Transcript of a Conference Call on India 2007 Article IV Consultation

Washington, D.C., February 4, 2008

MS. KAMATA: Good morning. Welcome to the conference call on the release of the Article IV Consultation documents on India. The documents, as you know, were posted at 7:00 this morning on the Media Briefing Center, and I hope you already had a chance to take a look at them. I would also like to note that the contents of this teleconference and the documents are embargoed until 9:30 this morning, Washington time, which is 1430 GMT.

I am here with Ms. Kalpana Kochhar, Senior Advisor and Mission Chief for India in the Asia and Pacific Department of the IMF, and Mr. Charles Kramer, Division Chief in the Asia and Pacific Department. Ms. Kochhar will start with some opening remarks, and then we will take your questions. Thank you.

MS. KOCHHAR: Good morning or, actually, maybe good night for some of you who are not in the D.C. area. Thanks for dialing in. As you all know, the background to this consultation was India's very strong growth performance of the last four years, making it one of the world's strongest growing economies. The Article IV Consultations, the main consultation discussions between the Fund and India, took place late last year, and we focused on policies required to sustain rapid and inclusive growth while maintaining macrostability. Within that broad objective, we looked at four policy areas: calibrating the conduct of the exchange rate and monetary policy a more globally, financially integrated India; strengthening the financial sector; achieving debt reduction—this is public debt reduction to make room to finance spending priorities; and addressing the supply constraints to inclusive growth. So those are the four main areas. Our report has very detailed account of our discussions, our policy recommendations, the way the authorities responded, etc. But let me just quickly give you a two-minute rundown of what we discussed.

The first issue—and on everybody's minds—is the issue of capital inflows. The fact is that India has been enjoying large capital inflows, which we believe to be at least partly the result of the fact that there's a strong growth story in India and investors are looking to take advantage of this, of the returns that they see coming from India. Another part is due to interest rate differentials between India and the rest of the world—certainly the advanced countries. In any event, capital inflows are large.

India is not unique in facing capital inflows, but it is something that they are having difficulty coping with. We discussed whether or not there were any adjustments to the policy framework that would allow them to cope better with this situation while recognizing that it is, in fact, a challenging situation.

We also discussed ways in which the financial sector could be strengthened to prepare better for these larger capital inflows, of which we believe much of it is here to stay, reflecting the strength of India's economy.

We discussed fiscal consolidation. Some progress has been made over the last four years, but we discussed whether or not there was scope to do more in part to help India cope with these capital inflows and in part also to make room for spending priorities which are laid out very clearly by the planning commission for the 11th 5-year plan, social and physical infrastructure and other very critical priorities.

Then we also discussed structural reforms. These are longstanding discussions that we've had with the authorities, but we believe that they are now of critical importance because the economy is, in fact, growing, investing and exporting. We believe that these structural reforms will go a long way toward boosting India's productivity and its competitiveness through the increase in productivity. I'll stop there, and we can take questions.

QUESTIONER: I just wanted to check on the capital inflows. How critical is the problem and is India doing enough to check inflows?

MR. KRAMER: The main issue in dealing with capital inflows is upgrading the policy framework India has tremendous medium-term investment needs, and capital inflows can help those investment needs get met. Both in the corporate sector and on the infrastructure side, the authorities have identified some [US $] 400 billion in infrastructure investment needs. The capital inflows can help the finance part of that, for example.

For us, the key policy issues are first, is on the monetary policy side: how to best deal with those capital inflows. There, enhancements could be to improve monetary policy communication, where we have seen a fair amount of progress on that front over the last few years, some see this as an evolution. A second issue is monetary policy operations. In the background papers of the staff report we look at the most financially globalized countries to see how their central banks coped with very large and potentially volatile capital flows. We found that they they have enhanced toolkits of operations.

Another issue for us is expanding India's financial market. The issue involved in opening up the capital account and having a more open financial environment is having a set of markets that can intermediate those flows efficiently but also serve as a set of tools that, for example, corporations and banks can use to hedge risk. Two of the steps that we've advocated on those fronts are, one, developing India's bond market, which we think would be especially helpful for the infrastructure sector in terms of financing long-term risks, and another is developing its derivative markets, especially on the foreign exchange side so that, again, corporations and banks can hedge and manage those types of risks.

QUESTIONER: Information in the staff report where it says large capital inflows are creating tensions in the monetary policy, especially the part about the use of capital controls could dampen investment and raise doubts about the government's commitment to full capital accountability and raising questions about the strategy for [inaudible] controls. Could you elaborate?

MR. KRAMER: The issue for us is the direction that capital account policy is going over the medium term. What we have seen over the last few years, generally speaking, is a movement toward fuller capital account convertibility. As you know, the government has expressed a commitment to that goal and has moved towards it generally over time.

At the same time, a question has arisen about the best way to deal with what might be very volatile flows, and there is debate about the best way to do that. One point of view is that temporary controls might have influence in buying some space. We are a bit skeptical about that view.

Our view, based on the international experience, is that temporary controls in most countries do not work very well and the only kind of controls that really buy much space are ones that are fairly draconian and may actually cut off capital that's needed again for investment, for example, for infrastructure. Our preferred strategy is to use the space that's afforded by the existing controls to put in place the kinds of reforms that I mentioned earlier, for example, on the monetary policy framework side, developing financial markets and so forth.

MS. KOCHHAR: In terms of monetary policy, we acknowledge that the RBI [Reserve Bank of India] has allowed greater exchange rate flexibility and, as we all know, the rupee has in fact appreciated. But within the range of policy options, I think we would prefer to see somewhat more exchange rate flexibility, possibly with more appreciation over time rather than trying to control inflows using measures.

The authorities have been clear that the measures are temporary, but precisely for the reasons that Mr. Kramer just outlined, temporary controls tend not to be very effective and so it begs the question of why you need them, why you need to go for them and then, as we said, there are questions about how you might exit from those controls.

QUESTIONER: My question is kind of more in a current perspective as to what you two officials at the IMF would have to say on the impact of the financial market troubles on India because last week one of your colleagues, Simon Johnson, took the position that while nobody is going to be exempt from a global slowdown, it's too early to say as far as India is concerned. I was wondering if there's an update on that.

MS. KOCHHAR: Well, perhaps a bit more detail on that. I think, along the lines of Mr. Johnson's comment, India is increasingly part of the global economy, and so it can't be decoupled and it does move in sync with the rest of the world. Then the question is what is the impact of this going to be? Some part of it, we have seen already, fluctuations in the stock market, etc, starting from last fall.

But, in our view, there are a few things that are going on in India that would likely insulate it from the worst of the effects that would be felt in other countries. First of all, domestic demand in India is very strong. You still have investment that's growing quite strongly. Consumption, especially of durables, has come off a little bit as interest rates increases from last year are beginning to bite, but we do see that overall domestic demand growth is strong. So that's going to keep growth going.

India is plugged into the world trade system, but India's exports have been diversified both in terms of goods as well as markets with far less reliance on the U.S. than for many other countries. On service exports, for which of course the biggest destination is in fact the U.S., we don't have a whole lot of strong evidence but we do believe that the impact could go either way. If, in fact, U.S. corporates are looking to cut costs, it could be that they outsource more, and so India could benefit from that. If not, you could see a bit of a slowing in service exports.

So, overall, on the spectrum of countries that are likely to be affected by this crisis, India is probably a bit further down. That said, as Mr. Johnson said it is early yet. It is just our views on given the structure of India's economy and its exports and financial markets, at this point, we don't anticipate having huge effects.

QUESTIONER: You know there has been a lot of talk on the appreciation of the Indian rupee. I think the IMF has dealt with it in a kind of extensive fashion for the last couple of months. I was wondering, do you see a continued concern of the rapid rise in the rupee? Do you feel that the central bank of India must take more intervening measures? What is the impact from a kind of later perspective here?

MR. KRAMER: The basic question one has to ask is: why is it that the rupee is appreciating? As you noted, it's appreciated significantly. We look at the rupee in what's called real effective terms, which is adjusted for the difference in inflation between India and its partner countries, and that's up 7 to 8 percent over the last year or so, which is a significant figure.

Our view is that the strength in the rupee reflects the strength in the Indian economy. It's one of the world's fastest growing economies. It has one of the highest rates of productivity growth in the region if not worldwide. It has very excellent prospects in terms of growth, a very strong corporate sector. As Ms. Kochhar noted, it's shown a significant degree of resilience.

You asked a related question about the policy response. As you noted, the RBI has been intervening. Now, as we discuss in the report, our understanding is that the intervention is basically aimed at smoothing adjustment in the exchange rate. That is, India maintains a managed float regime. One concern with the intervention it its cost. When the RBI intervenes or when central banks intervene, generally, they accumulate foreign exchange assets. Carrying those assets has a cost. While the cost isn't very high right now, eventually the cost could increase. In an environment where the authorities are trying to make progress in making space on the fiscal side, that could be undesirable.

QUESTIONER: The first is to housekeeping. Is there going to be set publication on selected issues and, if so, when or has that already happened?

MS. KOCHHAR: Yes, the Selected Issues are on the way. I think that we can just release it sometime today or tomorrow, very shortly.

QUESTIONER: Is that also going to look at the same range of questions about structural reforms.

MS. KOCHHAR: Yes. Basically, it provides detail on a lot of the critical, not each and every issue but a lot of the critical issues that are in the staff report for example, competitiveness.

QUESTIONER: Governor Reddy, when he was holding interest rates just now, did mention incomplete pass-through and suppressed inflation and things he is a little worried about. Do you have any sense of the magnitude of suppressed inflation and any sense of what we should be adding to the published inflation results to get a sense of what has yet to pass through?

MR. KRAMER: I'm sorry. Can you clarify the question a little bit?

QUESTIONER: [Inaudible] the prices that aren't yet showing up in the CPI, and I was wondering if that's something you're worried about and whether you have any sense, in sort of quantitative terms, of the size of that.

MS. KOCHHAR: We have some estimates, but let me just say that is our understanding also of what he meant by suppressed inflation. Our understanding is that retail prices of petrol and diesel reflect world oil prices of something like $50 a barrel or thereabouts. Of course, they're considerable higher now.

MR. KRAMER: We have an estimate. If you look at the [staff] report on page 13, footnote 3, you'll see our estimate of what the pass-through would be from moving to completely market-determined oil prices. By our calculations, it would add some three and a third percentage points to wholesale price index inflation. Although I should note that this would be a temporary phenomenon, of course.

QUESTIONER: Right, right. Then on capital inflows, it strikes me it's less of a dilemma if you're not worried about appreciation of the rupee and, by the looks of your Box 4, you're not particularly worried about the appreciation of the rupee. It seems to be generating a current account deficit that you think is about appropriate for India, given its good prospects. Is that right?

MS. KOCHHAR: Yes. I mean, in general, we do. If you look at the Selected Issues paper when it comes out on this very issue of competitiveness, you'll see that we run a number of exercises by which we sort of assess whether or not the appreciation of the rupee is an equilibrium phenomenon, something that we think reflects fundamentals, et cetera. And, yes, the short answer is we do think that it reflects fundamentals at least at the current level, given that India's productivity growth continues to exceed most of its trading partners probably for the future. You also heard actually the Finance Minister say this on a couple of occasions, talking about India's strong growth prospects, et cetera.

The other thing is if you look at the actual performance of exports, you will see that it is really a few sectors that are very badly hit. Others, there is some slowing maybe, but we're not seeing collapses in exports.

In that box, we do explain why the sectors that are hit, some of the special features of those sectors that are hit, including the fact that they are labor-intensive. They typically have been benefited from the reservations and policies for small-scale industries. So they're small-scale and, as a result, suffer more because they're unable to acquire large enough scale to withstand these competitive pressures.

QUESTIONER: You mentioned the corporate bond market as one financial reform that would help with this problem of capital inflows. I just don't quite see why. India needs corporate markets for many reasons, but why would it help with foreign inflows in particular?

MR. KRAMER: One of the issues we mentioned is financing India's very large infrastructure needs, and these types of investments have a particular type of maturity and risk structure to them. They tend to be very long-term. The amounts tend to be very large and then the question is how to best finance that.

Our concern is expressed in the report is trying to finance all of that, or a large measure of that, through the banking system could lead to large maturity mismatches and concentrations of risks.

So, in our view, the corporate bond market would be a good way of getting the necessary sort of maturity features that one would need and also spreading the risk around, for example, among institutional investors, including foreign investors. As you can see from the capital flows, there's a tremendous appetite right now on the part of international investors for taking on exposure to India, and we think the corporate bond market could potentially play a role in that.

QUESTIONER: You would prefer corporate bonds to banks, but how's that corporate bond vs. equity? It seems quite a lot of money is put into these high profile IPOs and such, certainly for infrastructure. That seems to me like quite a nice way of handling foreign inflows.

MR. KRAMER: We don't have a particular preference for debt over equity or equity over debt. But when we look around the world, we see that the best functioning financial systems are the ones that have a variety of options available.

Certainly when we talk to people in the international markets, there's a lot of interest in developing a corporate bond market in India. Parties on the ground there have a great deal of interest in it, including some of the institutional investors there in India.

MS. KOCHHAR: Can I just say one other thing about the debt market? I mean in the equity market, you're right. Eequity is coming in, and the good feature of that is that foreigners are taking the risk both on their investments as well as on the foreign exchange.

Now the current situation with debt financing is that you have Indian corporates going overseas to borrow and therefore facing the exchange risk. If you had a corporate bond market and foreigners wanted to invest in it, first of all, you'd be receiving investment with Indian corporates facing no foreign exchange risk. It would be on the part of the foreign investor. That's another advantage in terms of financial stability overall.

QUESTIONER: I just wanted to seek your guidance on the economic growth for India, especially after the government had revealed the growth figures on January 31st. How do you see that in context with what you all projected, please?

MR. KRAMER: We see the prospects as very bright. Our medium-term estimate of India's underlying growth is 8 percent, and essentially what we see in the near term is a gradual deceleration to about that, so 8-3/4 percent for the current fiscal year, about 8-1/4 percent for next fiscal year. As Ms. Kochhar mentioned earlier, the main driver of growth now is domestic demand, especially on the investment front. We've seen some evidence that growth is slowing down a bit but there is still a lot of fundamental underlying strength there, strength in corporate profits and certainly a lot of appetite for investment in India on the corporate sector side.

QUESTIONER: So, the 9.6 figure basically is nothing very extraordinary in that sense, right?

MS. KOCHHAR: We have built that in too. It is reflected in our full year forecast of 8-3/4 percent, yes. So it did come in a bit stronger than most had expected, but I don't think dramatically stronger to cause us to increase our projection by a lot, although it did increase. It increased, I believe, from about 8-1/2 to 8-3/4.

MS. KAMATA: Thank you very much for joining the teleconference. Again, let me just remind you that this conference call and the documents are under embargo until 9:30 this morning, 1430 GMT.



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