The Hindu Business Line : IMF twin reports applaud India’s macroeconomic policies

New Delhi, Feb. 6 Ahead of the Union Budget 2008-09, the International Monetary Fund (IMF) has come out with two weighty assessments on the Indian economy for the Indian policymakers to take due note of, though India has not been under any borrowing programme of the Fund for quite some time.

The tale of the two assessments, one by the IMF Executive Board’s 2007 Article IV Consultations with India released in Washington on February 4 and another by the Fund’s Asia and Pacific Department senior official Ms Andrea Richter Hume published in the February 4 issue of the IMF Survey, boils down to applauding India’s “sound macroeconomic policies and past structural reforms”.

However, in their own characteristic caution, the twin assessments did not desist from proffering policy prescriptions to buoy up the euphoria generated by what Ms. Hume put it “India’s average growth of 8.75 per cent over the past five years which has made it one of the world’s fastest-growing economies”.

Key challenges

As the Union Finance Minister, Mr P. Chidambaram, wrestles with the numbers to present a please-all Budget as it is his final year full Budget, the Fund’s Executive Directors have stated the key challenge is to sustain rapid and inclusive growth, foster job creation, and maintain macroeconomic and financial stability in the wake of large capital inflows.

No doubt, large capital inflows are complicating the conduct of monetary policy, creating excess liquidity and pressuring the rupee which, after remaining stable since 2000, appreciated by 7 per cent in real effective terms between December 2006 and August 2007.

IMF deems that as capital inflows swell, tensions in the monetary policy framework between exchange rate stability, monetary independence, and financial opening are beginning to emerge.

The same point is echoed by Ms Hume when said that India’s net capital inflows amounted to $25 billion in 2005 which had more than doubled to $66 billion by 2007 (January-September).

Foreign capital has been lured by India’s productivity-driven growth boom, and its increasing financial integration with the global economy.

Quality concerns

The consequent appreciation of the rupee has raised concerns about India’s competitiveness, particularly in the labour-intensive textile, garment and leather industries.

With capital inflows increasing the money supply, India is confronting the policy challenges of the “impossible trinity”: when there is free movement of capital, it is impossible to both target the exchange rate and maintain an independent monetary policy, Ms Hume contends.

She aptly notes that some restrictions on capital inflows, primarily on corporate borrowings, are not likely to be effective because investors and borrowers find ways to evade them.

Hence allowing greater exchange rate flexibility and improving liquidity management might be a better option to deal with continued capital inflows.

IMF Directors too emphasise that broader and deeper financial markets could better intermediate capital inflows, accommodate exchange rate volatility, and bolster financial stability and economic growth.

Encouraging growth

Hence the Fund is keenly encouraging the Indian authorities to press ahead with developing domestic corporate bond and derivatives markets and to implement more market-based monetary operations. Enhancing banks’ efficiency could also improve financial intermediation.

Policy analysts say that it is now up to Mr Chidambaram to put in place a series of measures to mitigate the capital inflows even as the latest RBI measure did not do anything to reduce the widening interest spread between domestic and global funds.

Interestingly, both the assessments by the Fund advert to a tighter fiscal stance to help counterbalance the liquidity impact of buoyant capital inflows and thus relieve appreciation pressures, besides limiting the inflationary impact of capital inflows.

Election point

With 10 State assembly elections slated this year and the General Election in 2009, could the Finance Minister afford any growth-choking measures in his forthcoming Budget or let both inflation and growth get embedded in the economy?

A point to ponder is that despite India’s impressive revenue performance, fiscal consolidation has stalled and public debt remains high, squeezing the fiscal space needed for public investment in physical and social infrastructure. The way out is that both expenditure and revenue measures are needed, including rationalising subsidies, cutting tax exemptions, enhancing tax administration and broadening the tax base.

The moot question is whether Mr Chidambaram would brace himself up to be fiscally right and politically wrong as he is preparing for his big Budget.

More Stories on : Economy | RBI & Other Central Banks | Forex

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page