IMF report: Can monetary policy rescue from economic slowdown?

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Updated: January 07, 2020 9:25 AM

The IMF report states that the downside risks to growth can arise mainly from the inability to undertake structural reforms, shortfalls in revenue collections, slowness in cleaning up the balance sheets of the PSBs and corporates as assumed in the baseline scenario.

IMF, IMF report, monetary policy, economic slowdown, GST, Goods and Services Tax,  Insolvency and Bankruptcy Code, IBC, FDI , PM KisanThe IMF report presents two scenarios for the future—one baseline and another with reforms. (Reuters photo)

The Article IV Consultation document of the IMF released in December, is much more optimistic than the recent commentaries on Indian economy. This is partly due to its analysis of the slowdown of the Indian economy. The policy prescriptions are based on the data available until October, and do not include the estimates of the second quarter GDP. While noting that the first quarter growth, at 5%, was low, it expects growth to rebound in the remaining quarters on the presumption that investment and private consumption will firm up in the second half of the year. This is supposed to transpire due to the lagged effects of accommodative monetary policy, actions to facilitate its transmission, ensuring liquidity, greater clarity on corporate and environmental regulatory uncertainty, and additional support by the government to augment rural consumption through programmes like PM-Kisan.

The IMF report presents two scenarios for the future—one baseline and another with reforms. Under the former, growth is expected to accelerate to a medium term potential of 7.3% on continued commitment to inflation targeting, gradual macro-financial and structural reforms, including the lagged effect of earlier reforms such as implementation of the Goods and Services Tax (GST) and the Insolvency and Bankruptcy Code (IBC) as well as measures to liberalise FDI flows, and further improve the ease of doing business. In the second scenario, it recommends a package of reforms to boost inclusive growth which will help spur productivity and employment. The three pillars of reform are, (i) ongoing clean-up of bank balance sheets complemented by strengthening of PSB governance and regulation, and oversight of NBFCs, (ii) a fiscal consolidation anchored to reduce general government debt toward 60% of GDP as recommended by the FRBM Review Committee—this is to be achieved by increasing revenue productivity of the tax system by expanding the tax base, especially on personal incomes and rationalising subsidies to achieve expenditure compression—and (iii) reform of the markets to enhance labour market flexibility, formalising the economy, improving employment opportunities, enhancing competition and reducing the scope for corruption.

The IMF report states that the downside risks to growth can arise mainly from the inability to undertake structural reforms, shortfalls in revenue collections, slowness in cleaning up the balance sheets of the PSBs and corporates as assumed in the baseline scenario. Subdued credit growth arising from risk aversion from the banks and external factors like rising protectionism and the possibility of oil price increase are other factors. Even so, it appears, the IMF team did not foresee the sharp decline in the second quarter growth of GDP to 4.5%, the lowest in 26 quarters, and it won’t be long before it allows a downward revision of growth for the year.

The report is clear in stating that the government should continue to pursue the medium-term fiscal consolidation towards reducing general government debt to 60% of GDP. It unequivocally states that fiscal stimulus should be avoided at the present juncture to reduce fiscal dominance which has led to financial repression. Besides, it recommends that immediate focus should be to make more realistic revenue projections, enhance fiscal transparency and make the budgetary coverage more comprehensive to avoid off-budget borrowings. It cautions that although the central government has adhered to the headline fiscal target and the states in the aggregate have, in fact, improved their fiscal position, the public sector borrowing including those of central and state government enterprises, and local governments has remained high.

Some of the downside risks reviewed in the IMF report have already been realised as the growth rate in the second quarter plunged to 4.5%. With both investment and private consumption as ratio of GDP, declining, and exports virtually stagnant, the only way to trigger a virtuous cycle of investment and growth, in the present juncture, may have to come from public investments. The cleaning up of the balance sheets of the banks and corporates has been a slow process and is still in the works. The important question is whether its recommendations on fiscal stimulus would have been any different if it were known that the growth in the first half of the fiscal would be just about 4.8%, and 5% for the whole year, as has been revised by the Reserve Bank of India.

A clear reading of the report indicates that IMF is not likely to recommend any slippage in fiscal consolidation path even if it recognises the constraints pointed above. The report is categorical in stating that the “fiscal space is at risk” and there is no scope to provide fiscal stimulus at this juncture. The only concession it seems is that the Central government’s extended deficit (including off-budget liabilities and financing from the NSSF) should be held constant at 5.4% of GDP. According to the report, the growth impetus should essentially come from monetary policy and structural reforms.

Considering that the space for further monetary policy actions depend on the inflation risk, and the unlikely immediate impact of both monetary policy and structural reforms, the prognosis is that we are not likely to see a quick turnaround, and returning to the medium-term potential growth rate of 7.3% is not likely. In fact, excluding public administration and defence, the first half of 2019-20 has seen the GVA growth of just 3% and without the fiscal stimulus, acceleration in the medium-term looks doubtful. Even the much promised strategic disinvestment has not been forthcoming. It is important that the government should speed up this process to accelerate public investment in the remaining months of the year. Perhaps, given the exceptionally subdued environment, some stimulus may be unavoidable.

Irrespective of whether it is decided to provide fiscal stimulus or not, its recommendations to make the revenue projections more realistic, and enhance budget transparency and budget coverage are noteworthy. It is important to clearly bring out the actual fiscal deficit and, taking that as the base, lay down a credible consolidation path to reduce debt. The experience shows that the government, on its own, does not seem to care for realism in projections nor bother about transparency and comprehensiveness in coverage. It is precisely for this reason that the time is opportune to think of an institutional monitoring mechanism by establishing an independent Fiscal Council reporting to the Parliament by amending the FRBM Act as recommended by the 14th Finance Commission. Besides monitoring the progress in fiscal consolidation, the Council can report to the Parliament on three important issues namely, evaluating the realism of the forecasts, bring out off-budget transactions to ensure greater transparency, and realistically estimating cost of various schemes and programmes announced by the government from time to time.

Counsellor, Takshashila Institution
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