Positive outlook

High public debt remains a risk

The latest Article IV Consultation Report of the International Monetary Fund (IMF) on India, underpinned by macroeconomic and financial stability, gives a largely positive outlook. Despite facing global headwinds, including a global growth slowdown and increased geopolitical fragmentation, India has displayed robust growth over the past year. The IMF has praised India’s near-term fiscal outlook and the Reserve Bank of India’s (RBI’s) commitment to price stability and its handling of monetary policy. Besides, resilience in India’s financial sector, as reflected in low levels of non-performing assets in the banking system, a surge in domestic credit, and adequate capital and liquidity buffers have also played a critical role in straightening the economic outlook. The IMF expects the Indian economy to grow at 6.3 per cent in the current and the next financial years.

However, despite a positive outlook, concerns remain. For instance, elevated levels of public debt and contingent liability could pose growth and financial-stability risks. The sharp increase in public debt can be attributed largely to pandemic-era fiscal disruption and the need to support various segments of society. According to the IMF’s projections, India’s public debt is expected to inch up to 82.3 per cent of gross domestic product in 2024-25, and will remain around 80 per cent till 2028. Given, for instance, the climate-related need for investment to attain the net-zero target by 2070, with the current mix of funding sources, public debt could further increase significantly. Consequently, the IMF has rightly suggested a review of the Fiscal Responsibility and Budget Management Act and the implementation of a medium-term fiscal framework (MTFF). The MTFF can act as a fiscal anchor and help rebuild buffers. Although the government has been pushing public investment to drive growth, it would at some point need to adjust to the overall fiscal position.

Notably, the IMF has raised the issue of the RBI’s frequent interventions in the currency market. The rupee has traded in a narrow range in recent months, making it likely that interventions from the central bank have reduced volatility in the exchange rate. As a result, the IMF called India’s exchange rate regime a “stabilised arrangement” instead of “floating”. However, it must be noted that the limited volatility in the exchange rate in 2023 could be on account of moderation in the current account deficit and an increase in capital flows after the news of Indian government bonds being included in a widely tracked global bond index. Global financial conditions have also eased considerably. In this context, it is also worth noting that it is critical for the RBI to maintain adequate foreign exchange reserves to protect financial stability, among other goals.

This is not to suggest that it should give up exchange-rate flexibility. In fact, the stated policy of the RBI is that it does not target any level of exchange rate and only intervenes to curb excess volatility. Foreign exchange reserves accumulated during favourable times helped the RBI fend off excessive pressure on the rupee when large central banks increased interest rates in a coordinated fashion for the first time in decades in 2022. In the absence of large reserves, India would have witnessed more volatility in the currency market, with implications for both inflation and growth outcomes. It would have also increased financial-stability risk as was witnessed in several developing economies. Thus, the IMF staff remarks on exchange-rate management are somewhat unwarranted. It needs to understand the RBI’s position and look at exchange-rate management from a longer-term perspective.