Transcript of a Press Briefing on the International Monetary Fund's 2010 Article IV Consultation with India

January 11, 2011

With Sanjaya Panth, Senior Resident Representative in New Delhi, India
Asia and Pacific Department
Thursday, January 6, 2011
New Delhi Press Conference

MR. PANTH: India’s growth is among the highest in the world with little slack in the economy. Inflation has been a concern, currently running at around 8-8.5 percent to 10 percent, depending on which measure of inflation you look at. Financial conditions are very comfortable, capital flows have been very strong, investors have favored India very strongly. The Indian growth story is very attractive, with good prospects for growth continuing. India, thus, looks very good in the global context with the rest of the world, particularly the West continuing to be weak. India has, therefore, been a very favored destination for inflows. The very deft handling of the economy by policy makers, both by the central government as well as the RBI, also makes India attractive as a destination for capital inflows. So we expect the economy to continue to expand rapidly, supported by investment and productivity gains.

Of the main near-term challenges, one arises from the elevated inflation. The Reserve Bank of India’s efforts to tighten monetary conditions so far have been very welcome. With short term real interest rates still below historical norms, however, and financing conditions having hardened only marginally, we feel that further steps to bring the real repo rate into positive territory are warranted.

The second issue that we focused a lot during the consultation was fiscal consolidation, including plans to streamline spending. There is a very clear program laid out in the government budget this year. We believe that that’s a very appropriate path of fiscal consolidation going forward. What we have been suggesting is that saving this year’s over performance in revenue would help reconstitute fiscal space going forward. To the extent that you can bring this planned fiscal consolidation earlier because of this extra savings that you have right now, that would be very good.

In other areas, financial stability was also an area of focus. The RBI has come out with a Financial Stability Report again, which we welcome very much. The Indian authorities have also requested the IMF to carry out another FSAP (Financial Sector Assessment Program) which will begin towards the end of this year. Financial soundness indicators currently appear sound and the RBI is continuing to monitor them very closely.

On capital inflows, as I said, India is a very attractive destination. The current account deficit has increased a bit lately and warrants continuous very close monitoring. The composition of inflows has also changed a bit lately but in terms of the total quantum, the current account deficit is continuing to be financed quite comfortably. Going forward, there is some risk that inflows could exceed absorptive capacity but we do not see that at this moment right away. We see it at a very comfortable position right now but again, that’s something that we would advise the RBI and government to continue to monitor carefully.

QUESTIONER: How do you define the positive real interest rate and what is your recommendation in that respect?

MR. PANTH: There are many ways to look at real interest rates - there are backward interest rates, forward interest rates and in the latter, there are different interest rate expectations one can use. So there is no one single measure of the real interest rate. But I think a good rule of thumb could be the following - our inflation projections for the WPI for the end of this fiscal is 6.5 percent and I believe this is also something that some of the Indian authorities are also saying currently. To the extent that the current repo rate is below that level, it is clearly in negative territory. Does that mean that just 0.25 percent is enough to bring it into positive territory? I would not say that because one also has to look at inflation dynamics and where things are going forward. Clearly, though, the fact that the inflation projection is higher than the current repo rate points to the fact that real rates are negative.

QUESTIONER: So you think that interest rate should rise?


QUESTIONER: And to what level it should rise?

MR. PANTH: That’s a question that I am not prepared to answer at this point for a number of reasons. Because that is something that needs to be continuously monitored and updated. I can talk about the direction and the direction of our recommendation is clear. Rates should move into positive territory and in that sense we see room for further increase. But at the same time, to what level and how is something that has to be done gradually and something that needs to be looked at continuously and modulated as necessary and this is indeed what the RBI has been doing. We have very much welcomed the steps that the RBI has taken so far in a gradual way to increase interest rates and we would expect it to do that going forward.

QUESTIONER: What do you mean by macroprudential measures? Are these Capital controls?

MR. PANTH: Macroprudential measures include a number of things, including possibly capital controls but it is not limited to just that. For example, if the inflows are going into a particular sector in an economy and that sector of the economy is overheating; say for example, the real estate sector, one could take measures to dampen inflows to the real estate sector along the lines that the RBI has done recently. That is welcome. So, macroprudential does not mean just capital controls. It could include capital controls but that is just one possible element. At the same time we need to be very clear that India has a very extensive system of capital controls already in place. We do not currently see the need for further capital controls for India. With the current situation being where it is, we do not think India’s absorptive capacity has been reached or exceeded. If and when that does occur, India already has the tools available to be able to tweak things to modulate flows. For example, the ECB (external commercial borrowing) regime which India has used very actively in the past in both directions, for both relaxation and tightening.

QUESTIONER: What is the RBI’s current stance in this regard?

MR. PANTH: Right now the answer to your question is given by what the RBI has done, which is allowing the exchange rate to be very flexible in line with its policies. We have not seen a huge pressure in terms of reserve build-up or build-down, either way. Again, the RBI is better placed to answer your question but based on the RBI’s actions, I would suspect that they see the level of inflows right now as something that is quite comfortable and something that they are handling quite well.

QUESTIONER: Is there any qualitative comment by the Board on how the current account deficit is worsening? Second question is what kind of significant differences have there been between this year’s assessment, compared to 2009?

MR. PANTH: The current account deficit has widened and that warrants close monitoring. It is something to keep watching very carefully. At the same time, the current account deficit is completely being financed by capital inflows, reserves are high, short term debt is low. So India’s external vulnerability compared to lots of other countries is much lower. Having said that, it is also true that over the last couple of quarters, we are seeing FDI decrease as a share of financing and short term portfolio flows have become more important. That, coupled with the fact that the world is still a very risk averse and uncertain place, has increased the risks of sudden outflows. All of those things need to continue to be monitored carefully. But as I said when I began on this question, the situation right now is one where things are financed quite well. So what the Directors have said is that we welcome the authorities’ efforts to continue to monitor the situation carefully.

But, again, at this particular time I would not want to make too much from just one or two quarters of data. India’s reserves are high and to the extent that one has good policies in place and India has done that, over time you do find that inflows tend to become more stable. People take comfort in the fact the policy regime is predictable and the economy is going to continue to be well steered. So, because of that also volatility can decrease.

So just to sum up, it is something to continue watching very carefully but it is not something to send alarm bells right away at this moment.

On your second question, the assessment differs every year because the situation is different every year. Last year, we were talking about coming out of the crisis, and we were talking about the midst of the crisis. 2010 has been a different year from both. So, the assessment differs from year to year but beyond that I do not know how we can say fundamentally how it is different. Whether it is more positive or negative – that is what lots of people have in mind. But our job is not to be positive or negative - our job is to be honest and give a true assessment of where the situation is, and to the extent that India is doing very well, naturally our assessment tends to highlight this fact.

QUESTIONER: Are there any significant aspects that this year’s assessment is focused on?

MR. PANTH: Inflation has been a very key theme in this year’s consultation which was not the case two years ago, because inflation was much lower at that time. The fiscal consolidation path that has been laid out and the importance of sticking with that is another. And as in the last year and continuing further this year, infrastructure & infrastructure financing and the things that need to be done in this respect, has featured in the consultation. All these things have been laid out in the background section and [Executive] Directors’ assessment that you have with you.

QUESTIONER: Is inflation a long term concern and what is the fiscal position and how is it related to the fight against inflation?

MR. PANTH: There is no need for inflation to be a long-term phenomenon. There is no trade-off in the long term between inflation and growth in the sense that you can achieve high growth and low inflation. So we do not see inflation to be an issue for medium term growth. It should not be and it need not be. I think the important point to make is to make sure that you nib inflation expectations in the bud. So to the extent that inflation expectations get entrenched because policies do not act sufficiently in time, then there is a risk that going forward inflation becomes a long term phenomenon. And that’s exactly why the RBI has been tightening over the past few months. So it is important to make sure that you get inflation expectations down and once you do that, then inflation will not become a medium-term phenomenon.

The other part of the question, on the role of the fiscal is also very important. I think this is again where fiscal consolidation can help. Fiscal consolidation will help reduce inflation. So along with monetary policy, if the government continues on its path towards fiscal consolidation, that should also help prevent inflation becoming a long term phenomenon.

QUESTIONER: Why did you project the growth rate for next year at 8 percent while the government is hoping to achieve 9 percent in the next year?

MR. PANTH: Growth will moderate next year because in a sense this year has been an unusual year. Our medium term forecast for India in terms of potential growth is in the range of 8-8.5 percent and we are expecting India to return to that next year. What has been unusual this year is that there have been two or three things that have helped growth to be even higher than that. First and foremost is the fact that we came out from a period of excess capacity last year. During the crisis growth was much lower so in a sense, parts of this year’s growth is because of this catching up to that. Once that plays itself out, that effect will go away. Secondly, last year there was the drought so to the extent that agricultural performance has been stronger this year which helps growth relative to last year. We certainly hope that agriculture will perform well again next year but relative to the base this year, we will not see the same performance in terms of growth next year. Those are the two issues primarily. Our last set of forecasts also had world GDP being slightly weaker so that also plays into that but that is a small part of the story.

QUESTIONER: What is your outlook for international crude oil prices and do you think it is the right time to pass on higher crude oil prices to consumers?

MR. PANTH: It is very commendable that the government has decided to proceed on this path of freeing at least some of the fuel prices. That does certainly add to risk of first round of inflation when you have oil prices pass through but you do have a huge amount of benefits out of that as well. To be precise, India has very large and pressing fiscal needs going forward, not just in terms of reducing the deficit in line with the government’s own budget and the 13th finance commission recommendations but also the composition – there is a need to increase more capital spending. There are also lots of social programs. So in order to finance all of these, one needs to find savings and subsidies is an area clearly where we see lots of potential and scope for savings. In that respect, beginning to free oil prices has certainly helped and we hope the government will continue with that process going forward.


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