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RBI vows soft rates, says drought may hit GDP

India is unlikely to achieve its gross domestic product growth target for the year to March 2003 because drought could dent farm sector output and stall a nascent industrial recovery, the Reserve Bank of India said on Friday.

The apex bank said it would persist with a soft interest rate bias, as record food grain stocks and lifetime high foreign exchange reserves would mitigate inflationary pressures from the drought.

"There is a strong possibility that the growth rate of 6.0-6.5 per cent projected, which was based on the assumption of a normal monsoon, will not be realised," the RBI added in its annual report for its financial year ended June 2002.

It said it might review this forecast, made in April, at its mid-term monetary policy review in October.

Earlier this month, a spokeswoman for the central bank said it was likely to lower its estimate for GDP growth to five per cent following a poor monsoon.

The central bank said in its annual report that the country's favourable financial, liquidity and inflation conditions had been offset by a sombre agricultural outlook due to a patchy monsoon.

Indian agriculture is heavily dependant on the monsoon, which runs from June to September. Rainfall between June and August was 24 per cent below normal, leading to the country's worst drought in more than 15 years.

The farm sector is crucial to India's economy, accounting for about a quarter of GDP and employing about 70 per cent of its billion-plus population. Rural incomes also drive a significant proportion of demand for industrial and consumer goods.

DROUGHT EFFECT

Economists say the widespread drought could force the central bank to cut interest rates when it reviews its monetary policy in October.

The central bank lowered the key bank rate thrice in 2001, bringing it to a three-decade low of 6.5 per cent, but has left it unchanged since then amid signs of an economic recovery.

The drought could also hit public finances as provincial governments step up spending for drought relief, which, in turn, could cause the central government to exceed its borrowing target for the year to 2003.

But this would not put significant pressure on interest rates and liquidity because the banking system is flush with funds, the central bank said.

Budgeted borrowing for the year is Rs 1.43 trillion, of which the government has completed nearly 62 per cent without pushing yields higher.

But persistent overshooting of targets would keep yields from falling, the central bank said.

On Thursday, the International Monetary Fund expressed concern about India's large fiscal deficit and debt, urging the government to implement reforms to achieve economic goals.

EXTERNAL SECTOR

The outlook for the external sector is encouraging, with reserves at a record $60.6 billion on August 16, up $6.5 billion from April due to foreign direct investment inflows, trade flows and expatriate remittances, the central bank said.

India's external debt, which fell marginally to $98.1 billion at the end of March 2002, is expected to decline further this year as the government may repay costly foreign loans by tapping into its huge reserves.

Strong foreign exchange inflows have pushed the rupee to a near seven-month high of 48.5025/5125 against the dollar, up 1.2 per cent from a lifetime low, struck in mid-May.

Analysts forecast further gains for the Indian unit, which is only partially convertible on the capital account. It is undervalued on a trade-weighted basis by about four percent due to the dollar's weakness against major currencies.

AGRICULTURE SECTOR

The apex bank said variability in agricultural production has emerged as a cause of serious concern. Much of this volatility seems to stem from poor performance of non-foodgrains, which was related to their excessive dependence on monsoon.

RBI said there was an urgent need to increase public investment in irrigation and water management, given the high correlation between the growth of area under high yielding varietes of seeds and gross irrigated area.

This could be achieved by restructuring the existing allocation of resources to agriculture and by increasing user charges (power and irrigation) with due consideration to appropriate phasing.

Moreover, investment needs to be directed towards watershed development in view of its salutary envirnomental implications, it added.

RBI and the government have been taking a number of initiatives to ensure adequate credit to the agricultural sector. Besides augmenting the total flow of institutional credit, the major objective was to improve distribution of credit in favour of farm sector, the report said.

The apex bank observed that "although public sector banks as a group have achieved the targets for lending to priority sector, the flow of credit to these areas by other segments of the banking system has not been buoyant."

Efforts were underway to improve the recovery rate in respect of agricultural loans and advances as accumulated overdues have constrained capabilities of expanding credit to the agricultural sector, it said.

Non-performing assets of regional rural banks have been declining in recent years largely due to a rise in share of standard assets. This augurs well for the credit delivery mechanisms of RRBs in context of their specialised function.

The rural co-operatives sector remains dependent on flow of finance from the National Bank for Agriculture and Rural Development.

"There is a need to examine the issue of rural credit and its delivery systems in an objective as well as transparent manner and accord it priority in legislative actions and financial allocations," the RBI said.

The scheme of micro-finance has made rapid strides in India, both in terms of self-help groups linked with banks and number of beneficiaries covered, the apex bank said.

"The progess of micro-finance across the states has, however, been uneven," RBI pointed out in the annual report.

(With additional inputs from PTI)

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