) account and nonresident special rupee (NRSR) account schemes were discontinued with effect from April 1, 2002. Existing accounts under the schemes would continue up to the date of maturity after which the amount would be credited to nonresident (external) accounts/nonresident (ordinary) accounts.

1.26 Ongoing liberalisation of current external transactions encompassed repatriation of current income like rent, dividend, interest and pension of nonresident Indians (NRIs) based on an appropriate certification. Indian corporates with proven track record were allowed to contribute funds from their foreign exchange earnings for setting up Chairs in educational institutions abroad, and for similar such purposes.

Indian Direct and Portfolio Investment Overseas
1.27 Existing limits for Indian direct investment outside India under the automatic route were raised to US $ 100 million. Two-way fungibility of American Depository Receipts (ADRs)/Global Depository Receipts (GDRs) became operational with the issuing of guidelines by the Reserve Bank in February 2002. The transactions will be demand driven and the custodian will monitor the re-issuance of ADRs/GDRs. Foreign Currency Convertible Bonds (FCCB) up to US $ 50 million were brought under the automatic route.

External Commercial Borrowings and EEFC Accounts
1.28 The Reserve Bank allowed corporates on a case-by-case basis to credit even higher proportions of export proceeds to their EEFC accounts than 50/70 per cent allowed hitherto with a view to enabling them to take advantage of lower interest rates and prepay their external commercial borrowings.

FISCAL POLICY
1.29 The Union Budget for 2002-03 adopted a six-pronged strategy, inter alia, emphasising continuation of agricultural and food economy reforms, enhancement of public and private investment in infrastructure, strengthening the financial sector and capital markets, deepening structural reforms and regenerating industrial growth. The strategy for fiscal correction continues to rest on control of non-Plan expenditure, tax reforms, larger disinvestment proceeds and maintaining a higher growth in revenue relative to aggregate expenditure.

Expenditure Management
1.30 The prospects for expenditure management have been strengthened by the success achieved in containing non-Plan expenditure during 2001-02. The Union Budget 2002-03 envisages several measures for reinforcing the process of expenditure management. Various Ministries/Departments have identified around 17,200 posts for abolition, of which around 7,800 posts have been abolished so far. Fresh recruitments will be limited to one per cent of total civilian staff strength over the next four years. To contain the expenditure on subsidies, the Union Budget increased the issue price of urea and other fertilisers. Capital disbursements and the capital outlay have been enhanced in order to reverse the trend of fiscal adjustment occurring through reductions in public investment.

Tax Measures
1.31 The Union Budget aims at providing a modern tax regime with a view to reviving demand, promoting investment, accelerating economic growth and enhancing productivity. On the direct tax front, measures were aimed at further progress towards widening the tax base, rationalisation and simplification of tax structure and encouraging voluntary compliance. The two per cent surcharge for Gujarat earthquake relief was abolished and a surcharge of five per cent was imposed on all categories of tax payers except income up to Rs. 60,000. Tax on perquisites in case of employees with taxable salary (excluding perks) up to Rs.1,00,000 will be exempted from tax for 2002-03 and for the subsequent years the employer may opt to pay the tax on perquisites on behalf of the employees. Tax on distribution of dividend by domestic companies and mutual funds was abolished; however, the ultimate recipients of the income would be taxed as per the rate applicable to them. Corporation tax for foreign companies was reduced from 48 per cent to 40 per cent to correct the disparity between foreign companies and domestic companies.

1.32 Additional depreciation at the rate of 15 per cent was allowed on new plant and machinery acquired on or after April 1, 2002 for setting up of a new industrial unit or for expanding the installed capacity of existing units by at least 25 per cent to give stimulus to the industrial sector. Banks were allowed to deduct up to 7.5 per cent (up from 5 per cent) of their total income against provisions made for bad and doubtful debts. Further, the optional deduction on account of non-performing assets (NPAs) falling in the category of loss or doubtful assets was enhanced from 5 per cent to 10 per cent and a similar option of deduction was allowed to public financial institutions.

1.33 Investment in bonds issued by Small Industries Development Bank of India (SIDBI) and National Housing Bank (NHB) were exempted from capital gains tax under 54EC. Tax concessions announced on July 31, 2002 include, inter alia, deductions from income derived from specified investments under Section 80L of the Income Tax Act raised from Rs. 9,000 to Rs. 12,000, no tax be deductible on dividend up to Rs. 2,500 received from each company or a mutual fund and exemption of life insurance premia from any service tax.

1.34 The indirect taxes were further simplified by reducing the number of items attracting special duty of 16 per cent. The tax base was expanded by including specified services provided by the corporate sector similar to services provided by banks and non-banking financial institutions. The peak rate of customs duty was reduced while rationalisation and simplification of the rate structure was carried further along with concessions for specified equipment for ports and airports and the civil aviation sector, the steel industry, IT hardware and units in Special Economic Zones.

Structural Reforms
1.35 The Union Budget, 2002-03 also provided momentum to the consolidation of structural reforms. A key policy change envisaged was the dismantling of the Administered Price Mechanism (APM) and Oil Pool Account from April 1, 2002. The outstanding balances in the Oil Pool Account would be liquidated by issue of oil bonds to the oil companies. The pricing of petroleum products would increasingly be determined by the market forces. Private companies will be permitted to undertake distribution, subject to specified guidelines to be overseen by a Petroleum Regulatory Board. The subsidy on Liquefied Petroleum Gas (LPG) and kerosene oil was reduced from April 1, 2002 and these subsidies are proposed to be phased out in the next 3 to 5 years.

1.36 Measures were outlined to enhance social security coverage. The Insurance Regulatory and Development Authority (IRDA) recommended a regulatory framework for setting up pension funds to enable individuals to subscribe on a defined contribution basis to obtain the benefit of pensions on their retirement. The public sector insurance companies will provide health insurance to the needy people in the rural areas under the scheme called "Janraksha", which will enable a person to get treatment up to Rs.30,000 per year at selected and designated hospitals with a payment of Re. 1 per day as insurance premium. These initiatives are expected to accelerate the pace of pension reforms in India.

1.37 In order to encourage State-level fiscal reforms, the Union Budget provided additional allocations in respect of Centrally Sponsored Schemes -Accelerated Power Development and Reform Programme (APDRP), Accelerated Irrigation Benefit Programme (AIBP), Urban Reform Incentive Fund (URIF) and Rural Infrastructure Development Fund (RIDF).

1.38 Measures were taken to facilitate adequate credit flow to small scale industries and a new Laghu Udyami Credit Card (LUCC) Scheme was introduced for providing simplified and borrower friendly credit facilities to small businessmen, retail traders, artisans and small entrepreneurs, professionals and other self employed persons, including those in the tiny sector. A micro venture capital fund for small innovations is being set up by the Small Industries and Development Bank of India (SIDBI) in cooperation with the National Innovation Foundation to facilitate the transition of innovations into enterprises.

1.39 The Expert Committee to review the system of administered interest rate and other related issues (Chairman: Dr. Y.V. Reddy) provided a framework for reforms in the administered interest rate regime. In pursuance of the Committees recommendations, the Union Budget, 2002-03 announced that interest rates on small savings would be linked to the average annual yield of government securities in the secondary market for the corresponding maturities. Such adjustments would be undertaken annually on automatic and non-discretionary basis, which would considerably reduce the rigidities of the interest rate structure in India.

MONETARY POLICY FRAMEWORK
1.40 During 2001-02, the Reserve Bank continued to ensure that all legitimate requirements for credit are met consistent with price stability. Towards this objective, the Reserve Bank continued its policy of active management of liquidity. The overall stance of monetary policy for 2001-02 was stated as: (i) provision of adequate liquidity to meet credit growth and support revival of investment demand while continuing a vigil on movements in the price level and (ii) within the overall framework of imparting greater flexibility to the interest rate regime in the medium-term, to continue the present stable interest rate environment with a preference for softening to the extent the evolving situation warrants. Banks and financial institutions were sensitised to the possibilities of a reversal or tightening of monetary policy in case the underlying inflationary situation turns adverse or there are unfavourable and unexpected external developments.

1.41 The measures undertaken in 2001-02 in pursuit of the monetary policy objective included, inter alia, a 50 basis point reduction in the Bank Rate effective October 23, 2001; a rationalisation of Cash Reserve Ratio (CRR) through a reduction of 200 basis points from 7.5 per cent to 5.5 per cent in two stages and withdrawal of exemptions from CRR on all liabilities other than inter-bank liabilities; freedom to banks to price loans at sub-PLR rates; rationalisation and reduction in ceiling rates on rupee export credit by one percentage point across the board effective September 24, 2001 up to September 2002; a 100 basis point reduction of the repo rate in three stages; and refinement of the Liquidity Adjustment Facility (LAF) and standing liquidity facilities.

1.42 The Bank Rate changes combined with CRR and repo rate changes have emerged as signaling devices for interest rate changes and important tools of liquidity and monetary management. The LAF has evolved as an effective mechanism for absorbing and/or injecting liquidity on a day-to-day basis in a flexible manner and, in the process, providing a corridor for the call money market.

1.43 For the purpose of monetary policy formulation for 2002-03, the growth rate of real GDP in 2002-03 was placed at 6.0-6.5 per cent in the April 2002 Monetary and Credit Policy statement. The rate of inflation is assumed to be slightly lower than 4.0 per cent. The projected expansion in broad money (M3) and in aggregate deposits for 2002-03 is 14.0 per cent each and 15.0-15.5 per cent for non-food credit. Against this background, the Reserve Bank proposes to ensure that all legitimate requirements for credit are met during 2002-03 consistent with the objective of price stability. Towards this end, the Reserve Bank will continue its policy of active management of liquidity using the policy instruments at its disposal, whenever required. Unless circumstances change unexpectedly, the Reserve Bank will continue to maintain current interest rate environment with a bias towards softer interest rate regime in the medium-term. Furthermore, the long-term objective would be towards realignment of interest rates of all types of debt instruments, both the government and private sector, within a narrow band. The Reserve Bank will also continue its efforts to bring about development and smooth functioning of the financial market and pursue further financial sector reforms towards achieving a greater degree of efficiency, transparency and financial stability.

1.44 In pursuit of the monetary and credit policy stance for 2002-03, the CRR was reduced by half a percentage point to 5.0 per cent which was to be effective from June 15, 2002 but was subsequently advanced to June 1, 2002. A flexible stance was indicated with respect to the Bank Rate with a reduction up to 50 basis points envisaged as and when necessary. Flexibility was sought to be imparted to interest rate policy by encouraging introduction of variable rate systems for deposits and transparency in disclosure of maximum spreads over Prime Lending Rates (PLRs) and various charges payable by borrowers. The ceiling rate on foreign currency export credit was reduced by 25 basis points.

FINANCIAL SECTOR REFORMS
1.45 Financial sector reforms in 2001-02 continued to focus on structural and regulatory measures with a view to strengthening the financial system and improving the functioning of the various segments of the financial markets. During 2002-03 so far, reforms in these directions have been accelerated with priority attached to developing the technological infrastructure of the financial system, a redefinition of the regulatory function of the Reserve Bank and a stronger vigil on asset-liability management in an environment characterised by the interaction of technology with deregulation.

Development and Regulation of Financial Markets
1.46 One of the main objectives of policy measures in the recent years has been to improve the functioning of financial markets by broadening and deepening the various segments and by equipping them with adequate infrastructure.

Money Market
1.47 Besides ensuring orderly conditions, the Reserve Bank took steps to develop the call/notice money market into a pure inter-bank market in a phased manner. Lending in call money market by non-bank participants was reduced to 85 per cent of their average lending in 2000-01. Corporates have been phased out of this market since July 1, 2001. Further scaling down of non-bank lending in the call/notice money market to 75 per cent would be considered once the Negotiated Dealing System (NDS) and Clearing Corporation of India Limited (CCIL) become fully operational and widely utilised. The standing liquidity support to the banks and primary dealers was also rationalised by apportioning two-thirds of the facility as a normal facility extended at the Bank Rate and the balance one-third as back-stop facility which could be availed at a variable rate with a spread over the reverse repo/repo rate under LAF/NSE-MIBOR. Operational modifications were also effected in the LAF in order to facilitate transactions. The daily minimum reserve maintenance requirement of banks was reduced from 65 per cent of CRR balances to 50 per cent for the first week while keeping it at 65 per cent for the second week, effective from the fortnight beginning August 11, 2001.

1.48 Repo auctions are generally conducted without any pre-announced rate; however, the Reserve Bank exercised its option and conducted a fixed rate repo at a cut-off rate of 6.0 per cent on March 5, 2002. Subsequently, the repo cut-off rate was reduced to 5.75 per cent on June 27, 2002. The Reserve Bank introduced longer term repos of 14 days on November 5, 2001. Prudential limits on exposure to call/notice money market including on call/notice money lending of PDs are slated to come into effect in October-December 2002.

Government Securities Market
1.49 Efforts to deepen and widen the government securities market continued during 2001-02. The maturity profile of Government debt was elongated with issuances of bonds up to 25-year maturity. There was "passive consolidation" by reissuing existing stocks through price-based auctions. In order to cater to diversified investor needs, Floating Rate Bonds (FRB) were reintroduced in 2001-02 and bonds with call/put options were issued in July 2002. An indicative advance calendar for issuance of dated securities of the Central Government for the first half of 2002-03 was announced in March 2002 to improve transparency in primary issuance of Central Government securities.

1.50 The NDS (Phase I) was operationalised from February 15, 2002 to provide online electronic bidding facility in the primary auctions of Central/ State Government securities and OMO/ LAF auctions, screen-based electronic dealing and reporting of transactions in money market and securities markets. Contemporaneously, the Clearing Corporation of India Limited (CCIL) also commenced its operations for clearing and settlement of transactions in Government securities (including repos). The envisaged replacement of the existing Public Debt Act, 1944 by a Government Securities Act, would simplify the procedures for transactions in Government securities, allow lien-marking/pledging of securities as also electronic transfer in dematerialised form.

Foreign Exchange Market
1.51 In the foreign exchange market, the prime objective of the Reserve Bank is to manage volatility with no fixed target for the exchange rate which is determined by market forces. During 2001-02, capital account transactions were further liberalised, as mentioned earlier. The existing limit on overseas borrowing as well as investment of 15 per cent of unimpaired Tier I capital by banks was increased to 25 per cent. Banks were permitted to invest their FCNR(B) deposits in longer term fixed income instruments. The ceiling interest rate on FCNR(B) deposits for a maturity period of 1-3 years was revised downward.

1.52 Importers and exporters were allowed to book forward contracts, subject to a cap of US $ 50 million or equivalent. The facility to cancel and rebook forward contracts which was available only in respect of export transactions was extended to all forward contracts effective April 1, 2002. The EEFC scheme was further liberalised for exporters with proven track record.

Banking Sector Reforms
1.53 Policy measures undertaken in the context of the banking sector during 2001-02 were guided by the objectives of strengthening the banking sector through rigorous operational, prudential and accounting norms set to gradually converge to international standards, improvement in the credit delivery system and gradual narrowing of the divergences in regulatory framework of different types of institutions. Prudential tightening covered exposure and disclosure norms, guidelines on investment, risk management, asset classification and provisioning. Banks were encouraged to prepare themselves to follow international practices in respect of assigning capital for market risk. Initiatives in the direction of redefining the regulatory oversight of the Reserve Bank included mitigating the potential conflict of interest regarding issues of ownership, risk-based supervision, consolidated accounting and supervision, off-site monitoring and inspection. Policy attention was also drawn to issues in management of non-performing assets (NPAs) and related supervisory initiatives, including the setting up of asset reconstruction company and the revival of weak public sector banks. New avenues of banking activity were created in insurance and the access of the banking sector to foreign direct investment was enhanced during 2001-02.

Prudential Norms
1.54 Exposure limits defined in terms of banks capital funds were tightened effective March 2002 for both individual and group borrowers. Foreign banks were brought on par with Indian banks for the purpose of exposure ceilings. The financing of equities and investments by banks was eased to allow banks to extend finance to stockbrokers for margin trading within the overall ceiling prescribed for banks exposure to capital market with adequate safeguards, including the requirement of dematerialised trading.

1.55 Banks were required to prepare for convergence with international standards on asset classification and provisioning norms. From the year ended March 2002, banks were required to make additional disclosures relating to movement of provisions held towards NPAs and depreciation of investments, the total amount of loan asset subjected to restructuring under Corporate Debt Restructuring (CDR) and amounts of sub-standard and standard assets subjected to CDR.

1.56 In order to ensure that banks follow a more prudent policy for utilising the gains realised on sale of investment in securities, they were advised to transfer the maximum amount of gains realised on sale of investment in securities to the Investment Fluctuation Reserve (IFR) Account which should reach a minimum of 5 per cent of their investment under "held for trading" and "available for sale" categories within 5 years, with the freedom to build up higher percentage of IFR up to 10 per cent of banks portfolios in the IFR.

Issues in Regulation and Supervision
1.57 The Board for Financial Supervision (BFS) evolved a country-specific approach to consolidated supervision through a multi-disciplinary Working Group which examined the introduction of consolidated accounting practices for consolidated supervision, in line with international best practices. The frequency of some of the off-site surveillance returns was increased to a monthly basis during 2001-02 and progress was made towards implementation of risk-based supervision.

1.58 The regulation of systemically important institutions performing payment and settlement services such as the Clearing Corporation of India Ltd., is to be performed by the Reserve Bank with oversight authority vested in the Board for Financial Supervision (BFS). Similarly, in view of the growing systemic implications of PDs operations for the stability of the financial systems, they have been brought in the purview of regulation of BFS.

1.59 In keeping with its approach to avoid the potential conflict of interest created by the ownership of regulated financial institutions, the Reserve Bank divested its entire holdings in the Securities Trading Corporation of India Ltd. and the Discount and Finance House of India. Similar disinvestment is proposed for its holding in the State Bank of India, the National Housing Bank and the National Bank for Agriculture and Rural Development. In pursuance of the objective of withdrawing from development financing functions, the Reserve Bank transferred assets on account of loans and advances to Development Financial Institutions out of National Industrial Credit (Long Term Operations) Fund to the Government, replacing them with long-term Government of India securities through private placement.

1.60 A Consultative Group of Directors of Banks/FIs (Chairman: Dr. A.S. Ganguly) was set up to strengthen the supervisory role of the Boards of banks. Banks have been requested to place the Report before their Board of Directors. Certain recommendations of the Group require the approval of the Government or legislative amendments.

Management of Non-Performing Assets
1.61 Several initiatives were undertaken to reduce the level of NPAs in the banking system and to manage them better. A special one-time settlement (OTS) scheme for small and marginal farmers was put in place. Banks were advised to formulate a policy for the recovery of loans from small borrowers in all sectors irrespective of the nature of business or purpose. The Union Budget for 2002-03 announced the establishment of a pilot Asset Reconstruction Company to take over the NPAs of the banking sector and to develop a market for securitised loans.

1.62 Policy efforts to deepen the banking sector and infuse competition into financial intermediation were accelerated. Banks were allowed to freely price and issue rights shares while bonus shares were delinked from the rights issues. Foreign direct investment (FDI) in banks in the private sector was allowed up to 49 per cent under the automatic route with transfer of existing shares from residents to non-residents requiring approval of the Foreign Investment Promotion Board and in-principle approval of the Reserve Bank. In order to provide a level playing field the maximum limit of share holding of Indian promoters in private sector banks was raised to 49 per cent of their paid up capital. In the case of public sector banks, FDI and foreign portfolio investment was allowed up to 20 per cent. Foreign banks were allowed to set up subsidiaries in India. The Union Budget for 2002-03 announced that the Deposit Insurance and Credit Guarantee Corporation would be converted into the Bank Deposit Insurance Corporation.

Urban Co-operative Banks
1.63 Withdrawal of the stipulation of the minimum lending rate (MLR) was announced in the Monetary and Credit Policy for 2002-03. Urban co-operative banks (UCBs) were allowed to determine their lending rates subject to appropriate disclosure norms. UCBs were advised to review their interest rate structure on term deposits of different maturities and to make them comparable with the rates offered by commercial banks.

1.64 Prudential guidelines were issued to UCBs in order to minimise their exposure to credit and market risk. They were also required to begin additional provisioning to achieve the international norms relating to asset classification and provisioning by March 2004. Criteria for classification of UCBs as weak and sick were revised with a view to sharpening the focus of efforts to implement revival plans. Guidelines were issued to the State Governments on one-time settlement of NPAs for UCBs under their jurisdiction. Registration and licensing procedures were subjected to critical review in the light of recent problems in the sector and the danger of contamination in other segments of the banking system. Recommendations of the Madhava Rao Committee such as inclusion of Directors with banking experience in their Boards and formation of Audit Committees were required to be implemented by all UCBs. An external screening committee was set up to assist the Reserve Bank in an advisory role for considering proposals for setting up UCBs. An off-site surveillance system on the lines of monitoring systems for commercial banks was introduced for scheduled UCBs and will be extended to all UCBs in a phased manner. Similarly, the system of Asset-Liability Management (ALM) has also been introduced for scheduled UCBs.

Financial Institutions
1.65 In August 2001, capital adequacy standards for financial institutions (FIs) were modified with a risk weight of 20 per cent on all loans and advances granted to their own employees, which are fully covered by superannuation benefits and mortgages of flats/houses and 100 per cent risk weights for all other loans and advances granted to employees. Refinancing institutions were advised in June 2001 that they need not classify the Government guaranteed accounts as NPAs, even if they are in arrears and not reckoned for income recognition purposes, unless the guarantees are repudiated. Exposure norms for refinancing institutions would be applicable in respect of their direct finance and not on their refinance portfolio for which FIs have to devise their own norms approved by their Board. Disclosure requirements for FIs were enhanced to include the movement in the provisions held towards non-performing assets and depreciation in investment portfolio. The treatment of time overrun in respect of projects under implementation for the purpose of asset classification was redefined/ reclassified. Norms were prescribed for the FIs for entry into insurance business. The Reserve Bank also introduced CAMELS-based supervisory rating model for the FIs.

Corporate Debt Restructuring
1.66 A three-tier Corporate Debt Restructuring (CDR) System was introduced in August 2001 to provide a transparent mechanism for restructuring of debts of viable corporate entities affected by internal or external factors, outside the purview of Board for Industrial and Financial Reconstruction (BIFR), the debt recovery tribunals (DRT) and other legal proceedings. In pursuance of the proposal made in the Union Budget 2002-03, the Reserve Bank constituted a High Level Group (Chairman: Shri Vepa Kamesam, Deputy Governor) to review the operations of the CDR scheme, to identify the operational difficulties in its smooth implementation and to suggest measures to make the scheme even more effective. The Group has submitted its report which is under examination. As an interim measure, permission for debt restructuring would be given by the Reserve Bank on the basis of specific recommendations of the CDR Core Group, if a minimum of 75 per cent (by value) of the lenders constituting banks and FIs consent for the CDR, irrespective of differences in classification of the assets by banks/FIs.

Non-Banking Financial Companies
1.67 The major thrust of policy in respect of non-banking financial companies (NBFCs) during 2001-02 was on bringing about convergence in the operational, prudential and accounting norms and practices of NBFCs with those of the banking industry. With a view to further strengthening the regulatory/ supervisory framework for NBFCs, guidelines were issued on investment policy and classification of investments, identification of loss assets and the need for a credit policy in respect of call/ demand loans. Guidelines for the ALM system for NBFCs issued on June 27, 2001 became operational from the year ended March 31, 2002. The concept of past due for the purpose of income recognition norms is to be dispensed with, effective from the balance sheet for the year ended March 31, 2003. The maximum rate of interest that NBFCs can pay on their public deposits was reduced.

1.68 In order to inculcate a sense of discipline among NBFCs, it has been decided to take serious action against NBFCs progressively for non-submission of returns to the Reserve Bank. Such action may include imposition of penalties as provided for in the Reserve Bank of India Act, 1934 and also launching court proceedings, besides considering rejection/cancellation of the certificate of registration (CoR). To start with, cases of NBFCs having public deposits of Rs. 50 crore and above, and defaulting in the submission of returns are being taken up.

1.69 The Reserve Bank continued its efforts towards educating the NBFC depositors about the regulatory framework, the role of the Reserve Bank in monitoring the functioning of NBFCs and the factors to be considered before investing money in NBFCs, etc., through both the print and electronic media.

Money Laundering and Financing of Terrorism
1.70 Sharing the increasing international concern on the use of the financial system for money laundering and financing of terrorism, the Reserve Bank and the Government initiated various steps to check misuse of the financial system for laundering proceeds of criminal activities. With a view to safeguarding banks from being unwittingly used for the transfer or deposit of funds from criminal activities, it was decided to reinforce the existing instructions on Know Your Customer (KYC) norms and cash transactions. The policy, procedures and controls required to be introduced by banks including strict adherence to KYC procedures have been issued in consultation with banks.

1.71 In the light of recent international developments and recognising the need for a critical assessment of Indias position vis-a-vis international standards on market integrity, the Standing Committee on International Financial Standards and Codes commissioned an internal technical group on Market Integrity. The Report of the Group provides an assessment of Indias position with respect to G-7 principles on Market Integrity and recommendations of the Financial Action Task Force (FATF) on anti-money laundering and terrorist financing which serve as a benchmark in this regard. The Report also provides an overview of international efforts to combat money laundering, briefly reviews the existing laws and regulations for the purpose of detection and law enforcement against criminal activities in financial sector, and notes the recent initiatives taken for prevention of money laundering. The full text of the Report on Market Integrity has been placed on the website of the Reserve Bank.

POLICIES FOR CAPITAL MARKETS
1.72 During 2001-02, several changes were introduced in the settlement practices in the capital markets, including extension of the rolling settlement on T+5 basis to all scrips. The risk management system for the stock exchanges was strengthened in the aftermath of the irregularities in the securities market. The year also witnessed major institutional changes for improving corporate governance practices. The norms for issuance of shares in the primary market were eased further in order to encourage companies to come out with public issues. In the derivatives segment, the range of products was extended further to include index options, stock options and stock futures.

Primary Market
1.73 The Securities and Exchange Board of India (SEBI) amended the SEBI (Disclosure and Investor Protection) Guidelines, 2000 to provide for the inclusion of Foreign Venture Capital Investors (FVCIs) and State Industrial Development Corporations (SIDCs) as Qualified Institutional Buyers (QIBs) for participating in the book-building process. It also abolished the lock-in period for the pre-issue share capital of an unlisted company held by Venture Capital Funds (VCFs) and FVCIs and removed the restriction of a minimum issue size of Rs.25 crore in case of an Initial Public Offer (IPO) through book-building. The option to allocate the unsubscribed portion of the fixed price portion in a book-building issue to any category or lapse altogether was allowed. Buyback norms were relaxed by the Government and the cooling-off period for a fresh issue of a security after buyback was reduced to six months from two years.

Secondary Market
1.74 The SEBI extended compulsory rolling settlement on T+5 basis to 414 scrips from July 2, 2001 and advised the stock exchanges to introduce uniform settlement cycle (Monday to Friday) in respect of remaining securities. Rolling settlement on T+5 basis was extended to all scrips with effect from January 2, 2002. The settlement cycle was shortened to T+3 effective April 1, 2002. This brings the securities settlement system in India at par with international standards, in line with the recommendations of the Report of the joint task force of the Committee on Payments and Settlement Systems (CPSS) and the International Organisation of Securities Commissions (IOSCO) on securities settlement systems.

1.75 Other reforms initiated by the SEBI included banning of all deferral products, including badla; introduction of a market-wide circuit breaker system applicable at three stages of the index movements and introduction of 99 per cent value-at-risk (VaR) based margin system for all scrips in the compulsory rolling settlement with effect from July 2, 2001; and shifting of the margining system from net basis to gross basis (sales and purchases) with effect from September 3, 2001. In order to widen the equity derivatives market, the SEBI permitted introduction of new derivative products. The stock exchanges, accordingly, commenced trading in index options in June 2001, followed by options on select securities in July 2001 and futures on select securities in November 2001. The FIIs were also permitted to trade in all exchange-traded derivative contracts subject to position limits effective February 2002.

1.76 Major initiatives were also taken to improve standards of corporate governance, including amendment to listing agreements requiring the companies to furnish segment-wise details of revenues, results and capital employed along with quarterly unaudited results, etc. The SEBI issued norms for speedy redressal of investors grievances and prescribed Model Rules for stock exchanges to be implemented in phases. The SEBI advised the stock exchanges to amend listing agreements requiring companies to furnish statements and reports on their Electronic Data Information Filing and Retrieval (EDIFAR) system.

Mutual Funds
1.77 The disclosure norms for mutual funds were tightened to help investors take more informed investment decisions. The SEBI decided that mutual funds should disclose the performance of benchmarks in case of various types of equity-oriented, debt-oriented and balanced fund schemes while publishing half-yearly results. Detailed investment and disclosure norms for employees of Asset Management Companies (AMCs) and Trustee Companies were laid down in order to avoid any actual or potential conflict of interests. The SEBI prescribed that all mutual funds should enter into transactions in Government securities only in dematerialised form. Mutual funds were allowed to invest in the listed or unlisted securities or units of VCFs within the overall ceiling for such investments. To bring about uniformity in calculation of the net asset value (NAV) of mutual fund schemes, the SEBI issued guidelines for valuation of unlisted equity shares. With a view to improving the professional standards, certification by the Association of Mutual Funds of India (AMFI) was made mandatory for the appointment of agents/distributors by all mutual funds.

II THE REAL ECONOMY
2.1 The Indian economy exhibited resilience in an uncertain global environment dominated by the worsening of the slowdown in economic activity in several parts of the world. Benefiting from an unusually strong rebound in agricultural production, India's real GDP growth accelerated to 5.4 per cent during 2001-02 as against a deceleration to 4.0 per cent in 2000-01 from 6.1 per cent in 1999-2000. Foodgrains output touched a record high of 211.3 million tonnes in 2001-02 while the production of non-foodgrains increased significantly, except for sugarcane. Stocks of foodgrains touched 51.02 million tonnes at the end of March 2002, well above thrice the prevailing norm. On the other hand, industrial production suffered a pronounced and fairly widespread deceleration, led by a marked slowdown in the manufacturing sector. Capital goods and crude petroleum production recorded absolute declines. Real GDP originating in the services sector rose by 6.2 per cent in 2001-02, up from 5.0 per cent in 2000-01, reflecting an improved performance of financial services, particularly financing, insurance, real estate and business services

2.2 Coincident peaks - Q₂ of 2000-01 and Q4 of 2001-02 - and troughs - Q3 and Q4 of 2000-01 - in real GDP and GDP from agriculture for 2000-01 and 2001-02 suggest that fluctuations in agricultural activity mainly influenced and set the pattern for the overall GDP growth path. The sharp slowdown in growth after the third quarter of 2000-01 in the industrial sector plateaued in 2001-02. Industrial growth increased marginally from 2.5 per cent in Q1 of 2001-02 to 3.4 per cent in Q4 of 2001-02. The quarterly growth rate of the services sector fluctuated between 2.9 per cent and 7.0 per cent during Q4 of 2000-01 and Q4 of 2001-02.

2.3 The rate of gross domestic capital formation (GDCF) at current prices decelerated from 24.3 per cent in 1999-2000 to 24.0 per cent in 2000-01 primarily on account of the rate of private corporate investment which decelerated from 6.5 per cent in 1999-2000 to 5.9 per cent in 2000-01. The public sector investment rate remained stable at 7.1 per cent for the years 1999-2000 and 2000-01. The rate of gross domestic saving (GDS as percentage of GDP at current market prices) edged up from 23.2 per cent in 1999-2000 to 23.4 per cent in 2000-01. All the constituent sectors registered improvement in saving rates except the public sector which increased its dissaving rate from 0.9 per cent in 1999-2000 to 1.7 per cent in 2000-01.

2.4 Tentative estimates of the Reserve Bank, based on latest available data, place the rate of household financial saving at 10.9 per cent in 2001-02 as against the revised estimate of 10.8 per cent in 2000-01. Instrument-wise, this marginal improvement in household financial saving is primarily attributable to currency and claims on government held by the household sector. In contrast, the rate of household financial saving in deposits is estimated to have shown a marginal decline from 5.0 per cent in 2000-01 to 4.9 per cent in 2001-02 on account of the non-bank deposits; household saving in the form of bank deposits increased from 4.5 per cent to 4.8 per cent. The household saving in the form of contractual instruments (life insurance fund and provident and pension funds) declined from 4.3 per cent in 2000-01 to 4.1 per cent in 2001-02 partly reflecting the lowering of the rate of return on these instruments.

Agriculture
2.5. Foodgrains production increased by 15.4 million tonnes during 2001-02, scaling a new peak at 211.3 million tonnes. The production of non-foodgrain crops such as oilseeds and cotton also showed improvement. The index of agricultural production (base : triennium ending 1981-82=100) increased sharply by 7.5 per cent in 2001-02 in contrast to a fall of 6.6 per cent in the previous year. In consonance, real GDP originating from agriculture and allied activities surged up by 5.7 per cent in contrast to a decline of 0.2 per cent in 2000-01. The rejuvenation of agricultural production in 2001-02 is attributable to better spatio-temporal distribution of rainfall. The South-West monsoon was normal for thirteen years in a row with precipitation at 90 per cent of the Long Period Average (LPA) in the 2001 season and 30 (highest in the last seven years) out of 35 meteorological sub-divisions reporting excess/normal rainfall. There was adequate rainfall in 71 districts of 11 states, viz., Chhattisgarh, Gujarat, Haryana, Himachal Pradesh, Kerala, Madhya Pradesh, Orissa, Punjab, Rajasthan, Tamil Nadu and Uttar Pradesh, which had experienced drought conditions in 2000. The North-East monsoon season also turned out to be satisfactory in 2001-02 with excess/normal rainfall in 23 out of 35 sub-divisions as compared with only 4 sub-divisions in 2000-01

2.6 The index of non-foodgrains (base: triennium ending 1981-82=100) rose by 5.7 per cent in 2001-02 in contrast to a fall of 5.7 per cent in the previous year. The improvement in non-foodgrains output was mainly due to the increased output of oilseeds, cotton and jute and mesta, even as sugarcane suffered a moderate decline mainly on account of moisture stress in the States of Maharashtra, Karnataka and Tamil Nadu and parts of Andhra Pradesh. The total off-take of rice and wheat during 2001-02 at 31.3 million tonnes was higher than 2000-01, reversing the decline in the previous year. Despite the higher off-take and large open market sales, the increased procurement resulted in stocks of foodgrains attaining a new peak of 51.0 million tonnes at end-March 2002. The Central issue concerning PDs is that of supply chain management and ensuring prompt delivery of foodgrains in scarcity areas. Procurement of rice and wheat at 22.1 million tonnes during the first quarter of 2002-03 was lower by 4.4 per cent than in the corresponding period of the previous year. Procurement of wheat at 18.9 million tonnes was lower than that of 20.5 million tonnes. Rice procurement was higher at 3.2 million tonnes than 2.7 million tonnes during the corresponding period of 2001-02. The total off-take of rice and wheat in the first quarter of 2002-03 (up to end-June 2002) was higher at 10.1 million tonnes than 5.2 million tonnes during the corresponding period in 2001-02. The total stock of foodgrains was higher at 63.1 million tonnes as at end-June 2002 than 62.0 million tonnes, a year ago.

Industry
2.7. The slowdown in industrial activity deepened during 2001-02, affecting all industry groups and symptomatically manifested itself in disinflation of manufacturing prices, low investment activity, persistence of excess capacity, an absolute decline in the production of capital goods sector and a listless performance of the infrastructure industries. Business sentiment was dampened by the uncertainties characterising the domestic and global environment including specific incidents purveying extreme instability such as the September 11, 2001 terrorist attacks in the US and the recent disturbances in an industrially advanced State like Gujarat. Infrastructural bottlenecks - power, communication, transport and labour laws - continued to be a binding constraint on industrial revival.

2.8 The Index of Industrial Production (IIP) showed lower growth in each month of 2001-02, except March 2002. During 2001-02, the IIP rose by only 2.8 per cent as compared with 4.9 per cent recorded during 2000-01 and 6.7 per cent during 1999-2000. The slowdown was visible across all constituent sub-sectors. In 2001-02, the slowdown in manufacturing became wide spread, affecting a broad spectrum of constituent industries.

2.9 During 2002-03 (up to June 2002), the IIP recorded a growth of 4.0 per cent as against 2.2 per cent in the corresponding period of the previous year. Manufacturing recorded a growth of 3.7 per cent as compared with 2.6 per cent in the corresponding period of the previous year. Electricity and mining also registered higher growth.

Use-based Classification
2.10 The performance of the capital goods sector deteriorated further during 2001-02 with the growth rate of 1.8 per cent during 2000-01 weakening into an absolute decline of 3.4 per cent during 2001-02. All other sectors, viz., basic goods, intermediate goods and consumer goods recorded lower growth in comparison with the preceding year.

2.11 Basic and consumer goods sectors registered an accelerated growth of 5.1 per cent and 6.5 per cent, respectively, during April-June 2002-03 as against 1.4 per cent and 4.8 per cent in the corresponding period of the previous year. The capital goods sector too registered an increase by 1.6 per cent during April-June 2002-03 as against a decline of 6.0 per cent during April-June 2001-02. The intermediate goods sector, however, recorded a lower growth of 1.1 per cent during April-June 2002-03 as compared with 3.3 per cent during April-June 2001-02.

2.12 The performance of infrastructure industries deteriorated during 2001-02. The composite index of six key infrastructure industries, with a weight of 26.68 per cent in the IIP, rose by 2.9 per cent as compared with 5.1 per cent during 2000-01 on a year-on-year basis, however, the growth rate remained higher since December 2001.

2.13 The composite index of six infrastructure industries recorded a higher growth of 5.7 per cent during April-June 2002-03 as against 1.2 per cent in the corresponding period of the previous year reflecting improved growth performance in all infrastructure industries.

Services
2.14 The services sector has been facing a deceleration of growth in recent years in comparison with the annual average growth of 7.7 per cent attained during the period 1997-2002. As per the revised estimates, the growth of real GDP from the services sector rose to 6.2 per cent in 2001-02, up from 5.0 per cent during 2000-01 but well below that of 9.4 per cent during 1999-2000. The share of services was estimated to be 54.1 per cent of GDP in 2001-02 as against 53.7 per cent in 2000-01. Sectors like 'financing, insurance, real estate and business services' and 'trade, hotels, restaurants, transport, storage and communication were the major contributors to growth in 2001-02.

2.15 A notable feature of the structural transformation of the Indian economy in recent years has been the rising contribution of skill intensive services with high value addition such as information technology, to the overall output in the economy. The services sector has emerged as the fastest expanding sector with implications for other sectors especially manufacturing in terms of productivity, employment and trade.

III MONEY, CREDIT AND PRICES
3.10 Monetary conditions remained easy for the most part of 2001-02, enabled by the stance of monetary policy in support of the revival of investment demand in the economy. Consistent with the policy preference for softer interest rates, market liquidity was modulated through reductions of cash reserve ratio (CRR), primary operations through private placements as well as secondary operations in the form of open market operations (OMOs) in government securities and through the Liquidity Adjustment Facility (LAF). Reserve money rose faster during 2001-02 mainly due to a strong accretion to net foreign assets (NFA) of the Reserve Bank. Accordingly, liquidity conditions were generally comfortable throughout the year. Interest rates generally moved southwards in various market segments with all-time lows being reached in the gilt markets. Broad money (M3) expansion was almost the same as in the preceding year. Similar patterns were exhibited in the behaviour of the new broad money aggregate (NM3, i.e., broad money adjusted, inter alia, for nonresident foreign currency deposits) and the wider measures of liquidity, viz., L1, L2 and L3. Currency growth returned to trend levels. Time deposit growth was maintained as uncertainty in other segments of the financial markets fuelled a flight to safety. Credit off-take continued to remain weak in the absence of the much-awaited industrial recovery. Inflation began to dip after August 2001 as the impact of administered price revisions effected in the previous year wore off and by the end of the year it had fallen to 1.6 per cent.

Reserve Money
3.20 Reserve money expanded by 11.4 per cent (Rs.34,659 crore) during 2001-02 as compared with 8.1 per cent (Rs.22,757 crore) in 2000-01, driven by the Reserve Bank's foreign currency assets. Consequently, the ratio of the Reserve Bank's NFA to currency, an important indicator of the quality of monetary management, rose to reach 105.2 per cent as on March 31, 2002. The rising profile of the NFA/currency ratio in a period characterised by capital inflows strengthens the prospective conduct of monetary policy as it empowers the monetary authority to deal with capital outflows, if they take place, without contraction in domestic economic activity or pressures on the balance of payments. Net domestic assets (NDA) of the Reserve Bank declined by Rs.23,335 crore (adjusted for revaluation) during 2001-02, partly off-setting the surge in the NFA and holding down the monetary impact of the foreign exchange inflows. The predominance of NFA in the sources of reserve money growth since the mid-1990s has reflected the growing openness of the economy to external capital inflows.

3.3 Devolvement/private placement of government securities on the Reserve Bank is a conscious strategy adopted by the Reserve Bank. In case liquidity conditions in the market are not appropriate for a market issue, or in the event of the market expecting unreasonably high yields from the primary offering as reflected in the bids received, the Reserve Bank may resort to private placement or devolvement. The Reserve Bank offloads such initial acquisitions when the liquidity conditions/ expectations stabilise, or, at its discretion through strategic open market sales depending upon capital flows, credit growth and requirements of monetary management. Devolvements/private placements, therefore, not only help contain volatility in the market, but also act as a monetary signal from the Reserve Bank.

3.4 Reserve money, on a year-on-year basis, registered an increase of 10.2 per cent (Rs. 31,007 crore) as on August 16, 2002 as compared with an increase of 9.5 per cent (Rs. 26,363 crore) as at mid-August last year. The major source of reserve money growth was the foreign currency assets which increased by Rs. 69,291 crore (adjusted for revalution) as compared with Rs. 42,917 crore during the corresponding period of the previous year. On the other hand, the Reserve Banks net credit to the Centre declined by 12.1 per cent (Rs. 18,436 crore) as compared with a decline of 0.9 per cent (Rs. 1,309 crore) during the corressponding period of the previous year. The Reserve Banks credit to commercial banks and PDs also declined by Rs.2,204 crore and Rs.884 crore, respectively.

Monetary Survey
3.50 Broad money (M3) increased by 14.2 per cent (Rs. 1,86,782 crore) during 2001-02 as compared with 16.8 per cent (14.5 per cent, net of India Millennium Deposits (IMDs)) during 2000-01. Monetary expansion was in consonance with the projections set out in the Monetary and Credit Policy Statement for 2001-02. On a monthly average basis, the year-on-year M3 (net of RIBs/IMDs) growth at 15.3 per cent during 2001-02 was almost the same as that of 15.1 per cent during 2000-01.

3.6 Currency with the public recorded a higher growth of 15.2 per cent during 2001-02 as compared with 10.8 per cent during the previous year. The increase in cash demand during 2001-02 reflected its typical co-movement with the performance of agriculture and rural demand for cash transactions.

3.7 Aggregate deposits increased by 14.2 per cent during 2001-02, which was lower than that of 15.3 per cent (net of IMDs) recorded during the previous year. The broadly steady accretion to time deposits against the backdrop of downward movement of interest rates reflected 'safe haven' sentiments and the decline in interest rates on alternative savings instruments.

3.8 Domestic credit (inclusive of commercial banks' non-SLR investments such as commercial paper, shares and debentures, which have assumed importance in recent years in banks' portfolios) decelerated to 12.4 per cent during 2001-02 from 16.3 per cent during 2000-01 as demand conditions in the economy, particularly in industry, continued to remain weak.

3.9 There were shifts in ownership within the banking sector's credit extended to the Government sector. SCBs investments in Government securities continued to record a strong growth although it decelerated to 20.9 per cent during the year from 22.1 per cent in the previous year; the net Reserve Bank credit to government, on the other hand, declined by 1.1 per cent. As a result, the share of the Reserve Bank in outstanding net bank credit to the Government sector declined from 32.1 per cent during 2000-01 to 27.9 per cent during 2001-02.

3.10 New monetary and liquidity aggregates were introduced in 1999 on the basis of the recommendations of the Working Group on Money Supply: Analytics and Methodology of Compilation (Chairman: Dr. Y.V. Reddy). The Reserve Bank has been disseminating the new aggregates alongside the existing monetary data with a view to sensitising the public to the analytical refinements in the new measures and thereby preparing the ground for replacing the existing broad money measure, i.e., M3. Considerable experience gained in the compilation of the new measures and feedback from reporting entities and analysts has been reflected in concurrent improvements in these aggregates. There is now a broader acceptance of the analytical and accounting superiority of the new monetary and liquidity aggregrates visa-vis M3, including in terms of international best practices.

3.11 Industry-wise, credit off-take by the petroleum industry declined by 2.2 per cent during 2001-02 as against an increase of 29.0 per cent recorded during 2000-01. Credit demand also slowed down significantly in the case of cotton textiles and infrastructure. Amongst the principal industries, credit off-take improved only in the case of iron and steel (an increase of 3.3 per cent as compared with 3.2 per cent recorded in the preceding year), engineering (3.4 per cent vis-a-vis 1.4 per cent), chemicals, dyes, paints, (8.0 per cent vis-a-vis 2.7 per cent) and other textile industries (12.0 per cent as against a decline of 7.6 per cent).

3.12 The net resource flow from non-bank sources (inclusive of capital issues, GDRs/ADRs/FCCBs, CPs subscribed by non-banks and credit from financial institutions) to the commercial sector at Rs. 5,726 crore during 2001-02 was lower than that of Rs. 13,714 crore during the preceding year.

3.13 Broad money (M3) expansion at 13.7 per cent as on August 9, 2002 remained within the projection of 14.0 per cent announced in the April 2002 annual Monetary and Credit Policy Statement and in consonance with overall macroeconomic developments. Currency, on a year-on-year basis, grew by 13.6 per cent as compared with 11.8 per cent in the same period of the previous year. Aggregate deposits increased by 13.8 per cent as compared with 16.2 per cent (net of IMDs) in the comparable period of the previous year. Net bank credit to the Government increased by 14.4 per cent (Rs.81,043 crore) as compared with 16.3 per cent last year. Bank credit to commercial sector increased by 19.1 per cent (Rs.1,31,858 crore) as compared with 13.8 per cent during the corresponding period of the previous year. The sharp increase in bank credit to the commercial sector during the current financial year reflects the accounting effect of the impact of mergers since May 3, 2002 on the assets and liabilities of the banking system.

Price Situation
3.14 The annual rate of inflation in India, measured as point-to-point variations in the wholesale price index (WPI), fell from above 5.0 per cent during the first five months of 2001-02 (April-August) to touch 1.1 per cent as on February 2, 2002 (the lowest during the year and in the last two decades). It was 1.6 per cent by end-March 2002 as compared with 4.9 per cent at the end of March 2001. The significant fall in inflation during the year represented a combination of factors: base effect correction (a higher base in 2000-01 due to administered price revisions), lower international crude oil prices, improved agricultural production, comfortable buffer stocks, absence of demand pressures due to sluggishness in investment demand, presence of excess capacities and inventory accumulation.

3.15 Inflation measured on the basis of variations in the WPI on an average of weeks basis, an indicator of underlying inflationary conditions, persistently trended downwards during 2001-02. The annual average WPI inflation fell to 3.6 per cent in 2001-02 from 7.2 per cent in 2000-01.

3.16 At the retail level, consumer prices diverged from headline inflation. The annual point-to-point variation in the consumer price index for industrial workers (CPI-IW) rose to 5.2 per cent in 2001-02 form 2.5 per cent in 2000-01 (Chart III.23). On an average basis, it was 4.3 per cent as compared with 3.8 per cent a year ago. The divergence between the WPI and CPI could be attributed to the order of change in primary articles inflation coupled with their larger weightage in the CPI. In addition, the movements of prices of some services which are included in the CPI could have contributed to the divergence.

3.17 The prevalence of different measures of inflation and the leads and lags in their relationship makes the assessment of inflationary pressures for monetary policy purposes a difficult task. In general, there is considerable co-movement between the WPI and CPI in India; the problem of assessment is complicated in periods when they move widely in opposing directions. Therefore, there is a need to observe a host of other factors and other indicators of inflation along with changes in the WPI and CPI for assessing future inflationary conditions with a view to providing guideposts for formulating forward-looking monetary policy.

3.18 The rate of inflation (year-on-year basis) during 2002-03 so far (up to August 3) has continued to remain low and stood at 2.7 per cent as compared with 5.5 per cent during the corresponding period of 2001-02. All major groups recorded deceleration in inflation. On an average basis too, the annual inflation rate consistently declined from 5.4 per cent to 2.0 per cent. The CPI-IW, on a point-to-point basis, showed an increase of 4.2 per cent as at end-June 2002 as compared with 3.4 per cent as at end-June 2001.

IV GOVERNMENT FINANCES
4.10 The finances of the Central Government came under pressure during 2001-02 from a shortfall in revenue collections, reflecting the continuing sluggishness in corporate activity and import demand. Consequently, despite some success achieved in the containment of non-Plan expenditure, deficit indicators recorded slippages from their budgeted levels. The gross fiscal deficit (GFD) during 2001-02 remained at 5.7 per cent of GDP [revised estimates (RE)] as in the preceding year, although higher than the budget estimates of 4.7 per cent. The information available in respect of State Governments indicates that the consolidated GFD of States at 4.5 per cent of GDP in 2001-02 (RE) was also higher than the budget estimates of 3.8 per cent^1. Accordingly, the combined fiscal deficit of the Centre and States widened to 9.9 per cent in 2001-02 from 9.4 per cent in 2000-01. The deterioration in the fiscal deficit at all levels necessitated an increasing recourse to market borrowings which financed 69.4 per cent of the GFD of the Centre and 15.2 per cent of the GFD of the States. The recourse by States to Ways and Means Advances (WMA) from the Reserve Bank was generally higher in 2001-02 than in the preceding year. The combined debt of the Centre and States rose to 69.9 per cent of GDP at the end of March 2002 from 66.9 per cent at the end of March 2001. Contingent liabilities of the Centre and States rose to 12.2 per cent of GDP at end-March 2001 from 11.2 per cent at end-March 2000.

CENTRAL GOVERNMENT FINANCES, 2001-02
4.20 The Union Budget 2001-02 aimed at fiscal consolidation through reduction in the fiscal deficit, the revenue deficit and the primary deficit to 4.7 per cent, 3.2 per cent and 0.2 per cent of GDP, respectively. In the actual outturn, according to the revised estimates for 2001-02, there were large gaps in revenues and disinvestment proceeds, whereas Plan expenditure registered an increase in relation to budgeted levels. As a result, the GFD overshot the budgeted level by 13.2 per cent in nominal terms. The revenue deficit in the revised estimates exceeded the budgeted level by 16.4 per cent and the primary deficit was more than six times the budget estimates. The revenue deficit accounted for 69.6 per cent of the GFD as against 67.8 per cent projected in the budget estimates.

Central Government Budget: 2002-03
4.30 The strategy of fiscal rectitude outlined in the Union Budget for 2002-03 is based on achieving a higher growth in revenue receipts at 15.3 per cent, while the aggregate expenditure is expected to grow at 12.6 per cent. In absolute terms, the GFD at Rs.1,35,524 crore is 2.9 per cent higher than that in the revised estimates for 2001-02. The revenue deficit, estimated at Rs.95,377 crore, is higher by 4.0 per cent but the primary deficit projected at Rs.18,134 crore is lower by 25.9 per cent than that in 2001-02. In terms of GDP, the key deficit indicators are budgeted to decline from 2001-02 levels

4.4 During the first quarter of 2002-03 (April-June), the Centres GFD amounting to Rs.39,560 crore was lower by 6.3 per cent over the level in April-June 2001-02 (Rs.42,198 crore) and constituted 29.2 per cent of the budget estimates (Rs.1,35,524 crore) as compared with 37.9 per cent during the same period of the previous year. The revenue deficit at Rs.34,543 crore during April-June, 2002-03 was higher by 6.5 per cent and constituted 36.2 per cent of the budget estimates (41.1 per cent in the same period of the previous year). The gross primary deficit at Rs.15,671 crore was lower by 36.5 per cent over the same period of the previous year.

STATE GOVERNMENT FINANCES
4.50 Revised estimates for 2001-02 indicate deterioration in the fiscal position of States. The gross fiscal deficit of States in 2001-02 at Rs.1,04,557 crore or 4.5 per cent of GDP was higher by 20.3 per cent over the year 2000-01. The revenue deficit in 2001-02 was also higher by 15.7 per cent in absolute terms; however, in terms of GDP, it rose marginally from 2.5 per cent in 2000-01 to 2.6 per cent in 2001-02. The primary deficit as a percentage of GDP also increased, though marginally, from 1.7 per cent in 2000-01 to 1.8 per cent in 2001-02; in absolute terms, it showed an increase of 14.4 per cent over the previous year level.

4.6 The fiscal outcome for 2001-02 reveals continued imbalance between revenue receipts and expenditures of States which is overshadowing the modest efforts towards fiscal consolidation in recent years. While revenue receipts grew by 13.0 per cent over the previous year, mainly on account of a rise in States' own taxes (12.1 per cent) and grants from the Centre (32.6 per cent), these were outpaced by the growth of 13.5 per cent in revenue expenditure. Interest payments accounted for 32.3 per cent of the rise in revenue expenditure in 2001-02. The disaggregation of total expenditure reveals that developmental expenditure rose by 12.3 per cent in 2001-02, while non-developmental expenditure rose by 19.9 per cent over the previous year.

State Budgets: 2002-03
4.70 In the budget estimates for 2002-03, several States have proposed measures to intensify fiscal consolidation process by widening the resource base and containing expenditure. Accordingly, the GFD of States is budgeted to decline to 3.8 per cent of GDP in 2002-03 from 4.5 per cent in the revised estimates for 2001-02. The revenue deficit is also budgeted lower at 1.8 per cent of GDP in 2002-03 than 2.6 per cent in 2001-02. Revenue receipts of States are budgeted to rise by 13.2 per cent with about 70.0 per cent of this increase to be contributed by States' own revenue receipts comprising tax and non-tax receipts, while current transfers from the Centre comprising sharable taxes and grants would account for the rest. Total tax receipts comprising States' own taxes and States' share in Central taxes are estimated to show a higher growth of 13.8 per cent during 2002-03 than that of 11.1 per cent in the previous year. The tax-GDP ratio of the States, which remained stagnant at around 8.0 per cent during the 1990s, is budgeted to increase to 8.3 per cent during 2002-03 from 8.1 per cent in 2001-02. On the non-tax front, States' own non-tax revenue receipts are estimated to show a rise of 19.1 per cent in 2002-03 as against a marginal rise of 0.5 per cent in 2001-02. The grants from the Centre are budgeted to increase by 7.2 per cent. Thus, States' own revenue receipts are expected to finance 54.0 per cent of revenue expenditure and 44.7 per cent of the aggregate expenditure in 2002-03 as compared with 50.1 per cent and 41.4 per cent, respectively, in the revised estimates for 2001-02.

DOMESTIC PUBLIC DEBT
4.80 The outstanding domestic debt of the Central Government rose to 58.4 per cent of GDP at the end of March 2002 as compared with 56.4 per cent in the preceding year. During the earlier period of the economic reform process initiated in 1991, there was considerable progress in improving the debt position of the Government. This was reflected in significant improvement in the debt-GDP ratio which steadily declined from 54.3 per cent in 1991-92 to 49.4 per cent in 1996-97. Subsequently, as a result of the widening fiscal gap, higher Government borrowings became necessary and outstanding liabilities of the Central Government rose at an annual average rate of 14.4 per cent from Rs.6,75,676 crore in 1996-97 to Rs.15,12,768 crore in 2002-03. Similarly, high growth in outstanding debt also led to sharp increase in interest payments which rose at an annual average rate of 12.1 per cent from Rs.59,478 crore to Rs.1,17,390 crore over the same period.

4.9 The States' debt-GDP ratio, which had declined during the period 1991-97, has been edging up in subsequent years to reach 25.6 per cent at the end of March 2002. Fiscal consolidation and reforms at the State level have received considerable attention during recent years. The Eleventh Finance Commission has recommended that as a medium-term objective, State Governments should endeavor to keep interest payments as a ratio to revenue receipts to about 18 per cent. Many of the States in their budgets have proposed measures for fiscal reforms such as setting up of consolidated sinking fund, guarantee redemption fund, statutory limits on guarantees and restructuring of PSUs.

4.10 The combined outstanding debt of the Centre and the State Governments is estimated to be 69.9 per cent of the revised GDP for the year 2001-02 as against 66.9 per cent as at end-March 2001 and 61.7 per cent as at end-March 1991.