The IMF’s outdated outlook and our policy challenges
The high growth projections of the IMF and RBI for India look odd, as the strong revival they indicate seems to overlook the damage that a big covid resurgence is likely to cause.
PremiumThe International Monetary Fund’s (IMF) long-awaited update on global growth was released on 6 April in its World Economic Outlook (WEO) of April 2021. Its projections were revised slightly upwards relative to its WEO January update. The world is now projected to grow 6% in 2021, compared to 5.5% earlier, and 4.4 % in 2022, compared to 4.2% earlier. This is largely because the global economy is now expected to shrink by 3.3% in 2020, compared to 3.5% estimated earlier, and because of a stronger recovery in the US.
India’s IMF projections for 2021 and 2022 have also gone up from 11.5% and 6.8% to 12.5% and 6.9%. That India would be the fastest-growing major economy in both these years has to be seen in the right perspective. This rebound is a statistical illusion, the base effect of the steep fall of -8% (-7.7% as estimated by India’s Central Statistical Office) in 2020-21. India’s average growth across the three years from 2020 to 2022 would remain under 4%, compared to 4.2% in 2019. The output loss relative to the pre-covid growth projection is one of the largest among major economies. The strong rebound is a classic illustration of the proverbial dead cat bounce—the harder the fall, the bigger the rebound on hitting the floor.
On 7 April, Reserve Bank of India (RBI) governor Shaktikanta Das announced that the central bank’s monetary policy committee (MPC) had decided to keep its key policy rates on hold. This was on expected lines, as it had to balance the conflicting objectives of upward pressure on inflation and supporting a recovery from the covid-related economic crisis. Raising rates at this juncture was out of the question. A lowering of the repo rate, currently at 4%, was also unlikely because that level is already very low—indeed negative—relative to consumer price inflation, which is trending upwards. Even if one were to take the average of wholesale price inflation (which is trending much lower) and consumer price inflation in India, RBI’s real repo rate works out to less than 1%.
The economy has been weakening over the last four years. Gross domestic product (GDP) growth has declined continuously from 8.2% in 2016-17 to 4.2% in 2019-20, even before the sharp fall of 7.7% in 2020-21. The burden of stimulating the economy has fallen largely on monetary policy, with both the nominal and real repo rates falling over this period. This accommodative monetary policy, however, did little to stimulate credit growth and private investment, as its transmission channels are clogged on account of a ‘twin balance sheet’ problem. The banking system is burdened with a big load of non-performing assets, which, according to RBI’s latest financial stability report, are expected to rise sharply again during the current year. This makes banks extremely cautious in extending fresh credit. The counterpart of non-performing loans is distress in corporate balance sheets, which makes firms hesitant to borrow. In these circumstances, fiscal policy is likely to be much more effective in stimulating growth and investment than monetary policy. The IMF’s WEO has pointed out that larger output losses and weaker recoveries in emerging markets relative to advanced economies are on account of weaker fiscal responses to the covid crisis. Clearly, the pre-covid crisis in India’s banking system needs to be resolved expeditiously to improve the potency of monetary policy.
The conflicting objectives of growth and inflation would need to be balanced going forward as well. RBI expects inflation to remain above 5%, in the upper range of its target of 4% +/- 2%. Hence, its price-stability worries are unlikely to diminish. It is significant that it has advised the government to reduce taxes on petroleum products to relieve some pressure. It has also flagged concerns over India’s economic recovery in view of the current covid resurgence. It is pertinent to note that RBI’s growth projection of 10.5% for 2021-22 is a full 2 percentage points below what is projected by the IMF in its WEO April update. The IMF projections appear not to have factored in the covid resurgence in India. It is equally surprising that RBI has reiterated its growth estimate of 10.5% for 2021-22 made two months ago, prior to the covid wave currently on the ascent. The output loss is likely to be significantly worse than what IMF numbers indicate. Average growth in 2020-21 through to 2022-23 is likely to be below 3.5%.
Another monetary policy headache that may lie ahead is having to respond to capital outflows arising out of a possible strong US recovery, inflationary pressures and rising interest rates in America, as the IMF has highlighted in its latest WEO. Were that to occur, RBI might well be placed in the unenviable position of having to cope with the ‘impossible trinity’, of balancing a second set of conflicting objectives, with domestic and external policy requirements pulling in opposite directions.
The priority that RBI has attached to smooth financing of the government’s huge borrowing programme during the current fiscal year also shows in its monetary policy statement of 7 April. It apparently does not want the Centre’s borrowing needs to crowd out private borrowers while India’s economy is still in recovery mode. It has signalled a willingness to intervene aggressively in the bond market to support the government’s borrowing requirements, and also to mop up excess liquidity if and when warranted.
Alok Sheel is RBI chair professor in macroeconomics, ICRIER
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