IMF Survey : India: Economy Stabilizes, but High Inflation, Slow Growth Key Concerns

IMF News, February 20, 2014

Source details

Canonical URL: IMF Survey : India: Economy Stabilizes, but High Inflation, Slow Growth Key Concerns

India has restored macroeconomic and financial stability, with substantive measures to narrow external and fiscal imbalances, tighten monetary policy, move forward on structural reforms, and address market volatility.
Policy actions that reduced vulnerability:
- Exchange rate flexibility.
- Tightening of liquidity conditions.
- Limited foreign exchange interventions.
The current account deficit has contracted, the fiscal deficit target has been met, and investment project approvals are accelerating.
The report notes India has significant foreign exchange reserves to deploy in the event of external financing pressures.

IMF recommendations to manage a potential resurgence of market volatility:
- Foster an environment conducive to foreign direct investment to finance the current account deficit.
- Implement a well-communicated package of policy measures to minimize disruptive currency movements and bolster market confidence.
- Continued flexibility in the rupee, judicious use of reserves, tightening of monetary conditions, additional fiscal consolidation, and further easing of constraints on capital inflows.

Growth projections and expectations:
- Growth projected at 4.6 percent in 2013/14.
- Modest pick up to 5.4 percent in 2014/15, helped by slightly stronger global growth, improving export competitiveness, a favorable monsoon, and confidence from recent policy actions.
- Expected to rise to medium-term growth potential of about 6¾ percent once recently approved investment projects are implemented and as global growth improves.
- IMF confidence that India can return to an 8 percent growth trajectory if further structural reforms—particularly in energy, agriculture, and the labor market—are implemented quickly.
Policy drivers for revived investment: recent important policy decisions that should help revive investment activities.

Persistently high inflation is a key macroeconomic challenge:
- Has induced double-digit inflation expectations and increased demand for gold.
- Eroded households’ financial savings and undermined rupee stability.
Monetary policy guidance:
- “Achieving a sustained reduction in inflation requires a tightening of the monetary stance, possibly over a protracted period.”
- Use headline consumer price index inflation as the principal nominal anchor for monetary policy because food and fuel price shocks propagate rapidly into core inflation, and inflation expectations and wage formation are closely linked to CPI inflation.
- Focus on headline CPI is recommended as the right call.

Fiscal stance and recommendations:
- Authorities resolved to meet the budget deficit target for 2013/14 despite slowing growth.
- Need to improve the quality of fiscal consolidation and make it more growth friendly.
- Medium-term fiscal targets and pace of consolidation are broadly appropriate, but specific measures need to be articulated and implemented to underpin targeted fiscal adjustment.
Revenue and spending priorities:
- Achieving durable medium-term fiscal adjustment will require more efficient taxation, including through the introduction of the goods and services tax.
- Better allocation of spending through reforms to fuel and fertilizer subsidies.
- “Raising the tax-to-GDP ratio to the pre-crisis level and reforming fuel and fertilizer subsidies will help reorient spending toward social priorities in health and education.”
Social policy:
- Progress praised on tying India’s social safety net to Aadhaar (India’s Unique Identification program).

Financial system assessment:
- India’s financial system remains well capitalized and supervised.
- Slowing growth is highlighting corporate vulnerabilities and leading to deteriorating bank asset quality.
Regulatory and supervisory measures welcomed:
- Reserve Bank of India’s initiatives to increase provisioning and capital requirements for bank lending to firms with sizeable foreign currency exposures.
- Improvements in the recognition of restructured advances on bank balance sheets.
Information and institutional gaps:
- A key information gap exists about the extent of unhedged foreign currency exposure of large firms, which needs to be rectified.
- Improvements in the legal and institutional insolvency framework will help deepen domestic capital markets.

Source: IMF Survey : India: Economy Stabilizes, but High Inflation, Slow Growth Key Concerns (February 20, 2014).