Pay more attention to those who highlight risks to India’s economy

The Executive Director’s statement reads as if it is engaged in a boxing bout with the IMF analysis.

The International Monetary Fund (IMF) recently released its staff report on the Indian economy. The report is part of the annual IMF exercise under which the international organisation holds bilateral discussions with its members on the state of the economy of the respective members. The report has attracted attention for the differences between IMF staff and India’s Executive Director (ED) to the IMF on certain analyses in the report. This article summarises and opines on the differences.

The first difference is in terms of growth rates. The IMF has projected growth for 2023-2024 and 2024-2025 at 6.3 per cent. The Reserve Bank of India (RBI) recently revised the growth rate for 2023-2024 from 6.5 per cent to 7 per cent. The growth rate for 2024-2025 is projected at ~6.5 per cent. While the IMF feels India’s private consumption has been subdued, the ED states that it is healthy and gathering momentum. With inflation moderating, the consumption could be even higher going forward. Based on the current data, one can say that indeed the IMF is underestimating growth. One reason for underestimation has been that the IMF has been criticised for overestimating growth rates in the past, which is reflected in the caution today.

The second difference is the reasons for moderation of inflation. The IMF believes inflation has moderated due to ‘extensive government interventions (restriction on wheat, sugar, and rice exports, removal of tax on import of lentils, reversal of earlier increases in excise duties on petrol and diesel)’. The ED’s statement disagrees with this analysis. It believes that inflation declined due to India’s sui generis (unique) economic policy which deployed a mix of demand and supply side measures during the Covid-19 pandemic. In this case, both government interventions (which is also a kind of supply side policy) and broader economic policy have led to decline in inflation.

The third difference is on employment. The IMF estimates unemployment at 5.7 per cent, which is seen as an overestimation by the ED. The statement notes that the IMF has taken the unemployment rate of 2017-2018, whereas the current unemployment rate as per the government’s Periodic Labor Force Survey (PLFS) is 3.2 per cent. The statement also noted that the ongoing reforms in manufacturing, and changes in the work environment due to work-for-home and service orientation are changing the labour markets. Hence, lack of employment opportunities may not be the primary driver of unemployment. Another source of disagreement within the labour markets is the female labour force participation rate (LFPR). The IMF estimates India’s female LFPR to be 19 per cent, which ED’s statement believes is too low. As per the PLFS, female LFPR is 37 per cent.

One can barely believe that India’s unemployment is just 3.2 per cent. In fact, even 5.7 per cent appears on the low side. India needs robust measurement of unemployment for a more meaningful discussion on it.

The fourth disagreement is on trade barriers. The IMF estimates that India’s tariff and non-tariff barriers are high. The ED disagrees, saying India’s trade barriers are lower than leading economies. The statement also notes that developed economies use more non-tariff barriers which are opaque. This rebuttal is fine, but the statement saying the IMF has done ‘selective characterisation of India’s trade barriers’ could have been avoided.

The fifth disagreement is on fiscal risks. The IMF states that India’s debt levels could touch 100 per cent of GDP in case of negative shocks. The ED’s statement says even in the case of an adverse pandemic shock, India’s debt reached levels of 80 per cent of GDP. India’s risks are limited as much of its debt is in domestic currency. India’s growth is higher than the interest rate which means debt levels cannot increase to 100 per cent levels. Further, India is showing high collections in taxes, which will keep the deficit and debt under control.

Of all the risks, the fiscal risk should be the focus of policymakers. Countries which disagreed on the possibility of rising debt levels are now facing high debt levels. India has not managed to achieve the fiscal targets it has adopted under the Fiscal Responsibility and Budgetary Maintenance (FRBM) Act. Successive governments have found ways to postpone these deficit targets, which translate into higher public debt over time.

The sixth disagreement is on the financial system which is connected to the fiscal risks. The IMF thinks the Indian financial system could face a risk if the sovereign debt levels increase. Further, it has cited risks from growth in unsecured loans in the Indian banking system. The ED feels that given the risks from sovereign debt are low, the question of financial risks from it does not arise. On unsecured loans, the ED says that the rise in unsecured loans is due to the digitalisation of the economy. In the earlier non-digital economy, loans were given on collateral. In the digital economy, loans can be given without collateral as one can verify records of cash flows.

We have heard this ‘this time is different’ story several times when we see high growth in loans/credit eventually becoming a crisis. Importantly, the RBI has acted on this growth of unsecured loans.

The seventh disagreement is on monetary policy and exchange rate management. The IMF says that the RBI has intervened in foreign exchange markets by selling foreign exchange reserves. This has prevented the Indian Rupee (INR) from depreciating. As a result, the IMF has reclassified India’s exchange rate system from floating to ‘stabilised arrangement’ for the period December 2022 to October 2023. The IMF adds that the flexible or floating exchange rate should be the first line of defense in absorbing external shocks. The ED statement says the reclassification is ‘incorrect and inconsistent with reality’. The forex intervention has been modest in 2023.

This is confusing from both ends. The last few years since the pandemic have been of high volatility and ambiguity. The pandemic saw central banks cut interest rates across the globe followed by a sudden increase in interest rates which led to a surge in inflation. Both, the decrease and increase of interest rates led to volatility in exchange rates. The US Dollar typically appreciates in global crises leading to sharp depreciations in other currencies including the INR. The foreign exchange reserves are accumulated to safeguard the currency against these very shocks. If the RBI did intervene to stabilise the INR, it should be seen as a case study to prevent these sharp depreciations. However, both the IMF and the ED think ‘Stabilised Arrangement’ is a bad thing.

Summing up, it is interesting to read these discussions and the disagreements between the IMF and the ED on state of the Indian economy. A broad-based two-sided discussion helps one get a better understanding of the ongoing economic trends and policies. However, the ED’s statement reads as if it is engaged in a boxing bout with the IMF analysis. The IMF staff has merely stated its views on the Indian economy and has pointed to both opportunities and risks. It is tempting to highlight the opportunities and disagree with the risks. But then we know from economic history that we should be watchful of emerging risks and pay more attention to those who highlight them.

(Amol Agrawal is an economist teaching at Ahmedabad University)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.