India’s growth is projected at 8.75 per cent in 2010/11, “highest among the world” and it would moderate to about 8 per cent next year, IMF cites elevated inflation (in the range of 8.5 to 10.5 per cent) as a challenge which needs to be tackled by bringing “the real short-term interest rates in line with historical norms” to help contain inflation within the end-March target of 6.5 per cent. High inflation is attributed to little slack in the economy and structural factors affecting food prices.

Although policy rates have been successively raised, IMF says, the real interest rates are low and financing conditions have hardened only marginally. The Fund’s review notes that a “greater burden has fallen on monetary policy to cool the economy” in the absence of a more rapid withdrawal of fiscal stimulus at an earlier stage.

The IMF's annual assessment (Article IV consultation) provides a timely agenda for Government to mull over as it goes through with the exercises for the Union Budget for 2011-12 to be presented by the end of February. It says fiscal policies have remained accommodative, without fully exiting from the stimulus extended during the global crisis, and despite some consolidation, the fiscal deficit remains high. The Centre’s fiscal deficit is projected at 6.6 per cent in the current year (as against the budgeted 5.5 per cent of GDP) while the combined deficit (including states) would be 9.6 per cent of GDP.

Equally, there are strong signals for RBI which will announce its third quarter monetary policy review on January 25. IMF has welcomed the central bank's focus on strengthening financial stability including regulations in regard to real estate market. While India’s banking system is resilient and well capitalized, it said, monitoring asset quality would remain important, particularly as prudential norms for infrastructure are eased.

Budgetary reform is underlined in IMF’s staff report. Moving toward normal policy stance, IMF has suggested complete withdrawal of the counter-cyclical measures. Given the high level of government debt, existing strong domestic demand and large capital inflows, fiscal policy is the preferred method for tightening. Government has laid out an ambitious roadmap to reduce public debt and deficits and high growth is expected to contribute toward this goal as well.

The IMF endorses the objectives to raise public investment, especially in infrastructure, and to improve social outcomes. The challenge would be to make savings elsewhere to meet these objectives while adhering to the consolidation path. With the tax reforms, DTC and GST to be revenue neutral, the inevitable emphasis on cutting subsidies and improving the targeting of spending.

In view of buoyant economic growth, and of future deficit targets becoming more difficult to reach, there is merit in a further strengthening of the consolidation effort. Saving this year’s over performance in revenue and one-off receipts can help reconstitute the fiscal space, it said. IMF commended the first step in fuel price deregulation with petrol and hoped it held promise of further steps in this direction.

According to IMF analysis, India’s strong recovery is led by domestic demand, especially infrastructure investment, and supported by accommodative monetary and fiscal policies.. Growth has also benefitted from rebound in agriculture and a pick-up in private consumption as disposable incomes continued to rise. Infrastructure is expected to remain an important growth driver, and corporate investment is likely to accelerate, aided by conducive financing conditions and robust demand growth.

India's medium-term growth prospects are strong and sustaining it over an extended period would depend on reforms to facilitate infrastructure investment—such as deepening the corporate bond market and lowering the cost of doing business.. Improving social outcomes and infrastructure are two key pillars of the government’s strategy to achieve rapid and inclusive growth. Risks stem mainly from weaker global growth. Other challenges such as elevated inflation, fiscal consolidation and buoyant capital inflows warrant careful calibration of macroeconomic policies and the diligent pursuit of ongoing reforms, IMF said.

On capital flows on which IMF is now making a new study to set guidelines for member-countries, the current view is capital inflows can further spur investment but a surge could also complicate macroeconomic management if the inflows are above absorptive capacity. In that case, exchange rate flexibility would be the first line of defence. Reserve accumulation and macro-prudential measures, could also be employed. Absorptive capacity could also be improved by deepening financial markets or by liberalizing foreign direct investment (FDI), consistent with India’s gradual approach to capital account liberalization, IMF noted.

India plans to invest one trillion dollars on infrastructure, half of it from private capital, in the 12th plan (2012-17). Measures are being taken to increase availability of long term finance, such as developing corporate bond market but foreign savings would also be needed, in the short run, IMF said. To overcome obstacles in infrastructure development, IMF noted reform efforts in areas such as land acquisition and government clearances and stressed the importance of strong accountability and transparency over large infrastructure projects. Reforms should lower the cost of infrastructure, encourage private investment and allow more efficient use of public resources.

India has experienced an increase in current account deficit over the last year. IMF economists expect the deficit to reach around 50 billion dollars or 3.3 per cent of GDP in 2010/11 and 3.5 per cent next year. The deficit has so far been financed mainly by foreign direct investment and equity inflows, but the authorities need to keep an eye on the level of the current account deficit, they said pointing out that as the deficit rises, “so does the potential impact of a sudden stop or reversal of capital flows”.. FDI and portfolio flows in the current year are expected to total 23.6 billion and 31.8 billion dollars, respectively according to IMF estimates.
(IPA Service)