India: Staff Report for the 2018 Article IV Consultation
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
06 Aug 2018
eISBN:
9781484373125
ISBN:
9781484373125
Language:
English
Keywords:
ISCR; CR; headline inflation; India; government; debt; government approval; household inflation expectation; medium-term headline inflation; upside inflation risk; gross investment; U.S. dollar; Value-added tax; Inflation; Global; Eastern Europe; short-term debt; potential GDP; Indian rupee; Foreign direct investment
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July 2, 2018

Abstract

July 2, 2018

July 2, 2018

Key Issues

Context: India has been among the fastest-growing economies in the world over the past few years, lifting millions out of poverty. The authorities have initiated important structural reforms to spur India’s catch up with more advanced economies and to improve living standards for all. The main reforms include the inflation-targeting monetary policy framework, the Insolvency and Bankruptcy Code (IBC), the goods and services tax (GST), and steps to liberalize FDI flows and improve the business climate.

Outlook and Risks: Following transitory disruptions, growth is projected to recover in FY2018/19 and strengthen in FY2019/20 as stability-oriented macroeconomic policies and progress on structural reforms continue to bear fruit. High foreign reserve buffers and strong FDI inflows have helped contain external vulnerabilities. Risks to the outlook are tilted to the downside. Key external risks—higher global oil prices and tighter global financial conditions-have grown in recent months, placing a premium on prudent policies. Domestic risks include tax revenue shortfalls and delays in addressing the twin bank-corporate balance sheet problems.

Key Policy Recommendations: A key focus of this consultation is macro-financial and structural policies to boost inclusive growth, including to harness the demographic dividend. As the economy recovers and given limited policy space and growing risks, India would now be served best by supply-side measures.

  • Continued fiscal consolidation is needed to lower elevated public debt levels, supported by simplifying and streamlining the GST structure.

  • With the output gap closing and inflation rising, monetary policy will need further gradual tightening.

  • India’s external position remains broadly consistent with fundamentals. In the event of external pressures, India should continue to rely on exchange rate flexibility, and foreign exchange intervention should be two-way and limited to disorderly market conditions.

  • Important steps have been taken to improve the recognition of non-performing assets (NPAs) and recapitalize public sector banks (PSBs), but more needs to be done. The IBC has the potential to improve significantly NPA resolution and corporate debtors’ repayment discipline. A recent large fraud at a PSB highlights financial sector weaknesses and underscores the need for the government to take further steps to improve the PSBs’ governance and operations, including by considering more aggressive disinvestment.

  • While important progress has been made, key structural challenges remain. Needed policies include labor market, land, and product market reforms, which will raise investment, job growth, and productivity.

Approved By

Kenneth H. Kang (APD) and Seán Nolan (SPR)

Discussions took place in New Delhi and Mumbai during May 8–22, 2018. The team comprised Mr. Salgado (head), Mr. Almekinders, Mr. Blagrave, Mr. Mohommad, Ms. Moussa, Ms. Sodsriwiboon, Mr. Wimanda (all APD), Ms. Maslova (SPR), Ms. Ogawa (MCM), Mr. Bauer (Senior Resident Representative), and Mr. Mohapatra (Resident Representative Office). Messrs. Gokarn and Joshi (OED) also participated in the discussions. The mission met with Reserve Bank of India Governor Patel, Deputy Governor Acharya, Ministry of Finance Economic Affairs Secretary Garg, Chief Economic Advisor Subramanian, and other senior officials as well as representatives of the business and financial community, multilateral institutions, and nongovernment organizations. Ms. Inoue and Mr. Singh (both APD) assisted in the preparation of this report.

Contents

  • Abbreviations and Acronyms

  • OVERVIEW

  • RECENT DEVELOPMENTS, OUTLOOK, AND RISKS

  • KEY POLICY ISSUES

  • A. Fiscal Policy—Enhancing Sustainability

  • B. Monetary and Exchange Rate Policy—Consolidating Credibility

  • C. Financial and Corporate Sector—Addressing the Twin Balance Sheet Problem

  • D. Structural Reforms—Boosting Investment and Inclusive Growth

  • STAFF APPRAISAL

  • BOXES

  • 1. Demonetization and its Aftermath

  • 2. Impacts of the GST Implementation on Short-Term Economic Activity

  • 3. PSB Recapitalization Plan

  • 4. Potential Output

  • FIGURES

  • 1. Growth and Activity

  • 2. External Vulnerabilities

  • 3. Financial Markets

  • 4. Monetary Developments

  • 5. Fiscal Developments

  • 6. Fiscal Vulnerability Indicators

  • 7. Corporate and Banking Sectors

  • 8. Structural Reform Areas

  • TABLES

  • 1. Selected Social and Economic Indicators, 2014/15–2019/20

  • 2. Balance of Payments, 2014/15–2019/20

  • 3. Reserve Money and Monetary Survey, 2013/14–2017/18

  • 4. Central Government Operations, 2014/15–2019/20

  • 5. General Government Operations, 2014/15–2019/20

  • 6. Macroeconomic Framework, 2014/15–2023/24

  • 7. Indicators of External Vulnerability, 2013/14–2017/18

  • 8. Financial Soundness Indicators, 2013/14–2017/18

  • 9. High Frequency Economic Activity Indicators

  • APPENDICES

  • I. Key Policy Actions 2017–18

  • II. Risk Assessment Matrix

  • III. Main Recommendations of the 2017 FSAP

  • IV. Public and External Debt Sustainability Analysis

  • V. Recent and Planned IMF Capacity Development

  • VI. External Sector Assessment

Abbreviations and Acronyms

AQR

Asset Quality Review

CA

Current Account

CAD

Current Account Deficit

CIT

Corporate Income Tax

CPI

Consumer Price Index

DBT

Direct Benefit Transfers

EBA

External Balance Assessment

ES

External Sustainability

FDI

Foreign Direct Investment

FPI

Foreign Portfolio Investment

FRBM

Fiscal Responsibility and Budget Management

FX

Foreign Exchange

FY

Fiscal Year

FSAP

Financial Stability Assessment Program

FSGM

Flexible System of Global Models

GDP

Gross Domestic Product

GOI

Government of India

GrAM

Gramin Agricultural Markets

G-Secs

Government Securities

GST

Goods and Services Tax

HRA

Housing Rent Allowances

IBC

Insolvency and Bankruptcy Code

IRDA

Insurance Regulatory and Development Authority

INR

Indian Rupee

IMF

International Monetary Fund

LIC

Life Insurance Corporation

MCI

Monetary Conditions Index

MSME

Micro, Small, and Medium-sized Enterprise

MSP

Minimum Support Prices

e-NAM

Electronic National Agriculture Market

NCLT

National Company Law Tribunal

NDTL

Net Demand and Time Liabilities

NPA

Non-performing Asset

OECD

Organisation for Economic Co-operation and Development

PCA

Prompt Corrective Action

PDS

Public Distribution System

PFM

Public Financial Management

PIT

Personal Income Tax

PMG

Project Monitoring Group

PMI

Purchasing Manager’s Index

PSB

Public Sector Banks

PSL

Priority Sector Lending

RBI

Reserve Bank of India

SARTTAC

South Asia Regional Training and Technical Assistance Center

SDL

State Development Loan

SLR

Statutory Liquidity Requirement

TFP

Total Factor Productivity

UDAY

Ujwal Discom Assurance Yojana

US$

U.S. Dollar

WEO

World Economic Outlook

WTO

World Trade Organization

y/y

Year-on-year

Overview

1. A key focus of this consultation is macro-financial and structural policies to boost inclusive growth, including to harness the demographic dividend.1 While India has been one of the fastest-growing large economies in recent decades, investment growth has been comparatively modest and formal job growth insufficient. This creates challenges for creating jobs for a young and growing population and sustaining inclusive growth.

Real Growth: India and G20 Peers

(Index, Seasonally Adjusted, 2010-Q1 =100)

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Sources: Haver Analytics and IMF Staff CalculationsIndia’s G-20 peers are Brazil, Russia, China, South Africa, Indonesia and Turkey

Real Gross Fixed Capital Formation: India and G-20 Peers

(Index, 2010-Q1 = 100)

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Sources: Haver Analytics, WEO and IMF Staff CalculationsIndia’s G-20 peers are Brazil, Russia, China, South Africa, Indonesia and Turkey

2. Important reforms have been implemented in recent years. This includes the inflation-targeting monetary policy framework, the Insolvency and Bankruptcy code (IBC), the goods and services tax (GST), and steps to liberalize foreign direct investment (FDI) flows and the ease of doing business (Appendix I). A further deepening and broadening of structural reforms is needed to raise investment, job growth, and productivity over the medium term, to spur India’s catch up with advanced economies and create jobs needed for India’s young and growing labor force. The priorities should be to enhance several important recently implemented reforms—e.g., further steps on financial sector reforms and simplifying and streamlining the GST—combined with a vigorous push for labor, land, and product market reforms.

3. General elections will be held by May 2019. Against this background, government policies have shifted mainly to accelerating implementation of ongoing reforms rather than initiating new ones. And budget pressures could increase in the coming months.

4. Macroeconomic policies have been broadly consistent with past Fund advice. The stance of monetary policy over much of FY2017/18 was appropriate and consistent with the Fund’s call to aim monetary policy at durably lowering sticky inflation expectations, given the temporary weakness in growth and headline inflation at the lower end of the target range. Partly because of one-off factors, including the introduction of the GST, the government did not achieve its FY2017/18 fiscal consolidation target as advocated in previous Fund advice. Important steps are being taken to address the bank and corporate balance sheet problems and revive credit. Recent reforms to rigid labor laws, most notably through the extension of fixed-term contracts to sectors beyond textiles and leather, go in the direction of past Fund advice, but further reforms to labor laws, trade policies, infrastructure, and product markets are needed.

Recent Developments, Outlook, and Risks

5. Stability-oriented macroeconomic policies and progress on structural reforms continue to bear fruit, despite transitory disruptions to economic activity. Key macroeconomic developments in FY2017/18 include (Figures 1–8, Tables 1–8):

  • GDP growth slowed to a 4-year low of 6.7 percent, but a recovery is under way. Following a recovery from disruptions related to the November 2016 demonetization (Box 1) and the July 2017 GST rollout (Box 2), growth reached 7.7 percent in the quarter through March 2018 (y/y).

  • Headline inflation averaged 3.6 percent, a 17-year low, reflecting low food prices on a return to normal monsoon rainfall and agriculture sector reforms (e.g., pulses buffer stock, national agriculture market, crop insurance, and irrigation), subdued domestic demand, and currency appreciation. However, with growth recovering and the output gap narrowing to -0.3 percent of potential GDP (staff estimate), inflation is now on the rise with core (6.2 percent in May, y/y) and headline (4.9 percent) inflation now above the mid-point of the target band for headline inflation of the Reserve Bank of India (RBI), and inflation expectations over the forecast horizon still elevated.

  • External vulnerabilities remain contained but have risen. The current account deficit (CAD) widened to 1.9 percent of GDP, on rising imports and oil prices. But capital inflows have remained strong and helped finance the bulk of the CAD. In response to these inflows, the RBI intervened to limit the appreciation of the Indian rupee (INR) to about 3.1 and 1.4 percent on average during 2017/18 in real and nominal effective terms (according to the IMF’s Information Notice System). Gross international reserves rose by US$54.6 billion during 2017/18 to US$424.5 billion (about 8 months of prospective imports of goods and services) in March 2018. The U.S. dollar value of India’s non-oil merchandise exports expanded by 12 percent in calendar year 2017, a 6-year high, helping to raise India’s global export market share somewhat. Nonetheless, India’s export market share remains low, indicating a need to boost competitiveness through structural measures.

Figure 1.
Figure 1.

India: Growth and Activity

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Figure 2.
Figure 2.

India: External Vulnerabilities

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Figure 3.
Figure 3.

India: Financial Markets

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Figure 4.
Figure 4.

India: Monetary Developments

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Figure 5.
Figure 5.

India: Fiscal Developments

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Figure 6.
Figure 6.

India: Fiscal Vulnerability Indicators

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Figure 7.
Figure 7.

India: Corporate and Banking Sectors

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Figure 8.
Figure 8.

India: Structural Reform Areas

Citation: IMF Staff Country Reports 2018, 254; 10.5089/9781484373125.002.A002

Table 1.

India: Selected Social and Economic Indicators, 2014/15–2019/20 1/

article image
Sources: Data provided by the Indian authorities; Haver Analytics; CEIC Data Company Ltd; Bloomberg L.P.; World Bank, World Development Indicators; and IMF staff estimates and projections.

Data are for April–March fiscal years.

Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions.

Divestment and license auction proceeds treated as below-the-line financing.

Includes combined domestic liabilities of the center and the states, and external debt at year-end exchange rates.

Short-term debt on residual maturity basis, including estimated short-term NRI deposits on residual maturity basis.

In percent of current account receipts, excluding grants.

Table 2.

India: Balance of Payments, 2014/15–2019/20 1/

(In billions of U.S. dollars)

article image
Sources: CEIC Data Company Ltd; Haver Analytics; and IMF staff estimates and projections.

Data are for April-March fiscal years. Based on BPM6, including sign conventions.

Calculated as the difference between the stock of reserves and the flow changes to net reserve assets.

Table 3.

India: Reserve Money and Monetary Survey, 2013/14–2018/19 1/

article image
Sources: CEIC Data Company Ltd.; Reserve Bank of India WSS; IMF IFS, and Fund staff calculations.

Data are for April–March fiscal years, unless indicated otherwise.

Table 4.

India: Central Government Operations, 2014/15–2019/20 1/

article image
Sources: Data provided by the Indian authorities; and Fund staff estimates and projections.

Data for April – March fiscal years

Auctions for wireless spectrum are classified as non-tax revenues.

Includes the surcharge on Union duties transferred to the National Calamity Contingency Fund.

Pensions are included under expense not otherwise classified.

Includes subsidy-related bond issuance.

Other expense includes purchases of goods and services.

Debt securities include bonds and short-term bills, as well as loans.

External debt measured at historical exchange rates.

Table 5.

India: General Government Operations, 2014/15–2019/20 1/

article image
Sources: Data provided by the Indian authorities; state level data from the RBI Study on State Finances; and Fund staff estimates and projections.

The consolidated general government comprises the central government (CG) and state governments. Data for April-March fiscal years.

The authorities treat states’ divestment proceeds, including land sales, above-the-line as miscellaneous capital receipts. IMF Staff definition treats divestment receipts as a below-the-line financing item.

Includes combined domestic liabilities of CG and states governments, inclusive of MSS bonds, and sovereign external debt at year-end exchange rates.

Table 6.

India: Macroeconomic Framework, 2014/15–2023/24 1/

article image
Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; and IMF staff estimates and projections.

Data are for April-March fiscal years unless otherwise mentioned.

Differs from official data, calculated with gross investment and current account.

Statistical discrepancy adjusted.

Divestment and license auction proceeds are treated as financing; includes subsidy related bond issuance.

Includes combined domestic liabilities of the center and the states, inclusive of MSS bonds, and sovereign external debt at year-end exchange rates.

Imports of goods and services projected over the following twelve months.

Including short-term debt on contracted maturity basis, all NRI deposits, and medium and long-term debt on residual maturity basis, different from authorities’ definition.

Table 7.

India: Indicators of External Vulnerability, 2013/14–2017/18 1/

article image
Sources: Data provided by the Indian authorities; Bloomberg L.P.; CEIC Data Company Ltd.; IMF, Information Notice System and staff estimates and projections.

Data for April-March fiscal years.

Equals nominal yield minus actual CPI inflation.

Terms of trade including goods and services. Goods volumes are derived from partner country trade price deflators, and services volumes are derived using U.S. CPI from the WEO database.

Including short-term debt on contracted maturity basis, all NRI deposits, and medium and long-term debt on residual maturity basis, different from authorities’ definition.

10-year sovereign bond spread over U.S. bond.

Table 8.

India: Financial Soundness Indicators, 2013/14–2017/18

article image
Source: Reserve Bank of India; Bankscope; and IMF staff estimates.

Gross nonperforming assets less provisions.

Net profit (+)/loss (-) in percent of total assets.