IMF has recommend that India substantively reforms areas such as land and labour markets to increase productivity, improve investments and create jobs
The International Monetary Fund’s (IMF) latest assessment of the Indian economy reiterates several of the multilateral institution’s key messages and policy prescriptions. The IMF has recommended that India substantively reforms areas such as land and labour markets to increase productivity, improve investments and create jobs. It has also called upon the government not to stray off the path of fiscal consolidation.
While the fund’s overall medium-term outlook on India is positive -- it dubbed the Indian economy as an "elephant starting to run" -- these messages are important especially in an election year and at a time when oil prices, a key risk to the economy, are rising, and global financial conditions are tightening.
Less than a month ago, the IMF trimmed its growth forecasts for India in its update to the World Economic Outlook. Economic growth is forecast at 7.3 percent for 2018-19 and 7.5 percent for the following fiscal year, about 0.3 percentage points lower than April's projections.
While consumption is expected to spur growth, the Fund has projected a rise in gross investment to GDP ratio to 32.2 percent this fiscal year and the next. Similarly, exports are also slated to grow 13.1 percent this fiscal — an optimistic assessment given the fears of a trade war.
But high oil prices would come to bite. For one, the IMF has projected consumer inflation at 5.2 percent for this fiscal and 4.8 percent the next, higher than the midpoint of the RBI's inflation target zone. Monetary tightening is a given. Second, the current account deficit is expected to rise to 2.6 percent of GDP this fiscal and a sharp drop in portfolio inflows projected means that the balance of payments would go into a deficit for the first time in several years.
Despite these optimistic projections about growth and investment, the IMF says that risks are tilted to the downside. The key among them is revenue shortfalls arising from the uncertainty in goods and service tax (GST) collections which will upset the fiscal deficit projections. Simplifying the GST rate structure and streamlining returns processing and refunds are important in this context. Remember, India’s debt to GDP ratio is close to 70 percent. This limits the fiscal space because the debt-to-GDP ratio is close to threshold that increase the likelihood of debt distress, the Fund noted. So fiscal consolidation is important not only in short term but also medium term.
The limited fiscal space also means that India has to focus on supply-side measures that increase productivity and revive credit growth. Although bank credit growth to the private sector is projected to improve to 13.6 percent this year, it is not a given owing to the precarious condition of public sector banks.
The IMF noted that this was holding back investment growth. Thus, addressing the twin balance sheet problem becomes important and it has highlighted this as another domestic risk. While the Insolvency and Bankruptcy Code and the RBI’s new bad loan recognition norms announced in February are positives, more needs to be done to boost investment demand further.
Addressing these domestic risks becomes all the more important, because the government has effectively no control over oil prices and tight global financial conditions which could reverse capital flows and raise external debt.
In the end analysis, while the IMF praises India for recent initiatives such as the bankruptcy code, the GST and flexible inflation-targeting framework, the fact remains that more needs to be done to achieve 8 percent-plus growth.That would require deep structural reforms such as repealing restrictive labour laws, liberalising trade further, and enable speedy land acquisition for infrastructure projects. Some of these may hurt certain special interest groups in the short-term even if there are long-term benefits, which the government may not risk in an election year.