KEY ISSUES Context: The tightening of global liquidity has increased external pressures and heightened the focus on India’s macroeconomic imbalances (high inflation, large current account and fiscal deficits) and structural weaknesses (particularly supply bottlenecks in infrastructure, power and mining). Outlook and risks: Growth is expected to slow to 4.6 percent this fiscal year, the lowest level in a decade, reflecting global developments and domestic supply constraints. Headline CPI inflation is expected to remain near double digits for the remainder of the fiscal year. The current account deficit is narrowing, driven by a significant improvement in exports, robust remittances flows, and a rapid diminution of gold imports. Nonetheless, India has very little room to adopt countercyclical policies, constrained by persistently-high inflation, and sizeable fiscal and external imbalances. Spillovers from renewed external pressures interacting with domestic vulnerabilities are the principal risks. Key policy recommendations: • High and persistent inflation is a key macroeconomic challenge facing India. Further increases in the policy rate will be necessary to tackle high inflation and inflation expectations. • If external pressures from global financial market volatility resume, rupee flexibility should be the first line of defense, complimented by use of reserves, increases in short-term interest rates, actions on the fiscal front, and further easing of constraints on capital inflows. • Further fiscal consolidation is needed. Tax and subsidy reforms will be required to durably lower fiscal imbalances. • Enhanced financial sector supervision, better monitoring of banks’ credit quality, and improved information on corporate vulnerabilities will be needed as a basis for tackling rising corporate and financial sector strains. • Addressing supply bottlenecks and structural challenges—particularly in the agriculture and power sectors, and in the pricing and allocation of natural resources (including coal, natural gas, and fertilizers)—will be essential to achieve faster growth, job creation and poverty reduction.