PremiumOn economic risks for India amid lingering geopolitical tension, IMF's India mission chief Choueiri said that India’s forex reserves were comfortable and provided sufficient cushion to withstand external shocks in the near term
India should pass higher international prices to consumers given the high fiscal costs while protecting vulnerable households, the International Monetary Fund’s India mission chief Nada Choueiri said in an emailed interview on Wednesday.
The advice comes amid India’s domestic fuel prices touching a record high and demands for excise duty cuts growing stronger. The government has estimated the fiscal deficit to narrow to 6.4% of GDP in FY23 from 6.9% in FY22.
With India planning to launch the central bank digital currency (CBDC) this year, Choueiri also cautioned about the risks surrounding such a move.
These include a likely structural shift away from commercial bank deposits and towards CBDC, cyber risks for both users and the issuing central bank, technical glitches, and data breaches.
On economic risks for India amid lingering geopolitical tension, Choueiri said that India’s forex reserves were comfortable and provided sufficient cushion to withstand external shocks in the near term. Edited excerpts:
The IMF economic outlook report points out that the external position for India would deteriorate and impact consumption in view of the high oil prices. Would discounted oil purchases from Russia help?
Indeed, the main channel through which the war in Ukraine will impact India is through rising oil prices. The “rule of thumb" we follow is that for each $10/ bbl increase in oil prices, India’s current account deficit widens by about 0.4% of GDP. According to the current IMF projections, the average global oil price envisaged for FY23 is about $30/bbl higher than projected in January, before the war in Ukraine. This adds about 1.2% of GDP to the current account deficit projected for FY23. However, it is important to note that oil prices are very volatile and difficult to predict. If the average effective price for India’s oil imports proves lower than currently projected, the current account deficit can be smaller as well.
Would you recommend the Indian government go for an excise duty reduction on fuel?
In general, the government should aim at passing higher international prices to domestic consumers while protecting vulnerable households. While a potential reduction in fuel excise tax can provide some temporary cushion in terms of the impact of the oil price shock on inflation and growth, it would have important fiscal costs, reducing prices for all consumers regardless of their ability to pay. Against the backdrop of inflationary pressures, targeted support to vulnerable households and increasing spending in other, high-multiplier, priority areas would constitute a more effective and less regressive use of the limited fiscal space.
What are the other factors impacting India’s external position?
On the one hand, India is affected by rising prices and the limited availability of imported products such as edible oils and fertilizers. It is also faced with lower external demand (particularly from Europe), heightened uncertainty, and lower investor confidence. On the other hand, India’s wheat and rice exports have gotten a boost from rising international food prices. Also, India’s international forex reserves are at a comfortable level (covering about eight months of prospective imports) and provide sufficient cushion to withstand external shocks.
While India is yet to develop legislation on cryptocurrencies or virtual digital assets, RBI is coming out with the CBDC this year. What is your broad view?
A number of countries are considering introducing CBDC. There are many reasons behind this move, including improving financial inclusion, increasing competition among payment service providers, offering public sector alternatives to crypto-assets, facilitating integration with the digital economy, enhancing cross-border payments, and improving the efficiency of fiscal payments.
However, there are also risks posed by the introduction of a CBDC. A prominent risk is a disintermediation, meaning a structural shift away from commercial bank deposits and towards CBDC. Threats to financial integrity risks may also be present and will vary depending on the design choice, as well as cyber risks for both the users as well as for the issuing central bank. A large balance sheet could expose the central bank to political interference, while technical glitches, cyberattacks, and breaches of data or financial integrity risks can damage the central bank’s reputation. Finally, easy access to foreign CBDCs could lead to risks of currency substitution, capital flow volatility, increased contagion risks, and circumvention of capital flow management measures.
Can these risks be mitigated?
To mitigate risks and maximize benefits, optimal design and implementation of CBDC are crucial. To this end, considerable capacity and resources are needed to cover many dimensions, including legal, regulatory, governance, risk management and technology. Finally, interoperability of CBDC across borders will be very important to prevent fragmentation of the payments system.
With limited fiscal space available, how can the government control inflation?
A more accommodative fiscal stance, with additional targeted support for vulnerable households, is warranted to protect the vulnerable from rising food and fuel prices, given weaker growth prospects. While India’s fiscal space has narrowed, there is fiscal space to continue to support the recovery and respond to downside risks if needed. The budget’s conservative revenue projections also suggest additional support is feasible within the budget envelope. Further, policy space can be enhanced through a credible and clearly communicated medium-term fiscal consolidation strategy, underpinned by improved revenue mobilization and expenditure efficiency.
