Rough ride for growth in 2018

It is time for the Modi Government to rise above mythical assumptions and go on hard slog to restore growth and stability to the 2-trillion dollar economy. Judging from a brutal, if benignly worded, assessment from IMF on the state of a post-demonetisation economy, India needs to get its act together on a broad front - fiscal, structural, inflationary, and external – as risks abound.

The IMF Report, after the most recent Article IV consultations, does not under-rate India's current difficulties, partly self-inflicted, or understate its efforts directed at fiscal consolidation and reforms like GST. But "persistently-high household inflation expectations and large fiscal deficits" are viewed as key macroeconomic challenges, limiting policy space for supporting growth through demand measures.

Also cited are excess capacity in key industrial sectors, strains in financial and corporate sector balance sheets remaining a drag on private investment, and weak external demand constraining India's exports.

On Demonetisation – regarded in Modi Government as a crowning achievement – IMF view holds cash shortages, and payment disruptions caused by the initiative have "undermined consumption and business activity, posing a new challenge to sustaining the growth momentum."

While supporting the authorities' efforts to clamp down on illicit financial flows, it points to the "strains that have emerged from the currency exchange initiative" and called for "action to quickly restore the availability of cash to avoid further payment disruptions".

The suggestion for "prudent monitoring of the potential side-effects of the initiative on financial stability and growth", must also be seen in the context of the current over-drive of the Government with incentives to promote digital payments system, irrespective of ground realities.

IMF has retained its January update estimate of GDP, lowered down to 6.6 per cent in FY2016/17, as also its rebound to 7.2 per cent in FY2017/18. These revisions are due to temporary disruptions, primarily to private consumption, "caused by cash shortages".

It is assumed that low oil prices (so far in a rising commodity market), easing of supply-side bottlenecks and robust consumer confidence will support near-term growth "as cash shortages ease". Investment recovery, however, is expected to remain "modest and uneven" across sectors, as deleveraging takes place and industrial capacity utilisation picks up, according to IMF.

On inflation, with temporary demand disruptions and increased monsoon-driven food supplies, inflation is expected at about 4.75 per cent by early 2017—in line with RBI's target of 5 per cent by March 2017. But IMF Report calls for continued vigilance against upside risks to inflation, given "sticky and elevated" household inflation expectations and food supply constraints.

In this context, IMF Directors have even recommended that RBI "stand ready to raise the policy rate should inflationary pressures gather pace". At its February 8 meeting, the Monetary Policy Committee/RBI decided to shift the policy from accommodative to a neutral stance in view of possible price pressure build-up and kept the repo (key lending rate) unchanged at 6.25 per cent.

IMF also stressed the importance of continued agricultural reforms aimed at boosting food supplies as well as maintaining fiscal adjustment to support monetary policy in achieving low and stable inflation. While India's international reserves are assessed to be adequate, (360 billion dollars end-December), it was emphasised that the flexible exchange rate should continue to act as a key shock absorber.

On public finance, IMF considers the ratio of public debt to GDP it estimates at 69.7 per cent in fiscal 2017 is relatively high and needs to be lowered. Fiscal consolidation, it is pointed out, will enable a gradual phasing-out of financial repression, help price stability and reduce the cost of credit for the private sector.

While the budgeted fiscal deficit for 2016/17 of 3.5 per cent of GDP (but 3.8 per cent in IMF calculation excluding divestment and licence auction receipts) will likely be achieved, it notes the adoption of GST should aid continued consolidation effort in fiscal 2018. The Fund estimates Centre's fiscal deficit at 3.7 per cent of GDP for next fiscal (under its method of calculation) as against the budgeted 3.2 per cent.

The country's general (including States) government deficits are shown as -6.8 per cent and -.6.6 per cent for these two fiscal years. Besides GST, further subsidy reforms and continued progress in financial inclusion for better targeting of subsidies and social spending programmes are needed, it is pointed out. The Centre and States are also urged to prioritise on labour market reforms besides continued efforts to reduce poverty and inequality, increase female labour force participation, and make further efforts to improve financial inclusion. In other structural reforms, the emphasis is on further trade liberalisation and enhancing business environment to boost exports and attract greater FDI flows.

In calling attention to tasks ahead, IMF takes note of the economy's strong growth in recent years, helped by large terms of trade gain, positive policy actions including implementation of the main structural reforms, a return to normal monsoon rainfall, and reduced external vulnerabilities. Inflation had also remained low after the collapse in global commodity prices and a range of supply-side measures and appropriate monetary stance.

Nevertheless, IMF says, the economy may not be immune to spillovers from global financial developments. Though well-cushioned with strengthened reserve buffers, there could be "disruptive" impact from global financial market volatility including from U.S. monetary policy normalisation. (The Federal Reserve is expected to hike its 'funds rate' at its mid-March meeting).

Any slowdown in China or Europe and the United States may have only modest adverse effect on India, given weak trade linkages. But the IMF sees a key domestic risk in the aftermath of demonetisation, whose near-term negative economic impact accompanying cash shortages remains difficult to gauge, even if it may have a positive economic impact in the medium term.