The International Monetary Fund (IMF) has warned India about global financial market volatility that may arise from any unexpected developments in the course of US monetary policy normalisation.
The spillover impact to India from any such volatility could be “very disruptive”, IMF said in its annual consultations with Finance Ministry mandarins under Article IV of its agreement with India.
IMF’s caution comes despite the reduction in India’s external imbalances and strengthening of buffer. It also comes against the backdrop of recent large capital inflows into India.
The observations are also significant as these come at a time when US Fed officials have indicated that they want to move beyond the easy money policies that defined the post-crisis period (after 2008).
Strong US jobs data in recent days also suggests that the US Fed might raise interest rates sooner than expected.
Risks ahead External risks also emanate from a prolonged period of weak global growth, which could dampen Indian exports, the IMF said in its report, the contents of which were released in Washington on Wednesday.
The report highlighted that India’s near-term growth outlook has improved, and the balance of risks is now more favourable, helped by increased political certainty, several positive policy actions, improved business confidence and reduced external vulnerabilities.
The domestic risks include a supply-driven spike in inflation, further deterioration in bank asset quality and continued stress in corporate financial positions, as well as slower-than-expected progress in addressing supply side bottlenecks, which could weigh on growth and stoke inflation.
The upside On the upside, expedited structural reforms and faster implementation of cleared investment projects could lead to stronger growth, as would sustained low global energy prices, the report said.
IMF executive directors, however, noted that significant external and domestic risks remain while room for countercyclical macro-economic policy support is limited by still high fiscal deficits and upside risks to inflation.
They considered that the main external risk facing India is a surge in global financial market volatility.
It was agreed that should external pressures re-emerge, rupee flexibility should continue to be an important shock absorber, complemented by judicious foreign exchange intervention, tightening of monetary conditions, and additional fiscal adjustment.
Adequate reserves They also noted that India’s international reserves are assessed to be adequate and foreign exchange intervention should continue to be limited to prevent disruptive movements in exchange rate, and emphasised the importance of further improving the external financing mix by enhancing the environment for attracting stable, non-debt creating capital flows, particularly foreign direct investment.