India - Economic Update

In December, the IMF published their findings on the Indian economy following their most recent Article IV consultations.    This note summarises their key conclusions.

Summary

The Indian economy has rebounded from the pandemic, with real GDP rising by 8.7% YoY in FY2021/22.  Output has returned to pre-pandemic levels.  The IMF projects growth of 6.8% YoY in FY2022/23 and 6.1% YoY in FY2023/24.  Consumer prices are projected to rise by 6.9% YoY on average in FY2022/23, and by 5.1% YoY in FY2023/24.  The current account deficit is expected to rise to 3.5% GDP in FY2022/23, as a result of higher commodity prices and strengthening imports.

The following is a summary of the IMF’s economic forecasts, the risks of which, they say, are tilted to the downside:

The IMF has commended India on the measures taken to respond to the COVID pandemic, in particular fiscal measures to protect vulnerable groups and monetary policy tightening to address inflation.

They commented that, whilst public debt sustainability risks have increased, they are mitigated by debt characteristics.  Nevertheless, they recommend a more ambitious, well-communicated medium-term fiscal consolidation, anchored on stronger revenue mobilisation and improved expenditure efficiency, which leaves high-quality spending on infrastructure, education and health protected.

They recommend that additional monetary policy tightening should be carefully calibrated to balance inflationary objectives and their impact on activity.  As India’s external position is broadly in balance, they recommend that the exchange rate should continue to act as a shock absorber, and that foreign exchange intervention should be limited.

Corporate and financial sector balance sheets have improved. Nonetheless, in an environment of tightening financial conditions, they suggest the banks should be encouraged to build additional capital buffers and to recognise problem loans, and that targeted prudential rules and further reforms should be used to strengthen the system’s resilience.

The IMF have praised India’s achievements in digitalisation, which has done much to modernise the public sector, to improve tax compliance, to streamline the provision of government benefits and services, and to provide a platform for innovation.  Digitalisation has also done much to increase financial inclusion.

They see scope for further productivity gains if the digital divide is further reduced through improved access and literacy. Although India hosts 1.15 bn mobile subscriptions, and 98% of the population has access to at least a 4G network, 57% of Indians are not internet users, and non-users are disproportionately female, live in rural areas, and in less wealthy states.

In the arena of structural reforms, the IMF have suggested measures to increase female labour force participation and reduce youth unemployment.  They comment that strengthening governance and the regulatory framework would foster transparency and public accountability.  They believe reductions in tariffs would help deepen India’s integration in global value trains.

Economic Overview

Real GDP growth has recovered strongly from the pandemic, led by private consumption, investment and exports.

The current account has returned to deficit, as a result of domestic demand recovery and surging oil import costs.

Nonetheless, steady foreign direct investment and debt inflows have supported financial account surpluses, even though external shocks have triggered large portfolio investment outflows.

A low level of external debt, as well as adequate FX reserves, serve to mitigate external vulnerabilities.

The rupee has come under depreciation pressure, albeit to a lesser degree than some other EM currencies.  The real effective exchange rate has moved in a tight range since 2019.  Looking forward, the IMF believe a flexible exchange rate should continue to act as the first line of defence in absorbing external shocks.

Inflation has risen in line with G-20 peers and has remained above the RBI’s upper band of 4% +/- 2%.  Core inflation is “sticky”.  In September, headline CPI rose by 7.4% YoY, and core inflation, excluding food and fuel, was 6%.  Inflation expectations, however, remain relatively well-anchored.

Monetary policy has been tightened through higher policy rates and liquidity absorption, and there has been some early reversal in pandemic-related easing.

Fiscal Policy

The fiscal deficit narrowed in FY2021/22, as pandemic-related measures were phased out and revenues recovered.  Although there are significant variations in debt burdens at the state level, in aggregate their deficit has declined to close to the medium-term target of 3% GDP.

India has reaffirmed its 4.5% GDP central government deficit target by FY2025/26.  This implies a general deficit of 7.5% GDP.  However, with debt/GDP at 84%, and gross financing needs of 15% GDP, debt sustainability risks have increased.

The IMF think consolidation should be more ambitious, targeting an extra 1% GDP by FY 2027/28, which would reduce debt/GDP to around 80%.  On the revenue side, reversing fuel excise cuts, further broadening corporate and personal income tax bases, simplifying the GST structure, and improvements in administration would all help to minimise India’s tax gap, estimated at 5% GDP.

Subsidies have fallen, but they remain elevated.  Improving expenditure efficiency is possible through greater usage of the Direct Benefit Transfer system to reduce leakages, and through reforms of electricity tariffs and of the electricity distribution companies.

In aggregate, capital spending exceeded its pre-pandemic average in FY2021/22.

Within this, central government spending exceeded its budget; however, performance has been patchy, particularly at the state level, and the IMF have cautioned that growth-enhancing expenditure risks being under-executed without a clear medium-term consolidation strategy.

Financial Sector Policies

Pandemic-related measures have contributed to improving the health of firm balance sheets and have supported credit flow to households and MSMEs.

The recovery in bank credit is common across all sectors, although lending by public sector banks is subdued.

Capital buffers have increased …

… and NPAs have been declining, although the banks’ aggregate NPA ratio remains high by international standards.

The IMF hav cautioned that, thus far, the impact of the reforms of the Insolvency and Bankruptcy Code and the launch of the National Asset Reconstruction Company (NARCL) have been limited.  The NARCL is expected to purchase about 28% of total bank gross NPAs, but no purchases had occurred before the end of September, and initial purchases are to cover fully provisioned NPAs, which will have limited impact on banks’ balance sheets.

The IMF believe there needs to be a further shift in facilitating the exit of non-viable firms, and in encouraging banks to build capital buffers and recognise NPLs.   As public banks continue to underperform their competitors, further reforms in the sector, including privatisation, remain priorities.

Climate Change Policies

Climate change and air pollution are reducing productivity and are damaging vulnerable regions and sectors such as agriculture, forestry, and fishing.

Pollution from burning fossil fuels is a major, and growing, source of premature deaths.

Total greenhouse gas emissions from coal are rising and represent around 70% of emissions.

India aims to lower emissions intensity/GDP by 45% from 2005 levels and to have 50% installed non-fossil-fuelled electric power capacity by 2030.  At COP26, it further committed to reaching NetZero by 2070.

According to the IMF, India is on-track to meet the first set of targets, but more ambitious policy efforts are needed for NetZero.

The IMF cautions that, if India chooses to concentrate its efforts on renewable energy subsidies only, the costs will be substantial, perhaps as much as 2.3% GDP by 2030, resulting in GDP being 2.1% lower.  By contrast, according to their models, if subsidies are combined with higher coal tariffs and a broad carbon tax, revenue would increase by 0.7% GDP.  The revenue could be spent on compensating the poorest, which would be progressive, and the impact on output would be a more modest 0.3% GDP.

Otherwise, the IMF is suggesting consideration be given to scaling up electricity storage, to improving the co-ordination of the flow of power between the distribution companies, to the roll-out of infrastructure for EVs, to subsidies to boost renewable capacity, and to a gradual move towards carbon pricing.  India is in the process of designing a carbon credit trading scheme.

For full details of the IMF’s Article IV report, please use the following link to its website:

https://www.imf.org/en/countries/ind?selectedfilters=Article%20IV%20Staff%20Reports#whatsnew