‘High growth’ cannot shield challenges

Close on the heels of a politically-loaded Union Budget, the International Monetary Fund (IMF) has reminded India of key macro-economic challenges that may hinder growth – high household inflation expectations, still large fiscal deficits, and potential risks from weak corporate and bank balance sheets.

Though IMF economists concluded the customary Article IV consultations with India on February 12, and would have been left in no doubt about firm policy directions and confidence with which India is determined to overcome obstacles, domestic and the global headwinds, the Fund statement reflects some abiding concerns.

Not that IMF has failed to applaud the Modi Government’s positive policy actions and supply side management to hold inflation, driven down by low oil prices and appropriate monetary stance, but there is no mistaking that collapse of global oil prices underpinned improvements in the current account and fiscal positions and boosted economic activity in the country.

The IMF remains optimistic about the Indian growth story. Economists in the IMF have retained projections of growth at 7.3 percent in 2015/16 and 7.5 percent in fiscal 2017, (at market prices), supported by stronger domestic demand.  The Budget for 2016/17, however, assumes 11 percent growth at market prices on the basis of which all revenue and expenditure estimates are set.

How the Indian economy grows in the coming year, given the bleak outlook for the global economy itself and the financial markets remaining volatile with disruptive impact, would depend on how well Government manages to overcome the key challenges at home as well as risks down the road.

Finance Minister Arun Jaitley has acknowledged that growth in the coming year would have to come mainly from domestic demand but that fiscal policy space is limited for stimulating the economy. Left unsaid, monetary policy has to chime in to celebrate the budget.

There can be some comfort in IMF’s reference to revival of sentiment and the recent pick-up in industrial activity which enables an “incipient upturn” in private investment to help broaden the recovery. While Jaitley has again provided for some public investment for the coming year, IMF sees such infrastructure investment and government initiatives to tackle supply-side bottlenecks and repairing corporate and public bank balance sheets should also help crowd-in private investment.

Acclaiming the Budget, which has his handiwork, Prime Minister Modi has directed his Ministers to go out and sell the path-breaking exercise. For his part, Jayant Sinha, Minister of State for Finance, keeping up his narrative contends that everything having been done on the fiscal side, the “more extensive” monetary space should come into play. In other words, he is looking for a rate cut from the RBI.

For its part, the IMF has noted that RBI has achieved its target to bring inflation below 6 percent by January 2016 while consumer price inflation dynamics, underpinned by supply-side factors, should help achieve the goal of around 5 percent for March 2017 and monetary conditions at present remain consistent with achieving this target. There is no call for easing or hardening.

Low oil prices should help contain the current account deficit at around 1.5 percent of GDP in fiscal 2017 and the current year’s budget deficit target of 3.9 percent of GDP (equivalent to about 4.25 percent of GDP in IMF terms) will likely be achieved. While unexpected global developments cannot be factored in at present, IMF does not consider slower growth in China would have any serious impact on India beyond modest adverse spillovers, because of weak trade linkages.

But what may restrain growth are domestic risks, such as continued weaknesses in corporate financial positions and public bank asset quality, as well as setbacks in the reform process and these could weigh on growth, accelerate inflation and undermine sentiment, IMF assessment said.

IMF Directors, however, have commended India’s appropriate policy actions that—along with favorable terms of trade—have underpinned India’s improved economic performance and reduced external vulnerabilities. These included recent measures aimed at increasing public infrastructure spending, rationalizing subsidies, creating more flexible labor and product markets, and enhancing financial inclusion.

With improved macroeconomic management, India experienced large FDI inflows in 2015 and reserves stood at 350 billion dollars at December-end. The government had taken policy measures to help reduce fuel and fertilizer subsidies, continue with fiscal consolidation, bolster the financial system, and strengthen the business climate, all of which have helped enhance confidence in the economy.

India’s challenge is to sustain its growth momentum when private investment is showing few signs of revival. An increase in public infrastructure investment and government initiatives to unclog stalled investment projects, IMF notes, are helping bolster investor sentiment which should have a positive impact on private investment. And, with the global slowdown, India will have to continue to rely mainly on domestic demand as a key source of growth.

IMF considers GST a high priority and it would, together with reform of energy sector and labour markets, boost growth potential. Increasing capital buffers in public banks, which is manageable even in a severe stress scenario, and implementing governance reforms in public sector banks along with the new bankruptcy law, are of key importance to ensure the durability of the Indian growth recovery,” Paul Cashin, head of IMF Team on India has said.

On inflation, IMF report notes that household inflation expectations remain high, and breaking away from this pattern would likely require a prolonged period of low inflation. In the near-term, inflation risks stem from an unfavorable monsoon and expected wage increases of government employees as a result of a once-a-decade wage adjustment. The government’s strong fiscal consolidation efforts over the past several years signify its commitment to place India’s public finances on a solid footing.

Deregulation of diesel prices and levies on petroleum products provided a cushion against upward swings in oil prices. Apart from better targeting and further efficiency reforms, authorities need to pare back untargeted food subsidies, including by rationalizing the list of eligible beneficiaries and reforming the inefficient Food Corporation of India.

Notwithstanding steady progress in recent years, raising India’s growth rate and ensuring sufficient jobs will require deeper structural reforms - addressing long-standing supply bottlenecks, labor and product market reforms, and further improving the business climate. “To remain in the economic ‘sweet spot’, India must ensure the forward momentum of its program of economic reforms,” Cashin said.