By S. Sethuraman
In a pre-budget appraisal (mid-February) of Indian economy, “the bright spot in the global landscape”, IMF says the recent revival, helped by policy actions improving confidence and lower global oil prices, must be strengthened by revitalising the investment cycle and accelerating structural reforms.
In its annual assessment under Article IV of its charter, IMF has projected India’s growth (at factor cost, as in the past) at a modest 5.6 per cent in 2014-15 and at 6.3 per cent in 2015-16. However, the Fund takes note of revised CSO growth data which, while baffling for economists at home, are seen by IMF to incorporate “conceptual and methodological improvements that make them more consistent with international best practices”.
Based on this revised GDP, the IMF forecasts growth to strengthen to 7.2 percent in 2014-15 and rise to 7.5 percent in 2015-16, being driven by stronger investment following improvements to the business climate. The Union Budget presented on February 28 expects growth at 8 to 8.5 per cent
The Finance Minister Mr Arun Jaitley also said aiming for a double-digit growth rate seems “feasible very soon”. While the thrust of his budget may be an enabler and facilitator for moving India toward a higher growth strategy, much of the actions. by no means easy, lie outside the Budget. Mr Jaitley does acknowledge major challenges ahead.
In this view, the IMF assessments of key issues and recommendations would need to be taken into account by policy-makers. Firstly, it notes, while recent GDP revisions may be indicative of a faster recovery with a more resilient performance of the services and manufacturing sectors, investment activity continues to be held back by structural and supply-side constraints.
While several policy actions have been taken recently, further steps in relaxing longstanding supply bottlenecks, especially in energy, mining and power sectors, as well as labor market reforms, are crucial to achieving faster and more inclusive growth.
Contrary to Government’s assumptions of CPI inflation set to decline further – not RBI -, Fund economists cite “high inflation expectations and wide fiscal deficits” as key macro-economic challenges. Also, supply side bottlenecks and structural challenges-particularly in the agriculture, mining and power sectors-constrain medium-term growth and hinder job creation.
Added to these are global risks which are already getting reflected in volatility in major international financial markets as also in Sensex movements of recent days. India no doubt is relatively comfortably placed with a significant reduction in current account deficit in the wake of fall in oil prices and gold imports and a surge in its reserves to 334 billion dollars as on Feb.20. However, as IMF points out, the spillover impact from global financial market volatility to India could be very disruptive, including from any unexpected developments in the course of U.S. monetary policy normalization, particularly against the backdrop of recent large capital inflows.
Given the recent improved job outlook in USA with the unemployment rate down to 5.5 per cent in February, widespread fears that the Federal Reserve may move to raise interest rate earlier in mid-2015 than later in the year, have triggered volatility in financial markets. The Federal Reserve’s Open Market Committee meeting on March 17-18 is awaited for guidance. For India, the other external risk is a prolonged period of weak global growth which could dampen exports.
IMF also reflects greater concern over domestic risks including a supply-driven spike in inflation, further deterioration in bank asset quality and continued stress in corporate financial positions, as well as slower than-expected progress in addressing supply-side bottlenecks, which could weigh on growth and stoke inflation. Weakened bank and corporate balance sheets could not only retard economic recovery but also weigh on financial soundness, according to IMF.
The Modi Government, with increased political certainty, has no doubt taken measures to revive investment, improve the ease of doing business and to consolidate fiscal deficit. Counter-cyclical fiscal policy space is, however, limited and for capital investment, Government would need to improve tax revenues and further reduce subsidies.
IMF has projected the fiscal deficit at -4.4 per cent in 2014-15 and -4.1 per cent in fiscal 2016 as against the Government budget estimates of 4.1 and 3.9 per cent of GDP respectively.(IMF treats divestment and licence auction proceeds as “below-the-line financing” i.e. outside revenues). Current account deficit is projected at -1.8 per cent and -1.7 per cent for the two years 2014-16. CAD was down to 1.7 per cent in April-Dec 2014. But on inflation, IMF does not share the Government’s optimism and has also broadly endorsed RBI”s approach in the conduct of monetary policy. It expects CPI inflation to move upto about 6.25 per cent by Mardh 2015 (from 5 per cent in December 2014) “and hover slightly above 6 per cent during 2015-16 as growth picks up, slack dissipates and favourable base effects unwind”.
This is also more or less the assessment implicit in RBI Governor Dr Raghuram Rajan’s recent statements after the second rate cut in the first week of March. IMF directors have welcomed progress thus far made in reducing inflation, supported by a tight monetary stance and government efforts to contain food inflation.
Nonetheless, they noted that in view of high inflation expectations and upside risks thereto, monetary policy should remain tight to reduce both inflation and inflation expectations durably. In IMF Executive board, Directors concurred that further efforts are needed to strengthen the monetary policy framework, including a move towards flexible inflation targeting. (This has since been announced in Government-RBI agreement on the subject).
On fiscal consolidation, they have suggested improving the quality, underpinned by comprehensive tax reform (such as introducing the goods and services tax and improving tax administration) and measures to further reduce subsidies. On the medium-term fiscal targets, directors encouraged the authorities to articulate and implement specific supporting measures, which could be used also to enhance the quality and sustainability of fiscal consolidation.
While India’s financial system is “well-capitalized and supervised” IMF cautioned that deteriorating corporate financial positions and worsening bank asset quality could weigh on financial sector soundness. Besides ongoing measures to enhance bank supervision and monitoring, authorities could further strengthen prudential regulation for banks’ asset quality classification, address concentration risks and augment capital buffers. Improving corporate governance at public sector banks and strengthen the insolvency framework are also urged. (IPA Service)