IMF Executive Board Concludes 2017 Article IV Consultation with India

February 22, 2017

On January 25, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation 1 with India.

The Indian economy has recorded strong growth in recent years, helped by a large terms of trade gain, positive policy actions including implementation of key structural reforms, a return to normal monsoon rainfall, and reduced external vulnerabilities. Inflation has remained low after the collapse in global commodity prices, a range of supply-side measures, and a relatively tight monetary stance. Fiscal consolidation at the Union government level resumed in FY2016/17, and has been complemented by measures to enhance the quality of public spending. External vulnerabilities are in check, with the current account deficit expected to remain compressed and international reserves standing at US$360 billion as of late-December 2016 (around 8 months of import cover). Persistently-high household inflation expectations and large fiscal deficits remain key macroeconomic challenges, which limit policy space for supporting growth through demand measures. Furthermore, excess capacity in key industrial sectors and strains in financial and corporate sector balance sheets remain a drag on private investment, and weak external demand continues to constrain India’s exports.

The post-November 8, 2016 cash shortages and payment disruptions caused by the currency exchange initiative have undermined consumption and business activity, posing a new challenge to sustaining the growth momentum. Growth is projected to slow to 6.6 percent in FY2016/17, then rebound to 7.2 percent in FY2017/18, due to temporary disruptions, primarily to private consumption, caused by cash shortages. Tailwinds from a favorable monsoon, low oil prices and continued progress in resolving supply-side bottlenecks, as well as robust consumer confidence, will support near-term growth as cash shortages ease. The investment recovery is expected to remain modest and uneven across sectors, as deleveraging takes place and industrial capacity utilization picks up. With temporary demand disruptions and increased monsoon-driven food supplies, inflation is expected at about 4.75 percent by early 2017—in line with the Reserve Bank of India’s inflation target of 5 percent by March 2017. Supply-side reforms, particularly in agriculture, continued fiscal consolidation, and relieving impediments to monetary transmission are crucial to retain low inflation in the medium term. The current account deficit is expected widen to about 2 percent of GDP over the medium term as domestic demand strengthens further and commodity prices gradually rebound. The FY2016/17 Union Budget deficit target of 3.5 percent of GDP (equivalent to 3.8 percent of GDP in IMF terms) will likely be achieved. Continued progress in reforms bodes well for a marked improvement in medium-term prospects, with the adoption of the Goods and Services Tax poised to raise India’s medium-term GDP growth to above 8 percent.

Economic risks are tilted to the downside. On the external side, despite the reduced imbalances and strengthened reserve buffers, the impact from global financial market volatility could be disruptive, including from U.S. monetary policy normalization or weaker-than-expected global growth. In the absence of disruptive global financial volatility, slower growth in China, Europe and the United States would have only modest adverse spillovers to India, given weak trade linkages. A key domestic risk stems from the government’s currency exchange initiative, where the near-term adverse economic impact of accompanying cash shortages remains difficult to gauge, while it may have a positive economic impact in the medium term. Domestic risks also flow from a potential further deterioration of corporate and public bank balance sheets, as well as setbacks in the reform process, including in GST design and implementation, which could weigh on domestic demand-driven growth and undermine investor and consumer sentiment. On the upside, larger than expected gains from GST and further structural reforms could lead to significantly stronger growth; while a sustained period of continued-low global energy prices would also be very beneficial to India.

Executive Board Assessment 2

Executive Directors noted India’s strong economic performance of the past few years and commended the authorities for their strong policy actions, including continued fiscal consolidation and an anti-inflationary monetary policy, which have underpinned macroeconomic stability. Directors recommended continued vigilance to potential domestic and external shocks, and urged the authorities to further advance economic and structural reforms to address supply bottlenecks, raise potential output, create jobs, and ensure inclusive growth.

Directors supported the authorities’ efforts to clamp down on illicit financial flows, but noted the strains that have emerged from the currency exchange initiative. They called for action to quickly restore the availability of cash to avoid further payment disruptions, and encouraged prudent monitoring of the potential side-effects of the initiative on financial stability and growth.

Directors acknowledged the authorities’ strong policy push for cleaning up bank balance sheets and welcomed legislation establishing the new bankruptcy code. Nonetheless, they noted that elevated corporate sector risks and heightened levels of non-performing assets in public sector banks continue to pose risks to banks’ soundness. Directors emphasized the importance of augmenting capital buffers and continued governance reform of these banks, strengthening the resolution regime for distressed bank assets by augmenting the capacity of newly established mechanisms, and further measures to develop corporate debt markets, as key to enhancing the financial system’s ability to contribute to growth.

Directors welcomed the completion of the institutional foundation of India’s flexible inflation targeting regime, in particular the formation of the Monetary Policy Committee. Directors agreed that given sticky and elevated household inflation expectations and food supply constraints, continued vigilance on upside risks to inflation is needed. Directors recommended that the Reserve Bank of India stand ready to raise the policy rate should inflationary pressures gather pace. They 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. Directors noted that India’s international reserves are assessed to be adequate, and emphasized that the flexible exchange rate should continue to act as a key shock absorber.

Directors emphasized that continued fiscal consolidation is critical to bring down the ratio of public debt to GDP. They noted that fiscal consolidation will enable a gradual phasing-out of financial repression, which will help price stability and lower the cost of credit for the private sector, and rebuild space for counter-cyclical policy responses in the future. Implementation of a robust goods and services tax, given its growth enhancing effects, and further subsidy reforms, should be key pillars of the authorities’ fiscal consolidation strategy. Directors encouraged the authorities to build on the fuel subsidy reforms and advances in financial inclusion to implement better targeting and more efficient delivery of the remaining subsidies and social spending programs.

Directors welcomed the authorities’ strong progress on structural reforms, and encouraged them to prioritize labor market reforms at both the center and state levels. They also urged continued efforts to reduce poverty and inequality, increase female labor force participation, and make further efforts to improve financial inclusion. They noted the importance of further trade liberalization and enhancing the business environment to help boost exports and attract greater FDI flows

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 .

India: Selected Economic Indicators, 2012/13–2017/18 1/

I. Social Indicators

GDP (2015/16)

Poverty (percent of population)

Nominal GDP (in billions of U.S. dollars):

2,073

Headcount ratio at $1.90 a day (2011):

21.2

GDP per capita (U.S. dollars):

1,581

Undernourished (2015):

15.2

Population characteristics (2015/16)

Income distribution (2011, WDI)

Total (in billions):

1.31

Richest 10 percent of households:

30.0

Urban population (percent of total):

33

Poorest 20 percent of households:

8.2

Life expectancy at birth (years):

68.0

Gini index (2011):

35.2

II. Economic Indicators

2012/13

2013/14

2014/15

2015/16

2016/17

2017/18

Proj.

Proj.

Growth (in percent)

Real GDP (at market prices)

5.6

6.6

7.2

7.6

6.6

7.2

Industrial production

1.4

0.1

2.8

2.0

…

…

Prices (percent change, period average)

Consumer prices - Combined

9.9

9.4

5.9

4.9

5.1

4.7

Saving and investment (percent of GDP)

Gross saving 2/

33.8

33.0

33.0

31.3

30.0

29.9

Gross investment 2/

38.6

34.7

34.2

32.4

31.1

31.3

Fiscal position (percent of GDP) 3/

Central government overall balance

-5.1

-4.6

-4.2

-4.1

-3.8

-3.7

General government overall balance

-7.5

-7.6

-7.3

-7.0

-6.8

-6.6

General government debt 4/

69.1

68.0

68.3

69.8

69.7

68.6

Structural balance (% of potential GDP)

-7.4

-7.5

-7.2

-6.9

-6.7

-6.5

Structural primary balance (% of potential GDP)

-2.9

-2.8

-2.5

-2.0

-1.8

-1.7

Money and credit (y/y percent change, end-period)

Broad money

13.6

13.4

10.9

10.5

12.0

13.4

Credit to private sector

13.5

13.7

9.3

11.1

10.5

12.3

Financial indicators (percent, end-period)

91-day treasury bill yield (end-period) 5/

8.2

8.9

8.3

7.3

5.9

…

10-year government bond yield (end-period) 5/

8.0

8.8

7.8

7.5

6.2

…

Stock market (y/y percent change, end-period) 6/

8.4

18.7

24.9

-9.4

0.0

…

External trade 7/

Merchandise exports (in billions of U.S. dollars)

306.6

318.6

316.5

266.4

274.1

301.0

(Annual percent change)

-1.0

3.9

-0.6

-15.9

2.9

9.8

Merchandise imports (in billions of U.S. dollars)

502.2

466.2

461.5

396.4

407.8

453.8

(Annual percent change)

0.5

-7.2

-1.0

-14.1

2.9

11.3

Terms of trade (G&S, annual percent change)

-0.2

2.2

3.2

6.5

0.9

-1.5

Balance of payments (in billions of U.S. dollars)

Current account balance

-87.8

-32.3

-26.8

-22.1

-24.1

-34.0

(In percent of GDP)

-4.8

-1.7

-1.3

-1.1

-1.1

-1.4

Foreign direct investment, net ("-" signifies inflow)

-19.8

-21.6

-31.3

-36.0

-38.1

-40.2

Portfolio investment, net (equity and debt, "-" signifies inflow)

-26.9

-4.8

-42.2

4.1

-2.7

-13.9

Overall balance

-3.8

-15.5

-61.4

-17.9

-15.4

-29.4

External indicators

Gross reserves (in billions of U.S. dollars, end-period)

292.0

304.2

341.6

360.2

375.6

404.9

(In months of imports) 8/

6.4

6.7

8.5

8.6

8.1

7.9

External debt (in billions of U.S. dollars, end-period)

409.4

446.2

474.7

485.0

512.3

553.2

External debt (percent of GDP, end-period)

22.4

23.9

23.3

23.4

22.9

22.7

Of which: Short-term debt 9/

9.0

9.9

9.1

9.3

9.3

9.0

Ratio of gross reserves to short-term debt (end-period) 8/

1.8

1.7

1.8

1.9

1.8

1.8

Debt service ratio 10/

5.9

5.9

7.6

8.8

7.8

7.9

Real effective exchange rate (percent change) 11/

(based on annual average level)

-2.4

-2.0

6.9

5.8

0.5

…

Exchange rate (rupee/U.S. dollar, end-period) 5/

54.4

61.0

62.6

66.6

68.4

…

Memorandum item (in percent of GDP)

Fiscal balance under authorities' definition

-4.9

-4.3

-4.0

-3.9

-3.5

-3.5

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; Bloomberg L.P.; World Bank, World Development Indicators;

and IMF staff estimates and projections.

1/ Data are for April–March fiscal years.

2/ Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions.

3/ Divestment and license auction proceeds treated as below-the-line financing.

4/ Includes combined domestic liabilities of the center and the states, and external debt at year-end exchange rates.

5/ For 2016/17, as of 30 November 2016.

6/ For 2016/17, year-to-date as of 2 December 2016.

7/ On balance of payments basis.

8/ Imports of goods and services projected over the following 12 months.

9/ Short-term debt on residual maturity basis, including estimated short-term NRI deposits on residual maturity basis.

10/ In percent of current account receipts, excluding grants.

11/ For 2016/17, year-to-date as of November 2016.


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