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Despite a sharp turnaround in economic growth over the past two years, downside risks remain and could derail India’s nascent economic recovery, says the International Monetary Fund (IMF).
The risks it outlines stem from potential surges in global financial market volatility. These could materialise when the US Federal Reserve raises interest rates, from slower global growth and from policy implementation issues within India.
In sharp contrast to the clamour for the Reserve Bank of India (RBI) to cut interest rates, the Fund argues in favour of a tight monetary stance. In its Regional Economic Outlook for the Asia and Pacific region, it says that despite the recent moderation in inflation, price rise expectations remain elevated. And, that possible supply-side shocks, a weak monsoon or higher oil prices could pose risks to achieving the medium-term inflation target.
It was, thus, in favour of maintaining a tight monetary stance, coupled with supporting structural reforms to boost food and agriculture production. It also called for “strengthening the monetary policy transmission to ensure changes to the policy interest rate are passed through to lending and deposit rates, including by lowering reserve requirements and further reducing the fiscal deficit.”
The IMF attributes the turnaround in growth to resolution of the earlier political uncertainty and to effective policies adopted by the new government. Risks to the economy, it feels, have moderated due to the sharp fall in the current account deficit and in inflation, the government’s commitment to fiscal consolidation and the improvement in capital inflows which has allowed RBI to build its foreign exchange reserves.
This improvement in the country’s macro economic fundamentals has led the IMF to conclude India is presently one of the bright spots in the global economy.
Yet, it adds, while recent policy measures have helped ease supply-side constraints, further initiatives are required in the energy, mining, and power sectors. “Reforms to streamline and expedite land and environmental clearances, increase labour market flexibility and simplify business procedures should continue to improve India’s business climate, crucial for sustaining faster and more inclusive growth.”
The Fund called for continued emphasis on fiscal consolidation and argues for a “strengthened Fiscal Responsibility and Budget Management Act to underpin the government's medium-term consolidation path”.
It expected the present dispensation’s policy of using the Aadhaar platform for better targeting of subsidies to yield large savings. This, it says, will be crucial to finance social and capital spending priorities.
Economic growth, it said, continued to be constrained by supply-side bottlenecks and delays in project implementation in the infrastructure sector. These have placed pressure on banks’ asset quality, particularly of public sector banks.
IMF has projected India’s economic growth to be 7.2 per cent for 2014-15, lower than the official advance estimate of 7.4 per cent. It estimates 7.5 per cent for the current financial year, also lower than the government’s Budget assumption of 8.5 per cent.
Given the rise it sees in corporate and financial sector strains, the Fund has called for enhancing financial sector supervision and greater monitoring. While acknowledging the recent moves of government and RBI on this account, it says: "Further progress is needed to strengthen prudential regulation for banks' asset quality classification, augment capital buffers and improve corporate governance at public sector banks, and strengthen the insolvency framework."
