IMF forecasts not a good omen for Indian markets

IMF forecasts not a good omen for Indian markets

The most worrying thing about the International Monetary Fund’s (IMF) new World Economic Outlook (WEO) report is not so much the lower growth -- it’s the fact that consumer price inflation is projected at a high 8.6% for 2012, down from an average of 10.6% this year, while it was 12% in 2010.

The figure of 8.6% is well above the Reserve Bank of India’s comfort level, which implies that interest rates are likely to stay high for much longer.

Only Vietnam has a higher inflation rate than India’s among Asian countries—the south-east Asian country’s average inflation rate this year is an average of 18.8%, according to the IMF estimates. Its central bank repo rate is 14%.

•• Also See | World Economic Outlook (Full Report) (PDF)

The WEO report says that in India, despite policy tightening, real interest rates are much lower than the pre-crisis averages and credit growth is still strong.

Interestingly, inflation is expected to remain high in India in 2012 in spite of lower global commodity prices. IMF expects oil prices to fall by 3.1% next year and non-fuel commodity prices to fall by 4.7%. That seems to suggest domestic factors will drive prices higher next year.

It is also interesting that IMF is projecting lower growth for India in 2012 than in 2011. Indeed, growth in the real gross domestic product in the fourth quarter of the current year is forecast at just 7%, while growth in 2012 is forecast at 7.5%, down from this year’s 7.8%. That is not a good omen for the Indian markets.

What will be the impact on capital flows? The bright spot in the assessment is that the forecasts see “net private capital flows to most regions rising further, assuming policymakers in advanced economies forestall a cycle of deteriorating sovereign and financial sector prospects. The effect of strong growth and tighter monetary conditions in emerging market economies would then outweigh the effect of more elevated risk aversion among investors."

But if downside risks rise, IMF also says there could be a sharp reversal in capital flows.