India needs to remain vigilant as greater reliance on debt financing and portfolio inflows could create significant external financing vulnerabilities, a recent IMF report has said. The The International Monetary Fund (IMF) in its report titled ‘The 2017 External Sector Report’ further said other risks to the Indian economy stem from global financial volatility and ‘longer-than-expected cash normalization’ following the currency exchange initiative. “Like other EMs, too great a reliance on debt financing and portfolio inflows would create significant external financing vulnerabilities. Therefore, there is need to remain vigilant to safeguard the Indian economy.
“…India’s economic risks stem from intensified global financial volatility including from a faster-than-anticipated normalization of monetary policy in key advanced economies, longer-than-expected cash normalization following the currency exchange initiative, as well as slower global growth,” the report noted. India’s Monetary policy framework has been strengthened, the report said, adding, “but further supply-side reforms and continued fiscal consolidation are key requirements to achieve a low and stable rate of inflation in the medium-term as well as to keep gold imports contained.” Emphasising that continued fiscal consolidation is needed, which includes implementation of the goods and services tax and further subsidy reforms, the report said, “safeguarding financial stability and enhancing the ability of the financial sector to contribute to growth are also necessary policy steps.”
According to the report, the external sector position in 2016/17 is broadly consistent with medium-term fundamentals and desirable policy settings.
“India’s low per capita income, favourable growth prospects, and development needs to justify running CA deficits. External vulnerabilities remain, although they have been reduced since 2013,” it said. The report pointed out that an increase in non-debt creating capital flows through FDI will help improve the current account financing mix and contain external vulnerabilities. “Further liberalisation of ECBs should proceed cautiously and be carefully monitored, given continuing corporate vulnerabilities,” it said.
According to the report, India’s net international investment position (NIIP) has improved slightly since 2013, going from -18.5 per cent of GDP at end FY2013/14 to -17.0 per cent of GDP at end-2016. Gross foreign assets and liabilities are relatively modest, at 25 and 42 per cent of GDP, respectively, and reflect India’s gradual approach to capital account liberalisation (most recently focused on FDI), it said. The report also predicted that India’s current account deficit is expected to widen to under 2¼ per cent of GDP over the medium term on the back of strengthening domestic demand. The report also found that excess current account imbalances represented about one-third of total global imbalances in 2016, remaining broadly unchanged since 2013, although increasingly concentrated in advanced economies.
While this rotation of imbalances towards advanced economies could entail lower external financing risks in the near term,the report said, adding,”a greater concentration of excess deficits in advanced debtor economies may engender protectionist sentiment and raise the risk of disruptive corrections down the road, including due to widening external stock imbalances.”