The International Monetary Fund (IMF), while maintaining its growth projection for India at 8.75% for 2007-08, has flagged the immediate need for fiscal consolidation and structural reforms to achieve “inclusive” growth in the face of growing income inequalities.
“The increase in income and wealth inequality is potentially much larger, as the prices of major sources of wealth, held by a small segment of the population, have risen sharply,” IMF said in its latest assessment of the Indian economy.
The Fund has also cautioned against an upside pressure on prices, revising inflation forecast for the year to 3.9%.
Despite impressive revenue performance, the Fund said, “fiscal consolidation has stalled and public debt remains high, squeezing the fiscal space needed for public investment in physical and social infrastructure.”
This is important as pressures on skilled wages as well as slowing consumption by the bottom half of the population are helping to widen income inequality, “potentially eroding support for growth-oriented reforms”, IMF said in its report on the latest Article IV consultation with the government of India on 23 January.
Under Article IV of IMF’s Articles of Agreement, IMF conducts an economic review of member countries and engages in discussions with the policy planners every year.
While cautioning on inflation, the Fund feels that the rupee is in line with fundamentals, and has advised against using further capital controls for macroeconomic management as it could adversely affect investment and growth.
Instead, a flexible rupee with sufficient intervention to curb short-term volatility would be the most effective way to address the triple problem of exchange rate stability, monetary independence and financial openness, the report argues.
Surging capital inflows have more than offset the current account deficit (projected at about 1.5% of gross domestic product or GDP in 2007-08, versus a capital account surplus of 9.5% of GDP). This has impacted the rupee as well as prices, resulting in the Reserve Bank of India following a tight credit policy, the report said.
The appreciation of the rupee, about 11% against the dollar over January-November 2007, has led to strong calls to support the export sector.
Acknowledging that some industries were experiencing the lowest export growth and making losses, the Fund said those were industries with very low import content and high labour intensity. In short, these industries had enjoyed significant government protection and failed to become efficient and competitive. In contrast, services exports and more capital-intensive manufacturing exports have been expanding more briskly, the report said. The solution, according to IMF, was to initiate more structural changes--labor market reforms and upgrading infrastructure to bolster productivity and lower costs for labour intensive sectors so that those too can adjust to the stronger currency.
Resident representative Kalpana Kochchar said: “We do not see this (the rupee’s rise) as undercutting competitiveness, but rather as an equilibrium phenomenon reflecting India’s strength.”
India’s total factor of productivity growth averaged about 3% in recent years, it said, compared with peak decade averages of 2% for Japan or newly industrialized countries in the past four decades.
Rajesh Chadha, principal economist, National Council of Applied Economic Research, agreed that “the problems of textile exports have less to do with the rupee’s rise and more with the government’s reservation policy which tied them to the small scale sector in the 90s and constrained their adoption of global efficiency standards.”
The Fund said that “vigilance was needed to guard against overheating risks, further progress in reducing public debt and addressing structural obstacles to job-intensive, inclusive growth.”
In 2006-07, the central government issued bonds amounting to 1% of GDP to oil companies and the Food Corporation of India to offset subsidy-related losses.
IMF treats this as off-budget expenditure. Including these bond issues, the Fund calculates the government deficit at about 7.25% of GDP, compared with 10% in the end-1990s. Thus, it said, despite buoyant tax revenues, public debt remains high, at roughly 80% of GDP in March 2007.
The forecast for the current account deficit is around 2% of GDP, as growing foreign currency earnings from services and remittances offset a widening trade deficit. For fiscal year 2008-09, the Fund forecasts a further moderation of growth to 8.25% as inflationary pressures mount. However, it says, a sharper-than-expected slowdown in developed economies could dampen exports.