IMF Executive Board Concludes 2006 Article IV Consultation with India

Public Information Notice (PIN) No. 07/9
January 25, 2007

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On December 20, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with India.1


India's economy has continued to grow above trend, with average growth of 8 percent in the last three years. Growth is broad based, with robust consumption, investment, and exports. With manufacturing expanding at over 10 percent y/y, industry has joined services as an engine of growth. A normal monsoon is supporting agriculture. Staff projects growth of about 9 percent this year, further moderating toward trend in 2007/08. WPI inflation is contained within the RBI's indicative projection range of 5−5½ percent, partly reflecting gradual hikes in policy rates since late 2005, limited pass-through of higher world oil prices to domestic LPG and kerosene, and cuts in import duties. However, high food prices are contributing to CPI inflation (industrial workers) exceeding 6 percent. Staff projects WPI inflation to remain in the 5−5½ percent range in the near term.

The investment recovery and consumption boom continue to widen the external current account deficit. In 2005/06, buoyant imports have offset rising goods and services exports, pushing up the trade deficit to 6½ percent of GDP and the current account deficit to 1¼ percent of GDP. While exports are growing apace, robust domestic demand is expected to contribute to a further widening in both deficits this year.

Strong capital inflows comfortably financed the current account deficit. In 2005/06, inflows remained dominated by portfolio flows and external commercial borrowings, particularly convertible bonds. While gross FDI inflows have begun to rise, they have been partly offset by a pickup in outward investment by Indian corporates. So far this fiscal year, capital inflows have remained strong and reserve coverage has remained stable at around 7½ months of imports of goods and services. While more reliance on debt and portfolio inflows has increased exposures to changes in international investor sentiment, India's large reserves and low external debt limit this risk.

The exchange rate has exhibited two-way flexibility and in real effective terms is broadly around its 2004/05 level. In the first half of 2006, the rupee depreciated against the U.S. dollar, against a backdrop of tightening global liquidity and a widening current account deficit. The RBI limited its intervention in foreign exchange markets to easing exchange rate volatility and smoothing domestic liquidity pressures that arose from the redemption of external bonds. Since then the rupee has regained ground against the dollar and the RBI continued to intervene only occasionally, both buying and selling dollars.

Financial markets continue to soar. Net foreign investor inflows rebounded after the May/June 2006 stock market correction and stock prices recovered smartly, reaching new historical highs. PE ratios are now high relative to other countries and India's recent past. Meanwhile, real estate prices continue to grow at a rapid clip on the back of a credit boom. To curb speculative pressures, the RBI has tightened prudential standards further, including by raising general provisioning requirements and boosting risk-weights on high-growth areas, including real estate, to above Basel norms. Indicators of financial soundness (backward looking) suggest that banks' balance sheets and income remain healthy.

Following three years of reduced deficits, fiscal consolidation "paused" in 2005/06. The general government deficit was broadly unchanged at around 7½ percent of GDP, with a modestly rising central government deficit broadly offset by a falling states deficit. All but five states enacted fiscal responsibility laws (FRLs) and nine states subsequently received debt relief under the new facility introduced last year by the Twelfth Finance Commission. General government debt remains high—over 80 percent of GDP—reflecting both budget deficits and off-budget subsidies for oil and food. Consolidation has resumed in 2006/07. The state and central government budget deficit targets of 2.7 percent of GDP and 3.8 percent of GDP, respectively, are consistent with the minimum reductions required under their fiscal responsibility legislations. Staff projects the general government deficit to overperform budget estimates by 0.2 percent of GDP on the back of strong revenue growth.

Executive Board Assessment

Executive Directors commended the authorities on India's continued outstanding economic performance—reflected inter alia in strong growth, enhanced resilience to shocks, and increasing integration with the global economy. The favorable conjuncture and outlook provide a good opportunity to accelerate key reforms to support the government's vision of reducing poverty and creating employment by boosting growth. Directors endorsed the government's reform priorities of fiscal consolidation, financial sector development, and removal of structural bottlenecks as the appropriate means to achieve these objectives.

While recognizing the difficulty in gauging inflation pressures during a period of financial deepening and other structural reforms, Directors agreed that vigilance is needed to guard against any potential risks of overheating. They supported the central bank's stance of continued gradual removal of monetary accommodation. Overperformance on the 2006/07 budget could support this policy stance by channeling the anticipated revenue windfall to deficit reduction. Directors concurred that India's policy of a market determined exchange rate is appropriately promoting flexibility, preserving monetary policy independence, and giving the private sector incentives to manage currency exposures as the capital account opens further. They supported the authorities' gradual approach to capital account liberalization, in step with fiscal consolidation and financial deepening.

Directors commended the improvement in government finances, but called for further progress in reducing public debt to make room for social and infrastructure spending. To achieve the target of bringing the central government's revenue deficit to balance by 2008/09, they recommended steps to broaden the tax base by eliminating corporate income tax incentives, paring exemptions, and reforming interstate taxation to pave the way for a national goods and services tax. On expenditure reform, Directors encouraged the authorities to implement the recommendations of government committees on subsidies, including the introduction of an automatic market-based mechanism for petroleum goods and better targeting of kerosene subsidies. Consideration should also be given to hardening state budget constraints, given that a number of states still face sizable adjustments.

Directors welcomed the strengthening of financial sector supervision, with prudential norms generally in line with international best practices. They advised continued vigilance to guard against pressures on asset quality in the face of rapid credit growth. Useful steps to expose potential vulnerabilities will be comprehensive stress tests and the authorities' self assessment of financial stability and development, while the future implementation of Basel II will give banks incentives to enhance risk management.

Directors saw the ongoing deepening and broadening of India's financial markets as key to fostering growth and facilitating greater capital account openness. Recent initiatives to develop money and government securities markets and strengthen regulation of derivatives activities are welcome. Directors encouraged the authorities to press ahead with measures that will further deepen markets, including the expansion of short selling, the consolidation of benchmark issues, and the streamlining of issuance requirements for corporate bonds. To broaden India's investor base and improve channels for funding longer-term investment, the limit on FDI in insurance should be raised and private participation in the pension system permitted.

Directors urged greater progress in addressing structural obstacles to job-intensive, inclusive growth. To help meet India's infrastructure needs, steps should be taken to strengthen implementation capacity and develop strong and independent regulators, as these would bolster investor interest and underpin the authorities' public private partnership initiative. Directors encouraged the consideration of steps to maximize the contribution of Special Economic Zones to India's growth strategy while limiting potential revenue losses. More broadly, efforts should continue to improve the business climate and reform education, as well as to alleviate rural poverty through promoting agricultural growth.

Directors welcomed the government's commitment to multilateral trade liberalization and supported India's intention to play an active role in restarting multilateral trade talks. They welcomed the unilateral extension of duty free, quota free access to the least-developed countries and the continued reduction in trade tariffs. Rapid economic growth provides an opportunity to move tariffs more quickly towards ASEAN levels.

India: Selected Economic Indicators 1/

  2002/03 2003/04 2004/05 2005/06 2006/07  

  (In percent)  

Domestic economy


Change in real GDP at factor cost

3.8 8.5 7.5 8.4 8.9  

Change in industrial production

5.8 7.0 8.4 8.2 ...  

Change in wholesale prices (period average)

3.6 5.4 6.5 4.4 5.2  

Change in consumer prices (period average)

4.0 3.9 3.8 4.4 6.6  
  (In billions of U.S. dollars)  

External economy


Merchandise exports

53.8 66.3 85.2 104.8 127.6  

Merchandise imports

64.5 80.0 118.9 156.3 196.8  

Current account balance

6.3 14.1 -2.5 -10.6 -17.9  

(In percent of GDP)

1.3 2.3 -0.4 -1.3 -2.0  

Direct investment, net 2/

3.2 2.4 3.7 5.7 9.3  

Portfolio investment, net

0.9 11.4 9.3 12.5 14.7  

Capital account balance

10.8 16.7 28.0 24.7 48.6  

Gross official reserves 3/

76.1 113.0 141.5 151.6 175.4


(In months of imports) 4/

9.4 9.2 8.7 7.5 7.9


External debt (in percent of GDP) 3/

20.7 18.6 17.7 15.7 16.7  

Short-term debt (in percent of GDP) 3/ 5/

3.8 1.8 3.1 1.9 2.2  

Debt service ratio (in percent of current receipts)

16.1 16.0 6.0 9.7 5.2  

Change in real effective exchange rate (in percent) 3/

-4.7 1.0 2.2 4.4 -1.4



Financial variables


Central government balance (in percent of GDP) 6/

-6.0 -5.1 -4.1 -4.2 -3.6  

General government balance (in percent of GDP) 6/

-9.7 -9.1 -7.3 -7.4 -6.2  

Change in broad money (in percent) 3/

14.7 16.7 12.3 21.2 19.3


Interest rate (91-day Treasury bill rate) 3/

5.9 4.2 5.3 6.1 7.1



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

1/ Data are for April-March fiscal years as available at the time of the Executive Board meeting, unless otherwise indicated.

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

3/ End of period.

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

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

6/ Excluding divestment receipts from revenues and onlending of small saving collections from expenditures and net lending.

7/ As of December 8, 2006.

8/ IMF calculations as of November 30, 2006.

9/ As of November 24, 2006.

10/ As of December 22, 2006.

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.


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