New Delhi: The International Monetary Fund (IMF) says it can’t rule out the risk of short-term overheating in the Indian economy and said the ‘immediate challenge is managing the near-term risk of inflationary pressures.”
“With gross domestic product (GDP) continuing to grow above trend, increases in international oil prices not yet fully passed through, credit and asset prices buoyant, and monetary conditions accommodative, the risk of overheating cannot be ruled out,” IMF said in its latest report on India. IMF had revised its 2006-07 growth target for India to 8.9% on 20 December.
IMF said that even though the country’s growth record had surpassed all expectations, job creation was disappointing. It, however, commended the government’s effort to encourage job-led growth through special economic zones (SEZs) and trade liberalization.
About SEZs, which have raised a huge controversy in the country, IMF said that international experience suggested that associated revenue losses could be high, particularly when tax incentives were not well targeted as in India.
“Among the 34 SEZs, more than half are in the IT sector, which has robust expansion prospects. These companies may simply relocate planned investments to SEZs. Moreover, unlike China where SEZs were used to experiment with market reforms at the start of its liberalization process, India already has a long track record in reform,” it said.
“Moreover, the small size of most SEZs—under 100 hectares—suggests that the infrastructure size would be limited,” the report added.
Therefore, the report suggested, doing away with corporate income tax incentives and cutting excise exemptions would bolster revenue and make up for possible erosion of revenues from tax incentives granted under SEZs.
The report also identified three reasons for monetary policy not being able to address the risks associated with volatile real estate prices.
First, policymakers had not been able to accurately identify asset price mismatches and bubbles. Second, fluctuations in asset prices were not known to be sizeable. Third, no clear relationships had been established between asset prices and inflation, asset prices and aggregate demand, and changes in monetary policy and changes in asset prices.
The study found that a 10% increase in the stock market index was associated with an increase in real private consumption of only 0.10%.
As a result, it felt, the Reserve Bank of India’s approach of tightening prudential norms, raising risk weights in sectors where credit was growing rapidly, and increased supervision was appropriate.
IMF wanted the government to act on reforming expenditure by implementing the recommendations for an automatic market-based mechanism for petroleum goods and s better-targeted on-budget kerosene subsidies. It also called for tighter controls on state borrowing.