The International Monetary Fund (IMF) cautioned that India’s fiscal space is at risk as it called for a more ambitious and well-communicated consolidation to ensure medium-term fiscal sustainability.

In its Article IV consultation report released Friday, the IMF called for further structural reforms, including addressing the adverse impact of climate change, to secure strong and sustainable growth.

IMF has forecast a 6.8% growth for India in FY23, falling to 6.1% in FY24.

Additional monetary tightening should be carefully calibrated and communicated to balance inflation objectives and growth needs, the IMF’s executive board said in its assessment included in the report.

The exchange rate should continue to act as a shock absorber with foreign exchange intervention limited to addressing disorderly market conditions, the board suggested.

The board welcomed India’s plan to introduce a central bank digital currency as it commended the country’s “remarkable achievements in digitalization” and suggested a further narrowing of the digital divide through improved access and literacy.

The IMF’s Article IV consultation report includes a Staff Report that provides a country assessment, an executive board assessment based on the report, and a statement by the executive director for the country.
“Policies are addressing new economic headwinds,” the IMF said in a statement warning a sharp global growth slowdown in the near term would affect India through trade and financial channels.

Tightening financial conditions can weaken asset quality and result in financial sector stress, limiting credit provision and negatively impacting long-term growth, it said sounding a note of caution.

Intensifying spillovers from the war in Ukraine, the emergence of a new Covid variant, and domestic inflation are other risks.

“On the upside, however, successful implementation of wide-ranging reforms or greater than expected dividends from the remarkable advances in digitalization could increase India’s medium-term growth potential.”

It favoured reforms in the financial sector to governance and reduced government footprint to support strong medium-term growth and suggested prudential tools could help address risks stemming from tightening in financial conditions.

Reflecting broad-based price pressures, inflation is projected at 6.9% in FY23 and is expected to moderate only gradually over the next year. The current account deficit is expected to increase to 3.5% of GDP in FY23 as a result of both higher commodity prices and strengthening import demand.

Fiscal consolidation
The report said Indian authorities have reaffirmed their commitment to bring down its fiscal deficit to 4.5% of GDP by FY2025-26, implying a general government deficit of 7.5% of GDP.

“A clearly communicated medium-term fiscal consolidation plan is critical to enhance policy space and facilitate private sector-led growth,” the Staff Report said, adding that announcing further deficit-reduction measures would reduce uncertainty and lower risk premia.

The Staff Report said reversing the fuel excise tax cuts, further broadening the corporate and personal income tax bases, simplifying the goods and services tax (GST) rate structure, rationalizing the items subject to preferential GST treatment, and continued improvements in tax administration, in line with international good practice, would help narrow India’s tax gap, estimated at around 5% of GDP.

Further, it said maintaining momentum in the asset monetization and privatization agenda can generate additional receipts.

On the expenditure side improved efficiency through better targeting of subsidies can reduce leakages.

India’s executive director at the IMF KV Subramanian did not agree with the staff’s view that India’s fiscal space is at risk. “Public debt remains very much sustainable given favourable growth dynamics and the strong commitment to consolidation,” he said in a statement included in the report.

Finance minister Nirmala Sitharaman said earlier this week the Centre will meet the fiscal deficit target of 6.4% of GDP in the current fiscal.

The IMF said Central Bank Digital Currency (CBDC) may yield greater additional benefits if it facilitates cross-border transactions. A CBDC would complement the already relatively efficient domestic payment system where private providers offer low-cost, real-time payments, the Staff Report said.

At the same time, a CBDC could significantly contribute to addressing the inefficiencies that characterise cross-border transactions but would require strong international cooperation.

Important risks, such as threats to cyber security, warrant caution in implementation, it said.


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