New Delhi: The International Monetary Fund (IMF) has warned against growing risks in the Indian economy and said growth may decelerate further because of slowing investments, high inflation and possible populist fiscal expansion.
“Since recovering rapidly from the global financial crisis, India’s economy has slowed substantially, and its growth rate is expected to decline further in the coming year for a range of domestic reasons,” IMF said in its annual health check of the Indian economy under the article IV consultation with the Indian government released on Wednesday.
IMF has projected the economy to grow 5.4% in 2012-13. The government will release the advance growth estimate for the year on Thursday. The Indian economy grew at 6.2% in the previous year.
IMF said external risks such as protracted slow growth in Europe and likelihood of capital outflow from emerging markets could pose serious challenges for India. Acknowledging the ongoing structural reforms being carried out by the government such as reducing subsidies on fuel and fiscal consolidation, the fund said such changes present both upside and downside opportunities. “A faster pace of reform could entail higher growth, while insufficient follow-through would weigh heavily on the outlook,” it said.
However, IMF said India’s slowdown is more driven by domestic structural constrains than external factors. “Global factors have hurt exports and weighed on investment, but India’s growth has slowed by more than the decline in trading partners’ growth would imply. Capital inflows remain resilient and international financing conditions favourable, suggesting that so far the financial channel has not been prominent in the transmission of external shocks,” it said.
While the government has begun to rein in expenditure, this year’s modified fiscal deficit target of 5.3% of GDP is still likely to be breached by 0.3 percentage points. However, IMF said the political risk taken in raising diesel prices indicate the government’s commitment to fiscal consolidation. Indian government officials told IMF that by 2016-17, cash transfers are expected to be in place for key subsidies, which will reduce the fuel and fertilizer subsidies.
Rating agency Crisil Ltd chief economist D.K. Joshi said both external and domestic economic environment has improved in last six months, which is mildly positive for growth outlook for next fiscal year. However, he maintained that investment will not revive quickly due to rate cuts by the central bank and recovery will remain fragile. “Sustainability of growth recovery beyond 2013-14 will depend on recovery in domestic investments,” he said.
IMF also warned against rising corporate debt restructuring by banks, which increased to 5.4% of loans in June 2012 from 3.7% in March 2011. “Corporate financial positions have weakened considerably, further dimming the outlook for investment and heightening vulnerabilities. Profitability, which had recovered after the global financial crisis, has weakened mainly due to weaker internal and export demand, bottlenecks, slow permits for infrastructure projects, and rising interest rates,” the report said.
The report observed that public sector banks are the worst hit with large exposures to infrastructure, especially power, aviation, agriculture, steel, and textiles. It also pointed out that loans to 10 of India’s largest conglomerates account for almost 100% of banks’ net worth.
The fund also warned about the deteriorating asset quality of banks as gross non-performing assets (NPAs) crossing 3% mark in the current fiscal. “With growth likely to be weaker for a longer period than after 2008-09 and the loan composition of banks more skewed toward large loans, more restructured advances are likely to slip into NPAs compared to the historical average of 15%,” it said.
The fund said the government needs to push forward with reforms such as developing the corporate bonds market and gradually lowering government-mandated purchases by banks of government debt to ensure India’s financial system is able to underwrite strong growth.
With domestic investment particularly hard-hit, IMF said India’s potential GDP is likely to be lower than previously estimated, down from 7.5-8% to 6.5%. The RBI estimates India’s potential growth at 7%.