ISSN 2330-717X

IMF Executive Board Concludes 2019 Article IV Consultation With India

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On November 25, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with India. The staff report and the macroeconomic projections are based on data available through October 16, 2019.

India has been among the fastest-growing economies in the world over the past few years, lifting millions out of poverty. However, growth slowed to 5.0 percent in the April-June 2019 quarter (y/y), a six-year low. The deceleration of consumption and investment was exacerbated by weaknesses in the non-bank financial sector and corporate and environmental regulatory uncertainty.

Weak demand in conjunction with continued low food prices—thanks to successive normal monsoon rainfall and agricultural sector reforms—caused average inflation to moderate to a multi-year low of 3.4 percent in FY2018/19. Through August, inflation remained below the mid-point of the Reserve Bank of India (RBI)’s medium-term inflation target band of 4 percent ± 2 percent.

After rising through late 2018, external vulnerabilities eased in the first three quarters of 2019, on lower oil prices and renewed portfolio inflows. In FY2018/19, the current account deficit (CAD) widened to 2.1 percent of GDP, on a rising oil import bill. Foreign direct investment (FDI) financed about half of the CAD. The rupee depreciated by about 3.4 and 5.9 percent on average in real and nominal effective terms in FY2018/19, also reflecting portfolio outflows in mid-2018. The U.S. dollar value of non-oil merchandise exports expanded by 6.6 percent, broadly maintaining India’s global export market share. Gross reserves declined by US$12 billion during FY2018/19 to US$413 billion (7 months of imports), while the net forward position fell by US$34 billion. Gross reserves rose to US$429 billion by end-August 2019 on renewed portfolio inflows and they remain adequate. India’s external debt remains low at 19 percent of GDP.

Macro-financial risks from banking sector weaknesses have decreased somewhat, and steps have been taken to enhance monitoring of NBFCs and alleviate liquidity pressures faced by some NBFCs. Capital injections from the government budget and the initial results of the implementation of the Insolvency and Bankruptcy Code (IBC) have improved public sector banks (PSBs) capital position and asset quality. The plan to merge several PSBs reduces their number to 12 but does not change the large presence of the government in the banking system. The growth of bank credit decelerated to 10 percent (y/y) in August 2019, from 14 percent (y/y) in December 2018.

Despite a shortfall in revenues relative to ambitious targets, the central government broadly adhered to its headline fiscal deficit objective. As a result, there was a small improvement in the on-budget fiscal balance in FY2018/19. This was accomplished through substantial on-budget revenue-expenditure compression, facilitated by financing some obligations off budget. While the headline general government fiscal deficit narrowed meaningfully, thanks in part to a decline in the fiscal deficits of the states, the public sector borrowing requirement (PSBR) remained high. The PSBR includes borrowing by most central public sector undertakings (PSUs, borrowing by state PSUs and by local governments is not included because of data unavailability).

The path of the PSBR in recent years suggests that fiscal policy has been more accommodative than what is implied by the path of the general government deficit. This also explains why India’s general government debt has remained high, at about 69 percent of GDP. But India’s debt profile is conducive to debt sustainability, with debt largely held by residents, denominated in domestic currency, and with relatively long maturity. The FY2019/20 central government budget envisages a reduction in the fiscal deficit of 0.1 percent of GDP (a reduction by 0.2 percent of GDP in the structural primary balance, both IMF definition) but is again based on overly optimistic revenue targets, and the recent reduction of corporate income tax rates makes achieving the budget targets increasingly unlikely.

The macroeconomic outlook is more subdued and uncertain than in recent years. Growth is projected at 6.1 percent in FY2019/20. Investment and private consumption are expected to firm in the second half of the fiscal year. This is expected to be supported by the lagged effects of monetary policy easing, recent measures to facilitate monetary policy transmission and address corporate and environmental regulatory uncertainty, and government programs to support rural consumption being rolled out. Over the medium term, growth is projected to gradually rise to its medium-term potential of 7.3 percent on continued commitment to inflation targeting, gradual macro-financial and structural reforms, including implementation of reforms initiated earlier, such as the Goods and Services Tax (GST) and the Insolvency and Bankruptcy Code (IBC), as well as ongoing steps to liberalize FDI flows and further improve the ease of doing business.

Inflation is projected to remain around 3.4 percent with the effect of subdued demand broadly offsetting dissipating base effects of low food prices. The current account deficit is projected to narrow marginally, to 2.0 percent of GDP. The balance of payments would return to surplus, on returning capital inflows thanks to more accommodative global financial conditions. The rise in protectionism and retreat from multilateralism could affect India directly through the trade channel and indirectly through confidence effects and related effects on financial markets. While there may be trade diversion toward India from the U.S.-China tariff escalation, the macroeconomic impact is expected to be small given India’s relatively low trade openness and less diversified exports base.

Risks to the outlook are tilted to the downside. Key domestic risks include tax revenue shortfalls and delays in structural reforms. Credit growth could also remain subdued, as there is a perception of increased risk aversion among banks and implementation of the recently announced PSB consolidation could divert focus and weigh on near-term credit growth. The main external risks pertain to higher oil prices, a sharp rise in risk premia in global financial markets, and rising protectionism globally.

Executive Board Assessment [2]

They noted that India’s rapid economic expansion in recent years has lifted millions of people out of poverty. However, in the first half of 2019 a combination of factors led to subdued economic growth in India. With risks to the outlook tilted to the downside, Directors called for continued sound macroeconomic management. They saw an opportunity with the strong mandate of the new government to reinvigorate the reform agenda to boost inclusive and sustainable growth.

Directors noted that a credible medium‑term fiscal consolidation path driven by subsidy‑spending rationalization and tax‑base enhancing measures is needed to reduce debt, free up financial resources for private investment, and reduce the interest bill. Some Directors advocated that automatic stabilizers should be allowed to operate in the short run. Directors called for more robust revenue projections and enhanced fiscal transparency and budget coverage.

Directors recommended that near‑term policies to address cyclical weakness focus on monetary policy and broad‑based macro‑structural reforms. In this regard, they welcomed the monetary policy easing undertaken so far this year and recommended that an easing bias be maintained at least until the projected recovery takes hold.

Directors noted that inflation targeting has contributed to macroeconomic stability by better anchoring inflation expectations, thus helping improve the economic well‑being of low‑income households. Continued action is needed to improve the monetary transmission mechanism to enhance the effectiveness of monetary policy and enable the central bank to achieve the medium‑term inflation target on a sustained basis. Directors also welcomed the authorities’ commitment to maintain exchange rate flexibility. They noted that foreign exchange intervention should continue to be two‑way and limited to disorderly market conditions.

Directors welcomed the steps taken to tackle the twin bank and corporate balance sheet problem but noted the continued challenges of the financial sector. They recommended that the recently announced public sector bank merger plan be accompanied by deep operational restructuring and far‑reaching governance reforms in order to improve efficiency, risk management, and credit allocation. Directors welcomed the strengthened monitoring and regulation of non‑bank financial companies and recommended enhancing the availability of timely and granular data to help restore confidence in the sector. Directors urged further follow‑up on the FSAP recommendations.

Directors commended the authorities’ concerted efforts to strengthen the business climate. These efforts need to be complemented by continued labor, product market, land, and other reforms aimed at increasing labor market flexibility, enhancing competition, and reducing the scope for corruption. This will help harness India’s demographic dividend by creating more and better jobs for the rapidly‑growing labor force and enhancing female labor force participation. Directors also welcomed the important progress that has been made in strengthening the supply side of the economy through large infrastructure investments. They noted that land reform remains essential to raise agriculture sector productivity and achieve the authorities’ ambitious infrastructure development targets. Directors also encouraged further trade and investment liberalization.


[1] Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

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