New Delhi: The International Monetary Fund (IMF) said on Tuesday that growth in the Indian economy had bottomed out and would recover on the back of improved external demand and recent policy moves by the Indian government.

“External demand, solid consumption, a better monsoon season, and policy improvements are expected to lift activity in India," it said.

It, however, cautioned that this forecast was subject to downside risks.

IMF, in its World Economic Outlook, pared down India’s growth projection to 5.7% for 2013 calendar year from its earlier projection of 5.9% for the same year in January this year, holding that “significant structural challenges" will likely lower potential output over the medium term and also keep inflation elevated by regional standards.

Blanchard said though worries about debt sustainability in the US have decreased, there should be an improvement in fiscal consolidation and a commitment to extend this in the future. On the euro zone, although institutional progress has been made over the past year on creating a road map for a banking union, there is a need for further and urgent measures to strengthen banks, without weakening the sovereigns, he said.

IMF also cut its global growth outlook to 3.3% and urged European policymakers to use “aggressive" monetary policy as a second year of contraction leaves the euro area’s recovery lagging behind the rest of the world.

In January, IMF had forecast that the global economy would expand 3.5%. It grew 3.2% in 2012. IMF also sees the 17-nation euro area shrinking 0.3%.

The main risk, according to IMF, is the potential reversal of easy external financing conditions and favourable commodity prices for emerging economies, including India.

“Were investment to disappoint in the BRICS (Brazil, Russia, India, China, South Africa), the result would be significantly reduced global growth, inflation, and commodity prices. If this came with capital outflows, the effect on BRICS output would be appreciably larger," IMF said.

D.K. Joshi, chief economist at rating agency Crisil Ltd, said that if external funding dries up, the rupee could be subject to wide volatility. “When you run a very high current account deficit, you are at the mercy of capital inflows," he added. Crisil on Monday revised its growth projection for 2013-14 to 6% from 6.4% projected earlier.

IMF further cautioned that such contagion may spread to many other emerging market economies which could lead to global growth dipping to about 1.5%, implying a decline in output per capita: “the first such recession in global output per capita to originate in emerging market economies".

Holding that India continues to face “significant fiscal challenge", IMF called for more immediate fiscal action to safeguard against adverse debt dynamics because of lower growth potential or the rising cost of private or government financing.

“Further structural reform, including subsidy reform, higher revenue from consumption taxes, and broader tax bases, would facilitate faster consolidation," it added.

IMF also cautioned against the rising pressure of bad loans, especially on public sector banks that account for 73% of banking assets.

“Gross non-performing assets in public banks reached 3.3% of advances in 2012. However, the long-run risk may be underestimated, as historically about 15% of assets reported as ‘restructured’ (a category that likely accounted for 7.3% of the public banks’ assets as of September 2012) are eventually classified as non-performing," it said.

It said state-owned bank portfolios remain vulnerable to losses from delayed infrastructure projects and, most importantly, to the recent growth slowdown that has dented the profits of the large companies that account for the bulk of Indian banks’ loan portfolios.

IMF said the current account deficit will remain elevated in 2013 at 4.9% against 5.1% while consumer price inflation is expected to peak up in 2013 to 10.8% from 9.3% in 2012.

Data released on Friday showed India’s retail inflation moderated in March, even though it continued to remain above the double-digit mark. In February, CPI (Consumer Price Index)-based inflation was 10.91%.

IMF said it expects India to grow 6.2% in 2014. It projects the global economy to expand 4.1% in the same year.

Bloomberg contributed to this story.

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