Millennium Post

Big challenges lie ahead

Even as the country is yet to fully grasp the dimensions of the deleterious impact of the UPA-II government’s interim budget arithmetic as well as growth-slowing supply constraints, IMF has added a chill note on the overall state of economy and projected growth at 5.4 per cent in 2014-2015 as against the six per cent budget estimate. It has also warned of near double-digit CPI inflation through the year.

Whatever be the character of the new government that would follow the May elections to the Lok Sabha – and there is great deal of uncertainty yet on political stability – it has humongous tasks for growth revival and social agenda in education, skills and jobs even while pursuing a prudent fiscal path and a manageable external current account. Tax and subsidy reforms would be required for durably reducing fiscal imbalances, IMF says.

IMF welcomes progressive tightening of monetary policy by RBI as appropriate stance to decisively tackle high and persistent inflation.  While headline (WPI) inflation is expected to lower from 7.43 per cent, well above RBI’s comfort zone, to 6.3 per cent by March 2015, the double-digit CPI inflation at 10.5 per cent would continue into the new fiscal year, lowering possibly to 8.6 per cent by end-March’15. Monetary policy would thus need to maintain tight stance for a ‘prolonged period of time’.

An IMF team had held consultations with India’s policy-makers toward the end of 2013 followed by the Executive Board’s deliberations in January but the public announcement on 20 February followed the Finance Minister Chidambaram’s presentation of a vote-on-account budget to the outgoing Lok Sabha on 17 February.

Briefly, IMF’s assessment is India faces relatively weak growth and high and persistent inflation into 2014-2015, which may yield a 5.4 per cent growth over the 4.6 per cent in the first half of 2013-2014 with the year ending below 5 per cent. (4.9 per cent as per CSO’s advance estimates). The growth rebound for the coming year is subject to stronger global growth, improving external competitiveness, favourable monsoon and confidence boost from recent policy actions (like any improvement on supply side).

While recent policy initiatives have reduced vulnerabilities, counter-cyclical policy space remains strictly circumscribed because of high deficits and debt, and elevated inflation. However, fiscal restraint and a tighter monetary stance will act as headwinds, slowing the recovery. With food and ongoing energy prices increases, inflation would remain above comfort zone, given that supply constraints will ease only gradually.

IMF has noted some narrowing of the current account deficit to about 3.3 per cent in the current year and expects it lower to 60 billion dollars or -3.1 per cent in 2014-2015. Such lowering is assumed to come from rebounding exports, higher remittances, shrinking gold imports, weakening domestic demand, and broadly stable oil prices.

Nevertheless, India would face continuing challenges from global developments (whether from US Fed’s ‘taper’ or euro-zone slowdown) and the slow progress in addressing infrastructure and supply side constraints. Spill-overs from renewed external pressures interacting with domestic vulnerabilities are the principal risks, IMF says.  Efforts to further strengthen macro-economic position by managing fiscal and external imbalances would be needed if there has to be space for any counter-cyclical policies. In addition, progress on structural reforms to raise potential growth is critical to reduce the burden on monetary policy. Persistently high inflation is found to have depressed real returns for household savings (prompting a surge in gold imports). Led by falling infrastructure and corporate investment, the slowdown has generalised to other sectors of the economy. The financial positions of banks and corporates have deteriorated. Vulnerabilities of India’s corporate sector are at their ‘highest since early 2000s’.

According to IMF staff study of factors behind the recent investment decline, in addition to macro-financial variables, heightened uncertainty and deteriorating business confidence played an important role. ‘In contrast, contribution of interest rates has been minor’, it said rejecting the corporates’ contention on rates, also buttressed by the finance ministry expressing itself in favour of duty cuts.

IMF staff studies point out that high and persistent food and fuel inflation have had large second round effects on core inflation.  Therefore, the monetary policy would need to maintain tight policy stance in order to reduce inflation durably. This is another area of debate within the country as to how far the monetary policy instrument could really reverse inflation and it also extends to the broader area of monetary policy objective – whether it should be tied to inflation with CPI as benchmark – following the report of the committee headed by Urjit R Patel, Deputy Governor of RBI.
For poverty reduction and inclusive growth, the IMF staff report says while robust economic growth remains the major driver, social expenditure, spending on education and educational attainment rates are important for fostering inclusive growth. At the same time, macro-financial stability with particular attention to inflation risks is ‘critical’ for sustained inclusive growth.

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