New Delhi: The Indian economy, expected to grow at a faster rate than estimated earlier, is facing new challenges in the form of high inflation and a rising current account deficit. Sanjaya Panth, senior resident representative to India of the International Monetary Fund (IMF), shared the fund’s view on ways India could tackle the new growth-inflation conundrum. Edited excerpts:
What are the key macro-economic challenges India is facing now that need to be addressed immediately?
India is doing very well now globally. It is (one of the) fastest growing economies in the world now. Along with that come certain challenges. On one side, we are seeing a little bit of challenge on inflation; this has been something the Reserve Bank of India (RBI) and the government in general have been very aware of. RBI continues to think that risks are on the upside and we concur with that assessment. So inflation continues to be a challenge.
Tackling growth: IMF’s Sanjaya Panth says the fact that inflation pressure has increased outside of food and fuel points to capacity constraints that have emerged in a number of areas in the economy. Pradeep Gaur/Mint
There is a clear medium-term path of fiscal consolidation that has been laid out first by the Finance Commission and later by the government itself in the budget for this year. It is important to continue on that path. The deficit is expected to come down this year. There have been some large revenue receipts that have been anticipated. Expenditure has also kept up, but overall deficit is expected to come down this year and it is important for that to continue in the medium term. It is good to consolidate and save as much as possible so that you create fiscal space going forward.
There is concern that high inflation is increasingly becoming a structural problem for the economy.
To some extent the food element of it has become a well-entrenched part of inflation in India. Part of it is (because of) demand-supply mismatch and part of it is higher incomes. At the same time, one needs to make a clear distinction between two things. One is that this is not a problem in India alone. We see a more generalized problem of inflation in the sense that inflation expectation has kept up. If you look at core inflation, which takes out food and fuel, that has gone up as well. So, I think, to look at the structural side of inflation as you mentioned is not really the issue at hand. The issue at hand is core inflation, which is something that needs to be addressed continuously.
IMF has also been focusing on the possibility of overheating in the Indian economy. Could you elaborate on that?
Yes. The fact that inflation pressure has increased outside of food and fuel points to capacity constraints that have emerged in a number of areas in the economy. Our estimation for long-term growth now is in the order of around 8-8.5%. But as you can see our projection for this year is higher than that already (8.75%). So that already points in many ways to the fact that India is producing at capacity. The inflation that you are seeing is a manifestation of that in many ways. You will also see other pressures emerge.
For example, if you look at PMI (Purchasing Managers’ Index) surveys, you will see that there is a lot of inbuilt price pressure; the input prices have come up quite a bit; other prices are also going up, particularly last month. The margin between input and output price also continues to narrow. So that shows there is a lot of pressure building within the system. So those are the kind of concerns we are expressing on the capacity side.
You want RBI to continue tightening interest rates. You have also identified domestic demand, investment and infrastructure as key growth drivers. Is there going to be a problem in finding a balance between trying to stimulate domestic demand and the need for further monetary tightening?
I think you are looking at two separate issues in the sense that there is no reason that over the medium term you need to have high inflation to have high growth. There is no trade off in the medium term. In the short run, however, if you want to tighten monetary policy, it can dampen the economic activity and a trade off is possible.
How much further monetary tightening can the economy accommodate?
Well, I think this is something that I would rather not say at this point because I do not have the answer. This is something that RBI and the government need (to) continue to look into. It is a question of timing. It is a question of looking at the data and what it tells you. There may be further need; there may not be further need. We are fairly confident that RBI will continue looking at the situation closely and take actions as warranted.
...but there is scope for further tightening, which is what the IMF report says.
Our sense is that interest rates are still negative right now in real terms. That points to further space. And overall risks are still on the upside. So one would have to say that the balance of risk is certainly to continue to combat inflation.
In a year when the revenue collections have been fairly good and there have been significant one-time gains through 3G auction, do you think government will be targeting lower deficits than budgeted for?
That is something the government will be better placed to answer. Our advice has been, because you have certain larger revenues and you have this medium-term path, it would be good to bring some consolidation forward to create room earlier than later on. That will help achieve targets in the medium term and make life easier. The government feels strongly that there are lot of uses of the money in the economy right now including infrastructure and it is right in that respect. The difference between the government’s view and ours is a question of pace and timing. It is not a question of amount and when. Both the government and we agree on the medium-term path that has been laid out in the budget.
For next fiscal, 2011-12, IMF is projecting a growth rate of 8% for India, lower than the 8.75% projection for this year. Why?
There are two or three reasons for that. One has to remember that this year has been an unusual year for number of reasons. There is a huge bounce-back from the crisis as a result you will see even in non-agricultural GDP (gross domestic product), there is a larger increase than normal because there was excess capacity for a while. Then, there is the fact that last year we had a drought and, hence, the agriculture sector is expected to perform very well. This will not be true next year again. Global growth is also expected to be marginally lower next year. So it is a combination of all of those things, but the first two in particular.
Over the last few months, the extent of current account deficit bridged through portfolio flows has increased. What is IMF’s take on that?
India’s current account deficit has increased and needs to be monitored carefully. But at the same time, it is being very easily financed because of the interest in India. To the extent it does increase the risk of a certain outflow. But India is starting with a very strong position with (forex) reserves (being) very high and short term debt, very low.
One should also not look at all investors with the same lenses. To the extent that there is more market reforms, deepening of financial markets and continuity of policy stability, then even the portfolio inflows tend to be more stable than they would be otherwise. We have seen that in India. There is increased faith in the Indian story and the very deft handling of the Indian economy by the authorities reassures investors. FDI (foreign direct investment) inflows were strong throughout the crisis; there is no reason to believe that it will not be strong going forward. So I will not make too much of the data for one or two quarters.