Public Information Notice: IMF Concludes 2003 Article IV Consultation with India

August 21, 2003

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On July 18, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with India.1


Economic activity in 2002/03 was uneven across key sectors. Growth is estimated to have slowed to 4⅓ percent in 2002/03 from 5½ percent in 2001/02, with the sharp drought-induced decline in agriculture (by 3¼ percent) offsetting the recovery in industry and the strong growth in services. Within industry, infrastructure-related sectors seem to have led the way, on the back of the publicly sponsored national highways development project.

Inflation has picked up in recent months, mostly owing to supply side factors. WPI inflation rose from under 2 percent in April 2002 to about 6¾ percent at end-April 2003 before subsiding again to around 5 percent in early June. The pickup was mostly due to the higher global oil prices and a drought, which affected edible oil prices.

Balance of payments developments have been favorable and foreign exchange reserves are being accumulated at an unprecedented rate. Goods and services export growth was strong—benefiting from improved competitiveness and the global trend towards outsourcing driven by the need to cut costs. Notwithstanding the relatively strong growth in non-oil imports (13¼ percent in 2002/03), India registered a current account surplus estimated at ¾ percent of GDP in 2002/03. Capital account developments appear to have been driven by dollar weakness and expectation of a rupee appreciation, a highly favorable interest rate differential, and changes in international banking practices. The result of these developments has been an unprecedented accumulation of reserves—reserves reached $83 billion in mid-July—and an appreciation of the rupee vis-à-vis the dollar by around 4 percent in the year to mid-July 2003.

Financial markets were characterized by general weakness in equity prices, coupled with a sustained rally in bond markets. Stock market developments in India have generally been weak, but have improved measurably since April 2003 along with global and regional equity markets. In contrast, bond markets have witnessed a sustained rally. Easy liquidity conditions, coupled with weak investment demand and structural reforms that have deepened government securities markets, resulted in a sharp decline in interest rates to historical lows, notwithstanding the large government borrowing needs. These conditions also allowed a lengthening of the maturity of government debt, and led to a flattening of the yield curve and a narrowing of spreads between government and corporate bonds, across the maturity and credit quality spectrum.

Monetary and exchange rate policy was aimed at maintaining easy liquidity conditions while also attempting to limit volatility in the rupee and stem its appreciation. Since April 2002, the bank rate—the key policy signaling rate—has been reduced by 50 bps to 6 percent, the repo rate by 100 bps to 5 percent, and the cash reserve ratio (CRR) by 1 percentage point to 4½ percent. At the same time, the RBI continued its policy to contain volatility in the exchange rate, with the effect of limiting the appreciation of the rupee. This intervention in foreign exchange markets was accompanied by sterilization operations. The authorities also used the opportunity provided by the strong reserve position to further open up the capital account, prepay some external debt, and offer debt relief to HIPC nations.

General government fiscal imbalances in 2002/03 are likely to be worse than expected in the budget. The provisional estimate is for a central government deficit (including privatization receipts in revenues) of 5.9 percent of GDP, compared with the budget target of 5.3 percent of GDP. The outcome for the subnational governments in 2002/03 is also likely to be worse than expected—the staff estimates a deficit of over 4½ percent of GDP, compared with a budget target of 4 percent of GDP. Revenue shortfalls were the main factors underlying the weaker-than-planned outcome, notwithstanding some expenditure compression. Consequently, the general government deficit in 2002/03 is estimated to be about 10 percent of GDP and general government debt about 85 percent of GDP. Contingent liabilities in the form of central and state government guarantees stand at around 12 percent of GDP.

The budget for 2003/04, announced in February 2003, makes little headway in checking fiscal imbalances. The deficit is to be reduced by only about ⅓ percent of GDP to 5.6 percent of GDP in 2003/04.2 On the revenue side, the budget includes some measures to improve tax administration, but does little to reduce exemptions. The budget also expects to collect some Rs. 132 billion (½ percent of GDP) in privatization revenues, compared with about Rs. 30 billion actually realized in 2002/03. There were only a few measures aimed at containing expenditure. A central plank of the budget is the promotion of infrastructure projects worth Rs. 600 billion (2¼ percent of GDP) over the medium term. These projects are to be undertaken through public-private partnerships, with the government expecting to contribute Rs. 20 billion annually.

The budget also contains several proposals aimed at taking advantage of the low interest rate environment to restructure the debt obligations of both the central and state governments. The central and state governments have agreed that, over a three year period ending in 2004/05, all states' debt owed to the central government carrying interest rates in excess of 13 percent will be swapped for additional proceeds from small savings and market loans, both of which currently have lower interest rates. In addition, the government also offered a scheme to buy back banks' holdings of central government securities which were contracted under high interest rates of the early 1990s. These securities are to be bought back on a voluntary basis from banks that are in need of liquidity or want to encash the premium on their bond holdings for making provisions on their nonperforming assets (NPAs). To provide the incentive for banks to do the latter, the authorities have allowed a tax deduction on the premium income if banks use it to increase provisions.

The staff projects that the economy will grow at 5½ percent in 2003/04, broadly in line with consensus forecasts, but there is some upside potential to this projection. Early indications are for good monsoon rainfall. The projection for 2003/04 incorporates a recovery in agriculture, but there is potential for an even stronger rebound in this sector. Inflation is expected to moderate to around 4½ percent by end-2003/04. The external current account is projected to remain in surplus.

Executive Board Assessment

Executive Directors viewed the recent resilience of the Indian economy as testimony to the benefits of the reforms undertaken since the early 1990s. They noted that, despite a weak global environment and a severe drought during 2002-03, the economy grew at a rate that compares favorably with that of most other countries. Directors welcomed the significant strengthening of India's external position—manifest in the high level of reserves and low external vulnerability. At the same time, Directors noted that the slowdown in growth since the mid-1990s is of concern because of its implications for poverty reduction. They reiterated the view that higher, sustained output and employment growth rests on pushing ahead with fiscal consolidation and critical structural reforms. Some Directors asked for further study on isolating the cyclical and structural factors affecting growth.

Directors stressed that India's large fiscal deficits and public debt are exacting an economic cost in terms of foregone growth. Despite the apparent ease with which the fiscal deficit has been financed, they noted the detrimental effects on growth through crowding out of critically needed spending on physical and social capital and through the preemption of resources for private investment. Directors pointed out that the large fiscal imbalances leave little room for maneuver in the face of shocks and have tended to result in ad hoc policy changes, which increase investment uncertainty. They believed that the authorities should use the favorable external and interest rate environment to build the necessary political consensus for accelerating needed fiscal and structural adjustments. Directors noted that the strategy of postponing consolidation while attempting to stimulate growth is risky, and that few countries have had success in growing out of severe fiscal problems without implementing a comprehensive reform program.

Directors looked forward to passage of the Fiscal Responsibility and Budget Management (FRBM) bill, and welcomed steps to advance implementation of provisions of the FRBM. They noted that the FRBM would bring important discipline and transparency to the central government budget process and enable the authorities to draw up a clear and time-bound plan for restoring fiscal sustainability. They urged early introduction of medium-term fiscal plans and targets, anchored by clearly specified fiscal rules that can be enforced. Directors noted that fiscal adjustment needs to focus on revenue mobilization through widening the tax net and simplifying the tax system. In particular, the range of exemptions should be narrowed and the scope for discretion reduced. Directors also encouraged the authorities to use the recommendations in the various reports on tax and expenditure reform that have been prepared in recent years to draw up a roadmap for fiscal reforms with explicit timetables.

Directors recognized that some important initiatives have been undertaken to strengthen state finances in recent years, including the use of performance-based transfers from the center, limits on government guaranteed loans, and the introduction of fiscal responsibility legislation by some states. Nevertheless, Directors pointed out that state finances have improved only moderately, suggesting that much more needs to be done, including in the areas of reforming the tax system, divesting public enterprises, and reducing subsidies and losses in the power sector. In this context, Directors regretted the delay in the introduction of the value added tax (VAT). They urged that top priority be given to developing the necessary consensus to implement the VAT within the current fiscal year, with the central government launching a concerted campaign jointly with the states about the VAT's benefits.

With inflationary pressures under control, Directors viewed the maintenance of easy monetary conditions as appropriate. They welcomed recent cuts in administered savings rates and policy rates, noting these should allow banks to lower lending and deposit rates and narrow the rupee/dollar interest rate differential. However, Directors noted that administered interest rates and directed lending reduce the effectiveness of monetary policy and hinder financial development. Many Directors encouraged a clearly specified automatic link between administered rates and market rates to prevent a prolonged misalignment of interest rates.

Directors noted that, going forward, the scope for continued sterilized intervention could narrow and make the task of managing the monetary impact of balance of payments inflows increasingly difficult. Several Directors cautioned that the current strategy could inadvertently expose the system to more risk—through further increases in interest-sensitive inflows and unhedged foreign currency exposure in the corporate sector. They welcomed recent measures to facilitate and encourage hedging, but noted that such measures would be most effective if market players perceive the need to undertake such hedging activities. While a few Directors noted the potential implication of exchange rate appreciation, most Directors encouraged the authorities to gradually allow greater flexibility in the exchange rate.

Directors saw the continued strength in the external accounts as a good opportunity to further liberalize external transactions. They welcomed measures to liberalize capital account transactions, but going forward, encouraged deeper trade reforms. Directors singled out the need to simplify the trade regime by lowering tariffs, introducing a more uniform duty structure, significantly reducing exemptions and eliminating administrative barriers. They welcomed India's decision to grant debt relief under the enhanced HIPC Initiative.

Directors commended the steady progress made in moving ahead with financial sector reforms. They welcomed the introduction of risk-based supervision and implementation of a prompt corrective action framework for commercial banks. They encouraged the introduction of time limits on remedial actions in the latter, so as to increase the framework's effectiveness. Directors also saw a need to broaden the scope of the market for interest rate derivatives and to tighten the regulatory treatment of state-government guaranteed loans.

Directors welcomed the recent reforms aimed at providing a comprehensive framework to clean up banks' impaired assets and strengthen their underlying finances. In particular, Directors saw the passage of the Securitization Act, the issuance of the accompanying guidelines by the Reserve Bank of India, and the amendments to the Companies Act creating the National Company Law Tribunal as important steps. To give full effect to these reforms, they encouraged early repeal of the Sick Industrial Companies Act and steps to ensure that borrowers are not able to obtain unduly long protection against collateral enforcement under the new tribunal.

Directors encouraged the authorities to advance the timetable for bringing India's classification and provisioning standards in line with international best practice. They viewed the government's new debt buyback scheme with banks, as well as banks' improved profitability and the new securitization framework, as a good opportunity to shorten the timeframe for classifying loans as doubtful and for building provisions needed under the new norms. Directors commended the recent passage of the anti-money-laundering law, and urged the authorities to complete the questionnaire on money laundering and terrorism financing.

Directors also encouraged further steps to strengthen the performance and efficiency of the banking system, including reducing government ownership and improving the commercial orientation of public sector banks. Some Directors noted that raising the foreign direct investment limit in private banks and lifting the restrictions on voting rights would be complementary steps to strengthen competition in the banking system. Directors also saw the need for a clearer strategy on the future role of development finance institutions, given their weak overall financial condition. Owing to the current fiscal situation and need to contain systemic risk, they encouraged the authorities to move away from government-orchestrated rescue packages of these institutions, with little conditionality.

Directors viewed sustained progress on other reforms also as critical to improving growth prospects and generating job opportunities. They welcomed recent steps to further decontrol fertilizer distribution and the planned introduction of a pricing system to discourage inefficient fertilizer production. However, Directors called for early action on lifting restrictions on agricultural marketing and trade and reforming the public distribution system, minimum support prices, and fertilizer subsidies. As for industry, they welcomed the removal of key goods from the list reserved for small-scale industries, the enactment of a more modern competition bill, and the passage of a new Electricity Bill allowing the power sector to be opened up to greater competition. Directors encouraged further progress with small-scale dereservation, and on reforming labor laws to allow more flexibility, reflecting market conditions.

Directors noted the promising start to the process of privatization in the first half of 2002/03, and encouraged publicizing the benefits of previous divestment to build popular support for this reform. They also supported the authorities' proposal to create a fund for divestment receipts, to be used for debt reduction and identified development programs, rather than for recurrent spending.

Directors welcomed the smooth operation of periodic price adjustments for diesel and petrol. Going forward, they encouraged the authorities to formulate an explicit strategy to deal with episodes when oil prices temporarily move out of a normal range.

Directors commended India for completing assessments under most of the Fund's standards and codes. They welcomed India's subscription to the SDDS, but urged that priority be given to addressing shortcomings in the timeliness and coverage of fiscal data to support the objective of fiscal consolidation. They also encouraged the authorities to facilitate early completion of the Statistics ROSC report.

India: Selected Economic Indicators 1/









(In percent)


Domestic economy


Change in real GDP at factor cost







Change in industrial production







Change in wholesale prices







Change in consumer prices







(In billions of U.S. dollars)


External economy


Merchandise exports 2/







Merchandise imports 2/







Current account balance







(In percent of GDP)







Direct investment, net 3/







Portfolio investment, net







Capital account balance







Gross official reserves 4/







(In months of imports) 5/







External debt (in percent of GDP) 4/







Short-term debt (in percent of GDP) 4/ 7/







Debt service ratio (in percent of current account receipts)







Change in real effective exchange rate (in percent) 4/








(In percent)


Financial variables


Central government balance (in percent of GDP) 8/







General government balance (in percent of GDP) 8/







Change in bank credit to commercial sector







Change in broad money 4/







Interest rate 4/ 9/







Sources: Reserve Bank of India; Ministry of Finance; CEIC; International Financial Statistics; and IMF staff estimates.


1/ Data are for April-March fiscal years, as available at the time of the Board Meeting for the 2003 Article IV consultation (July 18, 2003).

2/ Balance of payments basis.


3/ Net foreign direct investment in India less net foreign investment abroad.

4/ End of period.


5/ Imports of goods and services projected over the following twelve months.

6/ Staff estimates for 2002/03.

7/ Residual maturity basis, except contracted maturity basis for medium- and long-term nonresident Indian accounts.

8/ Excluding divestment receipts from revenue and onlending of small saving collections from expenditure and net lending.

9/ 91-day Treasury Bill rate.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.
2 On the staff's definition-excluding privatization receipts from revenues-the deficit would be broadly unchanged in 2003/04 relative to 2002/03.


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