The key challenge facing India is to sustain rapid and inclusive growth, foster job creation and maintain macroeconomic and financial stability in the context of large capital inflows, says the IMF. It expects India's economy to expand by 8.34 per cent this fiscal.
"India's favourable outlook has attracted record capital inflows, which help finance investment but also present challenges to managing capital markets integration," the International Monetary Fund (IMF) said on Monday.
In its assessment after annual bilateral Article IV consultations with New Delhi on January 23, the IMF Executive Board commended India's outstanding economic performance and its success in reducing poverty, calling it a tribute to its sound macroeconomic policies and structural reforms.
India's economy has been resilient in the face of heightened global uncertainties, slowing US growth and high world oil prices, and is expected to expand by 8.34 per cent this fiscal year as a result of rising productivity and investment, it said.
IMF endorsed India's policy priorities, which are to manage financial globalisation and tackle supply constraints through an enhanced monetary framework, financial sector development, fiscal consolidation and removal of structural bottlenecks.
Commending India' success in containing inflation and maintaining domestic financial stability, the board observed that large capital inflows have exacerbated tensions among exchange rate stability, monetary independence and financial openness.
The directors supported the central bank's active management of liquidity and accommodation of increased exchange rate volatility, while noting the appreciation pressures on the rupee.
They concurred that rupee appreciation reflected strong fundamentals and increasing productivity, and saw the policy of a managed float as remaining appropriate.
A number of directors, however, expressed concern that rupee appreciation has adversely affected India's external competitiveness in certain labour-intensive sectors, the IMF assessment said.
They supported New Delhi' cautious and pragmatic approach to managing capital flows, including through temporary capital controls, while commending its intention to move to fuller capital account convertibility gradually over the medium term.
Some directors also cautioned against restrictions on capital inflows, emphasising that increased exchange rate flexibility, strengthened monetary operations, and more effective communication with markets could be a better way to increase monetary policy effectiveness in a more financially open environment.
Directors emphasised that broader and deeper financial markets could better intermediate capital inflows, accommodate exchange rate volatility, and support financial stability and economic growth.
They encouraged policy makers in India to press ahead with developing domestic corporate bond and derivatives markets, and to implement more market-based monetary operations. Enhancing banks' efficiency can also improve financial intermediation.
IMF welcomed the Reserve Bank of India's (RBI) focus on preserving financial stability through close scrutiny of banks and efforts to improve banks' risk management.
While commending the overall soundness of the financial system, IMF called for continued vigilance, particularly in light of the rapid growth of real estate credit.
It welcomed the forthcoming implementation of the Basel II supervisory framework, and looked forward to the publication of the authorities' self-assessment of financial stability and development.
On the fiscal front, IMF welcomed the continued buoyancy of tax revenues, but noted that with public expenditure and debt still relatively high, more rapid fiscal consolidation is warranted.
A tighter fiscal stance could also help offset the liquidity impact of buoyant capital inflows and thus relieve appreciation pressures. IMF stressed that expenditure reforms are needed to create space for priority spending.
IMF also noted the growing fuel subsidy burden and the need to adapt to higher international oil prices through a phased reduction in subsidies for most fuel products, while ensuring that adequate and well-targeted safety nets are in place to protect the poor.
Welcoming plans for a national goods and services tax, it noted that cutting tax exemptions, increasing user fees and further improving tax administration would improve the tax base.
IMF urged greater progress in structural reforms to ease real sector rigidities, boost productivity and competitiveness, and ensure that the benefits of growth are widely shared.
It concurred with the priorities identified in the government's "inclusive growth" agenda: bridging infrastructure gaps with private sector participation, ensuring access to social services, and promoting a competitive environment that supports private sector investment and job creation.
Toward these goals, IMF emphasised that more flexible labour regulations can facilitate the reallocation of labour to stronger sectors, while higher and more effective public spending on education is needed to address the skills gap.