IMF Executive Board Concludes 2013 Article IV Consultation with India

On January 25, the Executive Board of the International Monetary Fund (IMF) concluded the 2013 Article IV consultation with India.¹

Background

Although India’s growth remains one of the highest in the world, it has slowed markedly and inflation remains elevated. The slowdown has been due to structural and supply-side factors, with cyclical and global factors also contributing. Capital inflows remain resilient suggesting that the financial channel has not been prominent in the transmission of external shocks. Mainly led by falling infrastructure and corporate investment, the slowdown has now generalized to exports and private consumption. The current account deficit widened to 4.2 percent of GDP in 2011/12, causing the rupee to depreciate sharply before its recent stabilization. The financial positions of banks and corporates, both strong before 2009, have deteriorated. With policy space strictly circumscribed because of high fiscal deficit and elevated inflation, the economy is in a weaker position than before the global financial crisis. In recent months, the authorities have taken steps to reverse the slowdown, which have led to improved market sentiment.

Growth is projected at about 5½ percent for 2012/13, but should pick up to 6 percent in 2013/14. Continued implementation of measures to facilitate investment and slightly stronger global growth should deliver a modest rebound in the near term. Inflation is forecasted to remain above the Reserve Bank of India’s comfort zone given that supply constraints are likely to ease only gradually. The current account deficit should narrow marginally this year to about 4 percent of GDP, aided by falling gold imports, a weaker rupee, and broadly stable oil prices.

Risks are on the downside, but recent government action has mitigated domestic risks. The uncertain global situation could present serious challenges to India, especially in case of a major global financial shock, and the macroeconomic environment limits the scope for policy response. On the domestic front, insufficient follow-through on recent reforms, in particular those intended to relieve supply constraints, or resorting to expansionary fiscal policy are key downside risks. On the upside, going beyond announced reforms or legislative progress would lead to higher growth and lower vulnerabilities.

Executive Board Assessment

Executive Directors noted that India’s growth has slowed markedly due to structural and cyclical factors, while inflation remains elevated. Directors noted, however, that growth prospects continue to be strong and welcomed the authorities’ recent measures to address supply constraints and revive investment activity. Structural reforms, fiscal consolidation, and low inflation were seen as critical for a sustained recovery and to lower vulnerabilities.

Directors considered that growth risks are on the downside, but recent government action has mitigated domestic risks. Stressing that the uncertain global situation could present serious challenges for India, they maintained that the flexible rupee would continue to be an important buffer, as the scope for countercyclical fiscal and monetary policy is limited.

Directors agreed that with financial conditions still relatively easy, it is advisable to maintain the current level of policy rates until inflation is clearly on a downward trend. They commended the RBI’s vigilance on inflation and expected that it will pay dividends for long-term growth. They suggested that more guidance from the RBI on future projected inflation may be helpful in anchoring inflation expectations.

Directors welcomed the government’s fiscal roadmap and underscored the importance of the quality and sustainability of fiscal consolidation. They welcomed the start of implementation of direct cash transfers using India’s impressive Unique Identification Number. Directors stressed, however, that rationalizing fuel and fertilizer subsidies is essential to create fiscal space and make the adjustment more equitable. They supported the reorientation of spending from untargeted subsidies to infrastructure investment and social spending. They also underscored the need to raise tax revenues to pre-crisis levels and concurred that the introduction of the Goods and Services Tax should have priority.

Directors noted that external vulnerability appears to have increased because of the deterioration in the current account deficit and the composition of its financing. However, they viewed it as manageable with the support of exchange rate flexibility. They suggested that fiscal consolidation and lower inflation, combined with addressing supply bottlenecks, would help strengthen the external position. Directors welcomed the authorities’ moves toward further gradual capital account liberalization and encouraged them to focus on foreign direct investment (FDI) and rupee bonds, which would improve the financing mix and deepen domestic capital markets.

Directors noted that strengthening growth and ensuring its inclusiveness would require tackling structural impediments to investment. They considered that removing obstacles to investment and addressing issues in energy and natural resources would be vital to boost growth. Directors suggested that easing restrictive labor laws, improving agricultural productivity, improving health and education outcomes, and addressing skills mismatches, would make growth more inclusive and would support formal job creation.

To reduce financial risks, Directors encouraged the authorities to tighten mechanisms to address deteriorating asset quality, bring concentration exposure norms in line with international practices, and improve the financial strength of public banks as the 2012 Financial Sector Assessment Program report recommended. They noted that financial reforms are also needed to improve access to credit and diversify funding sources, which in turn will require lowering the statutory liquidity ratio over time as fiscal consolidation progresses.

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. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.