IMF says India’s economy recovering, but warns of inflationary pressures

The International Monetary Fund (IMF) said India’s economy is gradually recovering after two Covid waves hit it but it cautioned the authorities against inflationary pressures. It recommended slow reduction in monetary policy support as recovery gains ground.

It said while the effect of Covid-19 on investment and human capital could prolong the recovery and impact medium-term growth, the recovery could also be faster than expected due to pace of vaccination and economic reforms.

In its annual report on India under the Article IV, IMF executive board said the economic outlook remains clouded due to pandemic-related uncertainties contributing to both downside and upside risks.

“The second wave resulted in another sharp fall in activity, albeit smaller and shorter and recently high frequency indicators suggest an ongoing recovery,” it said.

It warned that a persistent negative impact of Covid-19 on investment, human capital, and other growth drivers could prolong the recovery and impact medium-term growth. While India benefits from favorable demographics, disruption to access to education and training due to the pandemic could weigh on improvements in human capital.

At the same time, the Fund said the recovery could also be faster than expected. “Faster vaccination and better therapeutics could help contain the spread and limit the impact of the pandemic,” it said.

In addition, successful implementation of the announced wide-ranging structural reforms could increase India’s growth potential, the board said in its report released on Friday.

It agreed that maintaining accommodative monetary policy remains appropriate.

“Looking ahead, a well-communicated plan for a gradual reduction in monetary policy support as the recovery strengthens would foster orderly market transitions,” it said.

The Fund said despite policy support, bank credit growth has remained subdued even as large corporates have benefited from easier conditions in capital markets.

The IMF projected India’s economic growth to be 9.5 per cent in the current financial year and the headline consumer price inflation to be 5.6 per cent amid elevated price pressures.

It said inflationary pressures have been elevated, yet the rate of price rise eased to 5.6 per cent in July, returning to within RBIs target, driven by softer food prices and base effects. Since then, the headline inflation rate fell to 5.3 per cent in August and 4.3 per cent in September, according to official data.

The Fund said the contraction in economic activity, lower revenue, and pandemic-related support measures are estimated to have led to a widening of the Centre’s fiscal deficit to 8.6 per cent of GDP for 2020-21. The general deficit of both the Centre and the states stood at 12.8 per cent that year. IMF and India adopt slightly different methodology to calculate fiscal deficit. The IMF does not count disinvestment proceeds and license fees in the government’s revenues.

Fiscal policy continues to support the economy this year, it pointed out.

It also said net inflows and improvement in the current account have supported an increase in foreign exchange reserves.

The current account balance is projected to return to a deficit of about one per cent of GDP in FY’22 due to a gradual recovery in domestic demand and higher oil prices.

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