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India: 2018 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for India

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
August 2018
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Overview

1. A key focus of this consultation is macro-financial and structural policies to boost inclusive growth, including to harness the demographic dividend.1 While India has been one of the fastest-growing large economies in recent decades, investment growth has been comparatively modest and formal job growth insufficient. This creates challenges for creating jobs for a young and growing population and sustaining inclusive growth.

Real Growth: India and G20 Peers

(Index, Seasonally Adjusted, 2010-Q1 =100)

Sources: Haver Analytics and IMF Staff Calculations

India’s G-20 peers are Brazil, Russia, China, South Africa, Indonesia and Turkey

Real Gross Fixed Capital Formation: India and G-20 Peers

(Index, 2010-Q1 = 100)

Sources: Haver Analytics, WEO and IMF Staff Calculations

India’s G-20 peers are Brazil, Russia, China, South Africa, Indonesia and Turkey

2. Important reforms have been implemented in recent years. This includes the inflation-targeting monetary policy framework, the Insolvency and Bankruptcy code (IBC), the goods and services tax (GST), and steps to liberalize foreign direct investment (FDI) flows and the ease of doing business (Appendix I). A further deepening and broadening of structural reforms is needed to raise investment, job growth, and productivity over the medium term, to spur India’s catch up with advanced economies and create jobs needed for India’s young and growing labor force. The priorities should be to enhance several important recently implemented reforms—e.g., further steps on financial sector reforms and simplifying and streamlining the GST—combined with a vigorous push for labor, land, and product market reforms.

3. General elections will be held by May 2019. Against this background, government policies have shifted mainly to accelerating implementation of ongoing reforms rather than initiating new ones. And budget pressures could increase in the coming months.

4. Macroeconomic policies have been broadly consistent with past Fund advice. The stance of monetary policy over much of FY2017/18 was appropriate and consistent with the Fund’s call to aim monetary policy at durably lowering sticky inflation expectations, given the temporary weakness in growth and headline inflation at the lower end of the target range. Partly because of one-off factors, including the introduction of the GST, the government did not achieve its FY2017/18 fiscal consolidation target as advocated in previous Fund advice. Important steps are being taken to address the bank and corporate balance sheet problems and revive credit. Recent reforms to rigid labor laws, most notably through the extension of fixed-term contracts to sectors beyond textiles and leather, go in the direction of past Fund advice, but further reforms to labor laws, trade policies, infrastructure, and product markets are needed.

Recent Developments, Outlook, and Risks

5. Stability-oriented macroeconomic policies and progress on structural reforms continue to bear fruit, despite transitory disruptions to economic activity. Key macroeconomic developments in FY2017/18 include (Figures 18, Tables 18):

  • GDP growth slowed to a 4-year low of 6.7 percent, but a recovery is under way. Following a recovery from disruptions related to the November 2016 demonetization (Box 1) and the July 2017 GST rollout (Box 2), growth reached 7.7 percent in the quarter through March 2018 (y/y).
  • Headline inflation averaged 3.6 percent, a 17-year low, reflecting low food prices on a return to normal monsoon rainfall and agriculture sector reforms (e.g., pulses buffer stock, national agriculture market, crop insurance, and irrigation), subdued domestic demand, and currency appreciation. However, with growth recovering and the output gap narrowing to -0.3 percent of potential GDP (staff estimate), inflation is now on the rise with core (6.2 percent in May, y/y) and headline (4.9 percent) inflation now above the mid-point of the target band for headline inflation of the Reserve Bank of India (RBI), and inflation expectations over the forecast horizon still elevated.
  • External vulnerabilities remain contained but have risen. The current account deficit (CAD) widened to 1.9 percent of GDP, on rising imports and oil prices. But capital inflows have remained strong and helped finance the bulk of the CAD. In response to these inflows, the RBI intervened to limit the appreciation of the Indian rupee (INR) to about 3.1 and 1.4 percent on average during 2017/18 in real and nominal effective terms (according to the IMF’s Information Notice System). Gross international reserves rose by US$54.6 billion during 2017/18 to US$424.5 billion (about 8 months of prospective imports of goods and services) in March 2018. The U.S. dollar value of India’s non-oil merchandise exports expanded by 12 percent in calendar year 2017, a 6-year high, helping to raise India’s global export market share somewhat. Nonetheless, India’s export market share remains low, indicating a need to boost competitiveness through structural measures.

Figure 1.India: Growth and Activity

Figure 2.India: External Vulnerabilities

Figure 3.India: Financial Markets

Figure 4.India: Monetary Developments

Figure 5.India: Fiscal Developments

Figure 6.India: Fiscal Vulnerability Indicators

Figure 7.India: Corporate and Banking Sectors

Figure 8.India: Structural Reform Areas

Table 1.India: Selected Social and Economic Indicators, 2014/15–2019/20 1/
I. Social Indicators
GDP (2017/18)Poverty (percent of population)
Nominal GDP (in billions of U.S. dollars):2,602Headcount ratio at $1.90 a day (2011):21.2
GDP per capita (U.S. dollars) (IMF staff est.):1,942Undernourished (2015):14.5
Population characteristics (2016/17)Income distribution (2011, WDI)
Total (in billions):1.32Richest 10 percent of households:29.8
Urban population (percent of total):33.1Poorest 20 percent of households:8.3
Life expectancy at birth (years, 2015/16):68.3Gini index (2011):35.2
Sources: Data provided by the Indian authorities; Haver Analytics; CEIC Data Company Ltd; Bloomberg L.P.; World Bank, World Development Indicators; and IMF staff estimates and projections.

Data are for April–March fiscal years.

Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions.

Divestment and license auction proceeds treated as below-the-line financing.

Includes combined domestic liabilities of the center and the states, and external debt at year-end exchange rates.

Short-term debt on residual maturity basis, including estimated short-term NRI deposits on residual maturity basis.

In percent of current account receipts, excluding grants.

II. Economic Indicators
2014/152015/162016/172017/182018/192019/20
Est.Projections
Growth (in percent)
Real GDP (at market prices)7.48.27.16.77.37.5
Industrial production4.03.34.64.4
Prices (percent change, period average)
Consumer prices – Combined5.84.94.53.65.24.8
Saving and investment (percent of GDP)
Gross saving 2/33.030.729.728.829.630.0
Gross investment 2/34.231.830.330.632.232.2
Fiscal position (percent of GDP) 3/
Central government overall balance-4.5-4.1-3.7-4.0-3.6-3.5
General government overall balance-7.2-7.0-6.7-7.0-6.6-6.5
General government debt 4/67.869.668.970.468.767.2
Cyclically adjusted balance (% of potential GDP)-7.1-7.1-6.7-6.9-6.6-6.5
Cyclically adjusted primary balance (% of potential GDP)-2.4-2.4-1.8-1.9-1.6-1.6
Money and credit (y/y percent change, end-period)
Broad money10.910.110.19.511.411.8
Bank credit to the private sector9.310.68.09.813.613.3
Financial indicators (percent, end-period)
91-day treasury bill yield (end-period)8.37.35.86.1
10-year government bond yield (end-period)7.87.56.77.4
Stock market (y/y percent change, end-period)24.9-9.416.911.3
External trade (on balance of payments basis)
Merchandise exports (in billions of U.S. dollars)316.5266.4280.1309.0349.7385.0
(Annual percent change)-0.6-15.95.210.313.210.1
Merchandise imports (in billions of U.S. dollars)461.5396.4392.6469.0546.6592.2
(Annual percent change)-1.0-14.1-1.019.516.58.3
Terms of trade (G&S, annual percent change)3.06.01.4-2.8-2.91.8
Balance of payments (in billions of U.S. dollars)
Current account balance-26.8-22.1-15.2-48.7-70.6-68.3
(In percent of GDP)-1.3-1.1-0.7-1.9-2.6-2.2
Foreign direct investment, net (“-” signifies inflow)-31.3-36.0-35.6-30.3-38.7-47.1
Portfolio investment, net (equity and debt, “-” = inflow)-42.24.1-7.6-22.1-0.9-7.3
Overall balance (“-” signifies balance of payments surplus)-61.4-17.9-21.6-43.64.2-14.4
External indicators
Gross reserves (in billions of U.S. dollars, end-period)341.6360.2370.0424.5420.4434.7
(In months of next year’s imports (goods and services))8.58.97.67.56.86.5
External debt (in billions of U.S. dollars, end-period)474.7485.0471.8514.4559.3609.5
External debt (percent of GDP, end-period)23.323.120.819.820.220.0
Of which: Short-term debt 5/9.19.19.18.49.09.2
Ratio of gross reserves to short-term debt (end-period)1.81.91.81.91.71.5
Debt service ratio 6/7.68.87.87.98.38.5
Real effective exchange rate (annual avg. percent change)7.05.81.63.1
Exchange rate (rupee/U.S. dollar, end-period)62.668.364.865.0
Memorandum item (in percent of GDP)
Fiscal balance under authorities’ definition-4.1-3.9-3.5-3.5-3.3-3.2
Sources: Data provided by the Indian authorities; Haver Analytics; CEIC Data Company Ltd; Bloomberg L.P.; World Bank, World Development Indicators; and IMF staff estimates and projections.

Data are for April–March fiscal years.

Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions.

Divestment and license auction proceeds treated as below-the-line financing.

Includes combined domestic liabilities of the center and the states, and external debt at year-end exchange rates.

Short-term debt on residual maturity basis, including estimated short-term NRI deposits on residual maturity basis.

In percent of current account receipts, excluding grants.

Sources: Data provided by the Indian authorities; Haver Analytics; CEIC Data Company Ltd; Bloomberg L.P.; World Bank, World Development Indicators; and IMF staff estimates and projections.

Data are for April–March fiscal years.

Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions.

Divestment and license auction proceeds treated as below-the-line financing.

Includes combined domestic liabilities of the center and the states, and external debt at year-end exchange rates.

Short-term debt on residual maturity basis, including estimated short-term NRI deposits on residual maturity basis.

In percent of current account receipts, excluding grants.

Table 2.India: Balance of Payments, 2014/15–2019/20 1/(In billions of U.S. dollars)
2014/152015/162016/172017/182018/192019/20
Est.Projections
Current account balance-26.8-22.1-14.4-48.7-70.6-68.3
Merchandise trade balance-144.9-130.1-112.4-160.0-196.9-207.2
Merchandise exports316.5266.4280.1309.0349.7385.0
Merchandise imports461.5396.4392.6469.0546.6592.2
Oil138.382.987.0108.7
Non-oil323.2313.5305.6360.3
Services balance76.569.768.377.685.693.8
Credit158.1154.3164.2195.1216.0238.2
Of which : software services73.174.273.777.3
Debit81.684.695.9117.5130.4144.5
Primary income balance, net-24.1-24.4-26.3-28.7-26.8-27.1
Secondary income balance, net65.862.756.162.567.472.2
Capital and Financial account balance-27.6-23.1-14.6-47.8-70.6-68.1
Direct investment, net-31.3-36.0-35.6-30.3-38.7-47.1
Of which : Net incurrance of liabilties35.344.942.239.449.860.8
Portfolio investment, net-42.24.1-7.6-22.1-0.9-7.3
Financial derivatives, net1.6-0.6-9.82.92.42.6
Other investment, net-18.5-8.916.8-41.8-29.3-30.7
Reserve assets, net61.417.921.643.6-4.214.4
Errors and omissions-1.1-1.10.40.90.00.0
Increase in gross reserve stock
(including valuation changes)37.418.59.854.6-4.214.4
of which: Valuation changes 2/-24.00.6-11.811.00.00.0
Memorandum items:
Foreign exchange reserves341.6360.2370.0424.5420.4434.7
In months of next year’s imports (goods and services)8.58.87.67.56.86.5
Current account balance (percent of GDP)-1.3-1.1-0.6-1.9-2.6-2.2
Merchandise trade balance (percent of GDP)-7.1-6.2-4.9-6.1-7.1-6.8
Direct investment, net (percent of GDP)-1.5-1.7-1.6-1.2-1.4-1.6
Gold Imports (billions U.S. dollars)34.431.827.533.7
GDP in USD2,039.12,102.42,273.62,602.32,767.83,041.4
Sources: CEIC Data Company Ltd; Haver Analytics; and IMF staff estimates and projections.

Data are for April-March fiscal years. Based on BPM6, including sign conventions.

Calculated as the difference between the stock of reserves and the flow changes to net reserve assets.

Sources: CEIC Data Company Ltd; Haver Analytics; and IMF staff estimates and projections.

Data are for April-March fiscal years. Based on BPM6, including sign conventions.

Calculated as the difference between the stock of reserves and the flow changes to net reserve assets.

Table 3.India: Reserve Money and Monetary Survey, 2013/14–2018/19 1/
2013/142014/152015/162016/172017/182018/19 May
Reserve money(In billions of rupees, end-period)
Reserve money17,32719,28521,02319,00524,18724,610
Net domestic assets of RBI-698-1,988-2,812-4,967-3,421-3,535
Claims on government (net)6,9873,6454,2506,2084,7606,234
Center6,9763,6104,2466,1964,7436,221
States11354121713
Claims on commercial sector881482017314094
Claims on banks4861,8772,845-3,166493-132
Other items (net)-8,259-7,658-10,107-8,083-8,814-9,731
Net foreign assets of RBI18,02521,27323,83523,97227,60828,144
(Contribution to twelve-month reserve money growth)
Reserve money14.411.39.0-9.627.325.0
Net domestic assets of RBI-1.8-7.4-4.3-10.38.16.2
Claims on government (net)7.1-19.33.19.3-7.6-3.2
Net foreign assets of RBI16.118.713.30.719.118.8
Monetary survey(In billions of rupees, end-period)
Broad money (M3)95,174105,502116,176127,919140,114140,284
Currency with public12,45813,86215,97312,64117,59318,534
Deposits82,69691,494100,049115,067122,282121,481
Non-bank deposits at RBI20146154211239269
Net domestic assets75,93482,99590,839102,337111,168110,801
Domestic credit94,902100,571110,416122,681132,536133,638
Net credit to government30,44930,07432,38538,56640,14742,127
Of which: RBI6,9873,6454,2506,2084,7606,234
Credit to commercial sector64,45370,49778,03184,11592,38991,511
Of which: Bank credit (excluding RBI)64,36570,34977,83084,04292,24991,416
Other items (net)-18,967-17,576-19,577-20,344-21,368-22,837
Net foreign assets19,23922,50625,33725,58228,94629,483
(Twelve-month percent change)
Broad money (M3)13.410.910.110.19.510.7
Net domestic assets12.49.39.512.78.610.1
Domestic credit13.36.09.811.18.09.2
Net credit to government12.4-1.27.719.14.12.6
Credit to commercial sector13.79.410.77.89.812.5
Of which: Bank credit (excluding RBI)13.69.310.68.09.812.5
Net foreign assets17.617.012.61.013.113.2
Sources: CEIC Data Company Ltd.; Reserve Bank of India WSS; IMF IFS, and Fund staff calculations.

Data are for April–March fiscal years, unless indicated otherwise.

Sources: CEIC Data Company Ltd.; Reserve Bank of India WSS; IMF IFS, and Fund staff calculations.

Data are for April–March fiscal years, unless indicated otherwise.

Table 4.India: Central Government Operations, 2014/15–2019/20 1/
2014/152015/162016/172017/182018/192019/20
Est.Projections
(In percent of GDP)
Revenue9.19.09.38.89.49.4
Taxes7.36.97.37.47.97.9
Income tax5.65.45.65.86.16.1
GST2.64.04.0
Excise tax1.52.12.51.51.41.4
Service tax1.31.51.70.50.00.0
Customs duties1.51.51.50.80.60.6
Other taxes0.00.00.00.20.00.0
Less: States’ share2.73.74.04.04.24.2
Grants0.00.00.00.00.00.0
Other revenue 2/1.82.12.01.41.51.5
Property income0.91.00.90.60.70.7
Sale of goods and services0.30.20.20.30.20.2
Miscellaneous and unidentified revenue0.70.80.90.50.60.6
Expenditure13.613.113.012.813.013.0
Expense 3/12.011.211.111.211.411.4
Compensation of employees 4/1.10.81.21.11.11.1
Interest3.23.23.23.23.13.1
Subsidies 5/2.01.81.31.11.41.4
Food0.91.00.70.60.90.9
Fertilizer0.60.50.40.40.40.4
Petroleum0.50.20.20.10.10.1
Grants and other expense 6/5.75.45.55.85.85.8
Grants2.72.32.42.62.52.5
Other expense 6/3.03.13.13.33.43.4
Net acquisition of nonfinancial assets1.61.81.91.61.61.6
Gross Operating Balance-2.9-2.2-1.9-2.4-2.0-2.0
Net lending / borrowing (overall balance)-4.5-4.1-3.7-4.0-3.6-3.5
Net financial transactions-4.5-4.1-3.7-4.0-3.6-3.5
Net acquisition of financial assets-0.5-0.7-0.7-1.0-0.9-0.5
Domestic-0.5-0.7-0.7-1.0-0.9-0.5
Currency and deposits-0.4-0.5-0.6-0.4-0.50.0
Loans0.10.00.10.00.1-0.1
Share and other equity-0.3-0.3-0.3-0.7-0.4-0.4
Net incurrence of liabilities4.03.33.03.02.83.0
Domestic3.93.32.92.92.83.1
Debt securities 7/3.63.02.22.52.33.1
Other accounts payable0.30.20.60.40.50.0
Foreign0.10.10.10.10.00.0
Loans0.10.10.10.10.00.0
Memorandum items:
Balance under authorities’ definition-4.1-3.9-3.5-3.5-3.3-3.2
Primary balance-1.3-0.9-0.6-0.8-0.5-0.5
Central government debt 8/51.451.650.050.147.545.4
Sources: Data provided by the Indian authorities; and Fund staff estimates and projections.

Data for April – March fiscal years

Auctions for wireless spectrum are classified as non-tax revenues.

Includes the surcharge on Union duties transferred to the National Calamity Contingency Fund.

Pensions are included under expense not otherwise classified.

Includes subsidy-related bond issuance.

Other expense includes purchases of goods and services.

Debt securities include bonds and short-term bills, as well as loans.

External debt measured at historical exchange rates.

Sources: Data provided by the Indian authorities; and Fund staff estimates and projections.

Data for April – March fiscal years

Auctions for wireless spectrum are classified as non-tax revenues.

Includes the surcharge on Union duties transferred to the National Calamity Contingency Fund.

Pensions are included under expense not otherwise classified.

Includes subsidy-related bond issuance.

Other expense includes purchases of goods and services.

Debt securities include bonds and short-term bills, as well as loans.

External debt measured at historical exchange rates.

Table 5.India: General Government Operations, 2014/15–2019/20 1/
2014/152015/162016/172017/182018/192019/20
Est.Projections
(In percent of GDP)
Revenue19.220.320.920.521.321.3
Taxes16.217.117.717.918.618.6
Grants0.00.00.00.00.00.0
Other revenue2.93.23.12.62.72.7
Expenditure26.327.327.527.527.927.8
Expense22.422.722.923.123.523.5
of which: interest4.74.74.95.05.05.0
Net acquisition of nonfinancial assets3.94.64.64.34.44.3
Gross Operating Balance-3.2-2.4-2.0-2.6-2.3-2.2
Net lending (+)/borrowing (–) (fiscal balance)-7.2-7.0-6.7-7.0-6.6-6.5
Net financial worth, transactions-7.2-7.0-6.7-7.0-6.6-6.5
Net acquisition of financial assets-0.5-0.8-0.8-1.1-0.9-0.5
Domestic-0.5-0.8-0.8-1.1-0.9-0.5
Currency and deposits-0.3-0.5-0.6-0.4-0.50.0
Loans0.10.00.10.00.1-0.1
Equity and investment fund shares-0.3-0.3-0.3-0.7-0.4-0.4
Net incurrence of liabilities6.76.25.95.95.86.1
Domestic6.56.25.85.95.86.1
Debt securities5.44.94.04.13.74.5
Other accounts payable1.21.21.81.82.11.6
Foreign0.10.10.10.10.00.0
Loans0.10.10.10.10.00.0
Memorandum items:
Primary balance-2.5-2.3-1.8-1.9-1.7-1.6
Nondefence capital expenditure3.34.14.04.13.83.8
State and union territory governments’ balance 2/-2.7-3.0-3.0-3.0-3.0-3.0
General government debt 3/67.869.668.970.468.767.2
Sources: Data provided by the Indian authorities; state level data from the RBI Study on State Finances; and Fund staff estimates and projections.

The consolidated general government comprises the central government (CG) and state governments. Data for April-March fiscal years.

The authorities treat states’ divestment proceeds, including land sales, above-the-line as miscellaneous capital receipts. IMF Staff definition treats divestment receipts as a below-the-line financing item.

Includes combined domestic liabilities of CG and states governments, inclusive of MSS bonds, and sovereign external debt at year-end exchange rates.

Sources: Data provided by the Indian authorities; state level data from the RBI Study on State Finances; and Fund staff estimates and projections.

The consolidated general government comprises the central government (CG) and state governments. Data for April-March fiscal years.

The authorities treat states’ divestment proceeds, including land sales, above-the-line as miscellaneous capital receipts. IMF Staff definition treats divestment receipts as a below-the-line financing item.

Includes combined domestic liabilities of CG and states governments, inclusive of MSS bonds, and sovereign external debt at year-end exchange rates.

Table 6.India: Macroeconomic Framework, 2014/15–2023/24 1/
2014/152015/162016/172017/182018/192019/202020/212021/222022/232023/24
EstProjections
Growth (percent change)
Real GDP (at market prices)7.48.27.16.77.37.57.77.77.77.7
Non-agricultural sector (at basic prices)8.79.67.27.07.98.18.48.48.38.3
Prices (percent change, period average)
Consumer prices5.84.94.53.65.24.84.54.24.14.0
Saving and investment (percent of GDP)
Gross saving 2/33.030.729.728.829.630.030.330.630.630.8
Gross investment 3/34.231.830.330.632.232.232.532.833.033.4
Money and credit (y/y percent change, end-period)
Broad money10.910.110.19.511.411.812.311.911.911.9
Bank credit to the private sector9.310.68.09.813.613.313.413.713.213.3
Fiscal position (percent of GDP)
Central government balance 4/-4.5-4.1-3.7-4.0-3.6-3.5-3.3-3.1-3.0-2.9
General government balance 4/-7.2-7.0-6.7-7.0-6.6-6.5-6.4-6.2-6.0-5.9
General government debt 5/67.869.668.970.468.767.265.764.463.161.9
External trade (percent change, balance of payments basis)
Merchandise exports (in U.S. dollars terms)-0.6-15.95.210.313.210.19.79.47.97.8
Merchandise imports (in U.S. dollars terms)-1.0-14.1-1.019.516.58.39.09.49.49.5
Balance of payments (in billions of U.S. dollars, BMP6
(including sign conventions))
Current account balance-26.8-22.1-15.2-48.7-70.6-68.3-71.8-81.0-98.2-115.4
(in percent of GDP)-1.3-1.1-0.7-1.9-2.6-2.2-2.1-2.2-2.4-2.6
Foreign direct investment, net (“-” sign is net FDI inflow)-31.3-36.0-35.6-30.3-38.7-47.1-52.0-59.1-67.2-76.2
Portfolio investment, net (“-” sign denotes capital inflow)-40.94.5-7.6-22.1-0.9-7.3-14.1-17.4-28.1-30.9
Overall balance (“-” sign denotes surplus)-61.4-17.9-21.6-43.64.2-14.4-30.1-40.9-54.3-64.0
External indicators
Gross reserves (in billions of U.S. dollars, end-period)341.6360.2370.0424.5420.4434.7464.9505.7560.1624.1
(in months of imports) 6/8.58.97.67.56.86.56.36.36.36.4
External debt (in billions of U.S. dollars, end-period)474.7485.0471.8514.4559.3609.5666.4730.4812.4903.3
External debt (percent of GDP, end-period)23.323.120.819.820.220.019.919.820.020.1
Of which : short-term debt 7/9.19.19.18.49.09.29.49.69.810.0
Ratio of gross reserves to short-term debt (end-period) 7/1.81.91.81.91.71.51.51.41.41.4
GDP in billions of U.S. dollars2,039.12,102.42,273.62,602.32,767.83,041.43,354.93,695.54,070.84,484.9
Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; and IMF staff estimates and projections.

Data are for April-March fiscal years unless otherwise mentioned.

Differs from official data, calculated with gross investment and current account.

Statistical discrepancy adjusted.

Divestment and license auction proceeds are treated as financing; includes subsidy related bond issuance.

Includes combined domestic liabilities of the center and the states, inclusive of MSS bonds, and sovereign external debt at year-end exchange rates.

Imports of goods and services projected over the following twelve months.

Including short-term debt on contracted maturity basis, all NRI deposits, and medium and long-term debt on residual maturity basis, different from authorities’ definition.

Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; and IMF staff estimates and projections.

Data are for April-March fiscal years unless otherwise mentioned.

Differs from official data, calculated with gross investment and current account.

Statistical discrepancy adjusted.

Divestment and license auction proceeds are treated as financing; includes subsidy related bond issuance.

Includes combined domestic liabilities of the center and the states, inclusive of MSS bonds, and sovereign external debt at year-end exchange rates.

Imports of goods and services projected over the following twelve months.

Including short-term debt on contracted maturity basis, all NRI deposits, and medium and long-term debt on residual maturity basis, different from authorities’ definition.

Table 7.India: Indicators of External Vulnerability, 2013/14–2017/18 1/
2013/142014/152015/162016/172017/18
Financial indicators
General government debt (percent of GDP)68.567.869.668.970.4
Broad money (percent change, 12-month basis)13.410.910.110.19.5
Private sector credit (percent change, 12-month basis)13.79.310.68.09.8
91 day T-bill yield (percent; end-period)8.98.37.35.86.1
91 day T-bill yield (real, percent; end-period) 2/-0.72.42.32.62.5
External indicators
Exports (percent change, 12-month basis in US$) 3/3.9-0.6-15.95.210.3
Export volume (percent change, 12-month basis) 3/5.03.5-5.36.59.9
Imports (percent change, 12-month basis in US$) 3/-7.2-1.0-14.1-1.019.5
Import volume (percent change, 12-month basis) 3/-3.65.30.44.012.8
Terms of trade (percent change, 12 month basis) 3/2.13.06.01.4-2.8
Current account balance (percent of GDP)-1.7-1.3-1.1-0.7-1.9
Capital and financial account balance (percent of GDP, “-” sign for inflow)-1.8-1.4-1.1-0.7-1.8
Of which : Net portfolio investment (debt and equity, “-” sign for inflow)-0.3-2.00.2-0.3-0.8
Other investment (loans, trade credits, etc., “-” sign for inflow1.20.80.41.30.2
Net foreign direct investment (“-” sign denotes inflow)-1.2-1.5-1.7-1.6-1.2
Foreign currency reserves (in billions of U.S. dollars)304.2341.6360.2370.0424.5
Official reserves (in months of prospective imports of goods and services)6.78.58.97.67.5
Ratio of foreign currency reserves to broad money (percent)19.520.220.819.919.7
Total short-term external debt to reserves (percent) 4/60.554.253.455.651.7
Total external debt (percent of GDP)24.023.323.120.819.8
Of which: public sector debt3.73.53.43.22.9
Total external debt to exports of goods and services (percent)94.8100.0115.3106.4102.1
External interest payments to exports of goods and services (percent)1.71.82.42.92.5
External amortization payments to exports of goods and services (percent)19.220.625.726.823.0
Exchange rate (Indian rupees per U.S. dollar, annual average)60.561.165.567.164.5
REER (percent change; based on annual average level)-2.07.05.81.63.1
Financial market indicators
Stock market index (end-period)2 2,38627,95725,34229,62132,969
Foreign currency debt rating
Moody’s Investor ServicesBaa3Baa3Baa3Baa3Baa2
Standard and Poor’sBBB-BBB-BBB-BBB-BBB-
Fitch Ra ting sBBB-BBB-BBB-BBB-BBB-
Spread of benchmark bonds (basis points, end of period) 5/608.5581.4569.6429.3466.0
Sources: Data provided by the Indian authorities; Bloomberg L.P.; CEIC Data Company Ltd.; IMF, Information Notice System and staff estimates and projections.

Data for April-March fiscal years.

Equals nominal yield minus actual CPI inflation.

Terms of trade including goods and services. Goods volumes are derived from partner country trade price deflators, and services volumes are derived using U.S. CPI from the WEO database.

Including short-term debt on contracted maturity basis, all NRI deposits, and medium and long-term debt on residual maturity basis, different from authorities’ definition.

10-year sovereign bond spread over U.S. bond.

Sources: Data provided by the Indian authorities; Bloomberg L.P.; CEIC Data Company Ltd.; IMF, Information Notice System and staff estimates and projections.

Data for April-March fiscal years.

Equals nominal yield minus actual CPI inflation.

Terms of trade including goods and services. Goods volumes are derived from partner country trade price deflators, and services volumes are derived using U.S. CPI from the WEO database.

Including short-term debt on contracted maturity basis, all NRI deposits, and medium and long-term debt on residual maturity basis, different from authorities’ definition.

10-year sovereign bond spread over U.S. bond.

Table 8.India: Financial Soundness Indicators, 2013/14–2017/18
2013/142014/152015/162016/172017/18
(In percent, unless indicated otherwise)
Risk-weighted capital adequacy ratio (CAR)13.012.913.313.613.8
Public sector banks11.411.411.812.111.7
Private sector banks15.915.115.715.516.4
Foreign banks17.916.817.118.718.6
Number of institutions not meeting 9 percent CAR1011
Public sector banks0001
Private sector banks1010
Foreign banks0000
Net nonperforming assets (percent of outstanding net advances) 1/2.22.44.45.36.1
Public sector banks2.63.05.76.98.6
Private sector banks0.60.81.42.22.0
Foreign banks1.10.50.80.60.4
Gross nonperforming assets (percent of outstanding advances)3.84.37.59.611.6
Public sector banks4.45.09.312.515.6
Private sector banks1.82.12.84.14.0
Foreign banks3.93.24.24.03.8
Restructured loans (percent of outstanding loans)5.25.83.42.50.9
Public sector banks6.37.14.13.11.1
Private sector banks2.32.41.81.10.4
Foreign banks0.10.10.30.30.1
Return on assets 2/0.80.80.40.4-0.2
Public sector banks0.50.5-0.1-0.1-0.9
Private sector banks1.71.71.51.31.3
Foreign banks1.51.91.51.61.3
Balance sheet structure of all scheduled banks
Loan/deposit ratio77.876.677.772.9
Investment in government securities/deposit ratio28.729.228.128.2
Source: Reserve Bank of India; Bankscope; and IMF staff estimates.

Gross nonperforming assets less provisions.

Net profit (+)/loss (-) in percent of total assets.

Source: Reserve Bank of India; Bankscope; and IMF staff estimates.

Gross nonperforming assets less provisions.

Net profit (+)/loss (-) in percent of total assets.

6. Systemic macro-financial risks bear monitoring, nonetheless, as the weak credit cycle could impair growth and the sovereign-bank nexus has created vulnerabilities.

  • Bank credit growth recovered to 12.5 percent (y/y) in May. Incremental credit was mostly allocated to households and the services sector, with credit to industry remaining stagnant. The corporate sector has been deleveraging slowly and, while debt repayment capacity and profitability appear to have bottomed out, they remain weak in aggregate. The recent fraud at a large public sector bank (PSB) highlights governance weaknesses which have depressed bank share prices.
  • The RBI’s Asset Quality Review (AQR), initiated in 2015, improved recognition of non-performing assets (NPAs), especially in PSBs, which account for about 70 percent of the banking system’s assets. So far, 11 PSBs have been put under the prompt corrective action (PCA) framework that became effective in April 2017. Meanwhile, system-wide capital adequacy has continued to improve and remains above the minimum requirements. Nevertheless, PSBs continue to report low profitability, high NPAs, and increased provisioning, related to the reclassification of their loan portfolios, which remains a constraint on credit expansion and investment. As a result, the NPA ratio for the total banking sector increased to 11.6 percent in March 2018 compared to 9.6 percent a year ago, in large part reflecting the migration of restructured loans to NPAs and in line with the RBI’s new framework for the restructuring of stressed assets (see ¶31). A plan to recapitalize PSBs, announced in October 2017, will add at least 0.8 percent of GDP to public debt (financed through recapitalization bonds; Box 3). Depressed valuations may make it difficult to meet the government’s expectation that PSBs raise an additional 0.3 percent of GDP from the market over two years.2
  • Financial markets were generally robust through early 2018—especially equities. Market sentiment, however, has deteriorated in recent months, in line with increased global volatility. Moreover, 10-year bond yields rose by 130 basis points in the nine months through early-March, despite Moody’s upgrade of India’s government bond rating in November for the first time since 2004. This reflects concerns of higher global yields, that the center and state fiscal targets would be missed, and that some PSBs need to reduce holdings of government securities due to mark-to-market losses—further highlighting the bank-sovereign debt nexus. In recent months, yields have been particularly volatile given countervailing forces—announcements regarding the debt issuance calendar for the new fiscal year showing backloaded issuance and easing foreign investment limits for borrowings have been more than offset by global factors, including rising U.S. interest rates and higher oil prices.

Outstanding Corporate Debt in India

(in trillions of Indian Rupees)

Sources: RBI; Dealogic; and IMF staff estimates.

* Cumulative since 2012.

Banks’ Credit, Capital, and Non-Performing Assets

(In percent)

Source: Reserve Bank of India, and IMF Staff estimates.

7. India has been affected by the emerging market turmoil since mid-April. Portfolio outflows from India were relatively large, triggered by the runup in international oil prices and tighter global financial conditions, as well as domestic concerns over fiscal slippages and the banking system’s exposure to the sovereign. In the ten weeks since April 13, net portfolio outflows amounted to US$9.3 billion or about 0.3 percent of GDP, and pressures from significant capital outflows were absorbed through the rupee depreciating by about four percent vis-à-vis the U.S. dollar. Nevertheless, this episode of capital reversal has been less intense than the 2013 Taper Tantrum, thanks to India’s stability-oriented policies and progress with structural reforms in recent years. From mid-April to mid-June 2018, foreign exchange reserves fell by about US$16 billion (from US$426 billion), and the RBI accelerated the scaling back of its net forward foreign exchange position, which has been ongoing since September 2017. Following the sizeable purchases of foreign exchange in the spot and forward markets in 2017 to contain rupee appreciation, the recent declines in the central bank’s reserves and net forward position underscore the two-way nature of India’s exchange rate management.

8. The macroeconomic outlook for FY2018/19 is broadly favorable, even when considering the recent upward revision to global oil prices and tightening of global financial conditions (Text Table 1)3.

  • Real GDP growth is projected at 7.3 percent, on strengthening investment and robust private consumption. Compared to the Spring WEO projections, growth will be somewhat lower reflecting adverse terms of trade leading to real income losses to households and firms, and additional effects from an incremental further tightening of monetary policy.
  • Headline inflation is projected to rise to 5.2 percent, above the mid-point of the RBI’s medium-term inflation target band (4 percent CPI inflation ± 2 percent), as demand conditions tighten, along with higher oil prices, housing rent allowances (HRAs), and agricultural minimum support prices (MSPs), and the recent depreciation of the rupee. The effect of these factors was visible in recent inflation prints.
  • The CAD is projected to widen to 2.6 percent of GDP on rising oil prices and strong demand for imports, offset by a slight increase in remittances. The balance of payments would switch to a small deficit.
Text Table 1.India: Impacts of an Increase in Oil Prices
2017/182018/192019/20
Oil price (US$/barrel)Baseline52.871.867.5
April 2018 WEO52.862.358.2
Change from April 2018 WEO9.59.3
Growth (percent)Baseline6.77.37.5
April 2018 WEO6.77.47.8
Change from April 2018 WEO-0.1-0.3
Inflation (percent)Baseline3.65.24.8
April 2018 WEO3.65.05.0
Change from April 2018 WEO0.3-0.1
Current account (percent of GDP)Baseline-1.9-2.6-2.2
April 2018 WEO-2.0-2.3-2.1
Change from April 2018 WEO-0.2-0.1
Source: IMF Staff Projection.
Source: IMF Staff Projection.

9. Over the medium-term, the economic outlook is projected to continue to improve. Real GDP growth is expected to rise to 7¾ percent reflecting continued robustness in private consumption and a recovery in investment, supplemented by progress in bank balance-sheet repair, improved credit growth, and on-going structural reforms, most notably the productivity-enhancing effects of GST. Beyond potential fiscal gains, the national GST lowered internal trade barriers and will help create a common domestic market. This potential growth rate is estimated to be 0.5 percentage points lower than in the last Article IV consultation, due to a somewhat slower-than-previously-envisaged impact of structural reform, along with a downward revision to the historical GDP times series (Box 4).

10. Beyond the risk of a further increase in international oil prices, other risks are also tilted to the downside (Appendix II). Domestic risks pertain to tax revenue shortfalls related to continued GST implementation issues. Delays in addressing the twin balance sheet problems may lead to a further deterioration of the balance sheets of banks and corporates. Slow progress in implementing key structural reforms could weigh on investor sentiment, investment, and growth. On the external side, further tightening of global financial conditions could intensify the recent reversal of capital flows and add to external borrowing costs. A retreat from cross-border integration including spillover risks from a global trade conflict could affect exports. Nonetheless, given India’s relatively low trade openness, spillover risks of a global trade conflict are likely contained, to the extent that it does not affect capital flows. India’s outward spillovers are likely limited to its neighboring economies, namely Nepal and Bhutan, given trade ties and their currency pegs to the Indian rupee.

Authorities’ Views

11. The authorities broadly agreed with the staff’s assessment of the outlook and risks. They expected that the economic recovery would continue to strengthen and be broad-based, as agricultural output improves on the back of a predicted normal monsoon, industrial output expands in line with growing domestic and external demand, and services sector growth remains robust. The authorities observed a strong pickup in credit from banks and other financing sources to the commercial sector compared to last year. With improving capacity utilization and credit uptake, investment activity is expected to remain robust even as there has been some tightening of financing conditions in recent months. They also highlighted a significant rise in infrastructure investment, particularly in road construction, with the government’s focus on demand and job creation through spending on rural and labor-intensive infrastructure likely to support rural demand. They underscored that risks to near-term growth persist, mainly arising from volatile oil prices and tightening global financial conditions. On inflation, the authorities indicated that their projections were lower than staff’s. They also emphasized the need to look through the statistical impact of the HRA (0.35 percentage point on headline inflation) and cautioned that only the second-round impact would be relevant from a policy perspective. Moreover, they saw substantial uncertainty regarding the inflationary impact of higher MSPs, pending the operationalization of the mechanism to set and pay the higher prices.

Key Policy Issues

12. Policy mix. With limited policy space, growing risks (which places a premium on prudent policies), and the economy recovering, India would be served best by stepping up supply-side measures to revive credit growth (including to businesses) and promote inclusive growth. Fiscal consolidation should continue to lower elevated public debt levels and allow for easing of financial repression. The RBI will need to gradually tighten policy further, in response to inflation pressures, which will help to build monetary policy credibility. The staff’s advice on financial sector reforms is anchored by the recommendations made in the recent FSAP (Appendix III).

13. Macro-financial and structural policies are medium-term priorities to boost inclusive growth and harness the demographic dividend. Immediate priorities are to revive bank credit and enhance the efficiency of credit provision by accelerating the cleanup of bank and corporate balance sheets and a decisive strengthening of PSB governance. Gains can also be made by simplifying and streamlining the GST structure and broadening the tax base. More broadly, over the longer term, greater labor market flexibility, land reforms, and product market liberalization are needed.

A. Fiscal Policy—Enhancing Sustainability

14. Fiscal consolidation paused in FY2017/18 as the planned reduction in the central government deficit target did not materialize, partly reflecting one-off factors (Text Table 2). The central government deficit remained at the FY2016/17 outturn of 3.5 percent of GDP (authorities’ presentation; provisional accounts) and above the budget target of 3.2 percent of GDP. The deficit is estimated to have deteriorated by 0.3 percent of GDP relative to FY2016/17 in the IMF presentation.4 Relative to the FY2016/17 outturn as a share of GDP, non-tax revenue declined sharply, offset partly by a small increase in tax revenue and a reduction in expenditures, mainly lower capital spending. Lower-than-budgeted telecom spectrum sales, dividends from public sector enterprises, and profit transfers from the RBI due to demonetization and intervention-related costs reduced non-tax revenue receipts, whereas base broadening efforts through heightened enforcement helped boost tax revenue.

Text Table 2.India: Summary Fiscal Operations, FY16/17–18/19(In percent of GDP)
FY 2016/17FY2017/18FY 2018/19
BudgetActualBudget
Total revenues9.39.38.89.4
Net tax revenues7.37.47.47.9
Non-tax revenues2.01.91.41.5
Total expenditure13.012.912.813.0
Revenue expenditure11.111.011.211.4
Capital expenditure1.91.81.61.6
Central government balance-3.7-3.5-4.0-3.6
General government balance-6.7-6.5-7.0-6.6
Memo items
Fiscal deficit (authorities’ definition) 1/3.53.23.53.3
Public debt68.970.468.7
Source: Budget documents, RBI debt statistics, and IMF staff estimates.

Includes asset sales in receipts, and excludes certain non-tax revenue items.

Source: Budget documents, RBI debt statistics, and IMF staff estimates.

Includes asset sales in receipts, and excludes certain non-tax revenue items.

15. The central government’s FY 2018/19 budget again envisages a reduction in the headline fiscal deficit.

  • The authorities’ presentation shows a reduction of about 0.2 percent of GDP, while the IMF projects a reduction of 0.4 percent of GDP (0.3 percent of potential GDP in cyclically-adjusted terms).
  • Net revenues are budgeted to increase as a share of GDP, roughly half from an increase in direct tax collections. Continued base-broadening and enforcement measures would boost personal income taxes (PIT), offset by a slight fall in corporate income taxes (CIT) following a modest tax rate cut for micro, small, and medium-sized enterprises (MSMEs). Indirect tax revenue is budgeted to rise mainly on improved GST compliance. Non-tax revenue is projected to increase slightly, while other tax revenues are set for a small decline, with an increase in the states’ share from gross revenues. The budget introduced a long-term capital gains tax on equities at a 10 percent rate, raised custom duties on several items, and lowered excise rates on petrol and diesel. Pressures may mount on cutting back excises on fuel as retail prices have risen recently.
  • Expenditures are budgeted to increase as a share of GDP, primarily reflecting higher subsidy payments, offset by lower interest expenses. A key government initiative launched in the context of the budget remains unfunded, namely to offer farmers a MSP of 1.5 times production cost. The budget also announced the launch of a flagship national healthcare scheme to cover 500 million potential beneficiaries (about 100 million households), details of which are yet to be finalized, and the establishment of a dedicated Affordable Housing Fund (0.2 percent of GDP, financed mostly off-budget).

Fiscal Impulse and Output Gap

(In percent of potential GDP)

16. The government accepted the medium-term fiscal targets recommended by the Fiscal Responsibility and Budget Management (FRBM) Review Committee but with a delayed timetable. The recommendation to set-up a fiscal council was not approved.

  • The fiscal deficit, adopted as the operational target, will be reduced to 3.0 percent of GDP (authorities’ definition) by FY2020/21, two years later than the first year of meeting the target as recommended by the FRBM Review Committee.
  • Central government debt will be brought down to 40 percent of GDP by FY2024/25, two years later than recommended.

17. Staff supports the FY2018/19 budget targets, and the authorities should stand ready to take corrective measures if there are any slippages.

  • India has limited fiscal space as debt is close to thresholds that increase the likelihood of debt distress among emerging market economies (Appendix IV). High interest burden and risks from rising yields necessitate continued focus on debt reduction, to enable establishing policy credibility, building buffers, and further reducing the statutory liquidity requirement (SLR).
  • The states’ share in aggregate fiscal deficits and debt is large, and spending pressures pose risks, including from farm loan repayment waivers, the UDAY scheme under which states take over part of electricity distribution companies’ debts and losses in return for reforms, and the recommendations of the Seventh Pay Commission. While states’ fiscal deficits have generally been within 3 percent of GDP, stipulated under states’ self-imposed fiscal rules, they have risen recently even as the center has consolidated.
  • Against the backdrop of a narrowing output gap, the FY2018/19 budget targets imply a reduction of the cyclically-adjusted deficit as noted earlier (IMF presentation). However, revenue risks, mainly from GST, and expenditure risks may limit the adjustment.
  • Vigilance is needed in view of the higher-than-usual uncertainty surrounding GST revenue projections, stemming mainly from the absence of historical data on which to base projections. In the context of GST adoption, the center has guaranteed states’ annual revenue growth of 14 percent for a period of 5 years. Therefore, GST revenue slippages could exacerbate the central government deficit through additional transfers to states and necessitate further fiscal measures.
  • Enhancing GST compliance, including by streamlining filing and refund mechanisms and simplifying the rate structure, along with strengthening tax administration, are key to relieve the burden on MSMEs and help deliver on the GST’s promise of enhanced formalization of economic activity. Fewer rates and a broader base would limit opportunities for reclassification (to exploit rates differences between inputs and outputs) and simplify administration. In this context, consideration could be given to include petroleum products in the GST.
  • On the expenditure side, the government primarily needs to limit the fiscal cost of the proposed increase in MSPs and avoid increasing fuel subsidies (or alternatively reducing fuel excise taxes). In addition, rising interest rates could put pressure on the government’s interest burden.

18. Staff recommends a more ambitious medium-term fiscal consolidation path than currently envisaged by the authorities. The center has consolidated over the last few years from high deficit levels. The expected acceleration of growth provides room for a more rapid reduction in the deficit and would allow the authorities to adopt a consolidation path consistent with the FRBM Review Committee’s recommendation to reduce general government debt to 60 percent of GDP by FY2022/23, underpinned by further reforms to subsidies and continued measures to raise tax buoyancy (Text Table 3; the footnotes therein provide details on the measures underpinning the alternative scenario). This entails a cumulative improvement in the cyclically-adjusted primary balance of about 1.3 percent of potential GDP over 4 years, well below consolidations achieved by other countries (the top quartile of achieved adjustments is 3 percent over 3 years). A faster pace of consolidation would help cap the rise in long-term bond yields, reduce external and banking vulnerabilities, and improve market confidence.

Text Table 3.India: Medium Term Macro-Fiscal Outlook(In percent of GDP)
Actuals BudgetBaseline 1/Consolidation scenario 3/
FY17FY18FY19FY20FY21FY22FY23FY20FY21FY22FY23
Revenue20.920.521.321.321.321.321.421.421.621.822.0
o/w tax revenue17.717.918.618.618.618.718.718.819.019.219.4
Expenditure27.527.527.927.827.727.527.427.527.326.926.8
o/w central subsidies1.31.11.41.41.41.41.41.11.00.90.9
General govt overall balance-6.7-7.0-6.6-6.5-6.4-6.2-6.0-6.1-5.6-5.1-4.7
Cyclically Adj. Primary Balance 2/-1.8-1.9-1.6-1.6-1.6-1.5-1.5-1.1-0.9-0.6-0.3
General govt debt ratio68.970.468.767.265.764.463.166.764.562.360.0
GDP growth7.16.77.37.57.77.77.77.47.77.67.7
Inflation4.53.65.24.84.54.24.14.84.44.14.0

Buoyancy assumptions: Central CIT = 1.1, PIT = 1.05, GST = 1.00.

In percent of potential GDP.

This scenario illustrates achieving the FRBM committee’s recommendation that general government debt be reduced to 60 percent of GDP by FY2022/23. This is achieved with a combination of greater tax buoyancy and subsidy cuts. (A) Tax buoyancy assumptions are: CIT = 1.1, PIT = 1.1, GST = 1.15 (relative to broadly neutral buoyancy in the baseline), assuming continued base-broadening measures. GST is assumed to achieve buoyancy sufficient to raise GST to GDP ratio by around 0.5 percentage points over 5 years (in line with the median increase in central government Value Added Tax over 5 years in cross-country panel of 69 countries). (B) Subsidies are reduced gradually by 0.5 percent of GDP over 4 years, with a 0.3 percent of GDP cut in fertilizer subsidies, elimination of fuel subsidies, and a modest cut to food

Buoyancy assumptions: Central CIT = 1.1, PIT = 1.05, GST = 1.00.

In percent of potential GDP.

This scenario illustrates achieving the FRBM committee’s recommendation that general government debt be reduced to 60 percent of GDP by FY2022/23. This is achieved with a combination of greater tax buoyancy and subsidy cuts. (A) Tax buoyancy assumptions are: CIT = 1.1, PIT = 1.1, GST = 1.15 (relative to broadly neutral buoyancy in the baseline), assuming continued base-broadening measures. GST is assumed to achieve buoyancy sufficient to raise GST to GDP ratio by around 0.5 percentage points over 5 years (in line with the median increase in central government Value Added Tax over 5 years in cross-country panel of 69 countries). (B) Subsidies are reduced gradually by 0.5 percent of GDP over 4 years, with a 0.3 percent of GDP cut in fertilizer subsidies, elimination of fuel subsidies, and a modest cut to food

19. Staff assessed the growth impact of a more ambitious fiscal-consolidation scenario using the IMF’s Flexible System of Global Models (FSGM). This was done for the two components of the consolidation—a reduction in government expenditure (subsidies) and an increase in tax revenues. The limited growth impact reflects the gradual nature of the consolidation, the use of relatively less distortionary fiscal instruments, and monetary policy being assumed to ease relative to the baseline to moderate the impact on domestic demand—such a scenario represents a relatively growth-friendly consolidation.

20. Staff encourages the authorities to upgrade the fiscal-reporting framework. With states responsible for an increasing share of spending, maintaining fiscal discipline and strengthening macro-fiscal capacity at the state level is essential. This includes harmonizing state budgetary processes and decreasing the more-than-one-year lag in reporting fiscal data. The recently appointed 15th Finance Commission will address several state issues, for which IMF staff is providing background on international experiences and best practices related to subnational governments, including through SARTTAC (Appendix V). Additionally, to capture risks stemming from off-budget spending (which appear to have risen), coverage of expenditures should be broadened. These improvements would allow enhanced coverage of the general government’s fiscal position.

Authorities’ Views

21. The authorities agreed on the need to take corrective measures in the event of slippages to the FY2018/19 budget targets. With the economy improving, they believed that any fresh slippages are likely to be moderate. They were confident that the GST would be buoyant over the near term, adding up to ½ percent of GDP in revenues in each of the next two years. The GST was also expected to help boost direct taxes, through improved compliance and record-keeping. The recently introduced e-way bill, an electronically-generated document which is required to be generated for inter-state goods transactions above INR 50,000 (approximately US$750) in value would significantly help improve GST compliance. Further reforms to the GST would first focus on base broadening before considering further rationalization of the rate structure, although the pruning of the list of items subject to the top 28 percent tax rate had already effectively led to some rationalization. Regarding base broadening, the authorities noted that taxing certain fuels such as aviation fuel and natural gas under the GST would be relatively easy, but including other products such as petrol, diesel, and immovable property would be more challenging as they were key revenue sources for states. In the Indian context, pruning exemptions would also be difficult. On the expenditure side, the recent public financial management (PFM) reforms including advancing the budget calendar, reducing subsidy leakages through Direct Benefit Transfers (DBTs), and reducing project cost overruns had helped improve expenditure control. The PFM System developed by the Ministry of Finance is being implemented. It needs to be strengthened to improve the quality of expenditure and fiscal data reporting.

22. The authorities noted that the recommendations of the FRBM committee including a formal debt anchor had been accepted by the government and amendments to the FRBM Act had been passed through the Finance Act of 2018. While underscoring the importance of medium-term fiscal consolidation, they felt that a gradual pace was called for because of the need to support growth and development. A gradual pace was also deemed to be more feasible and would avoid disappointments relative to a more ambitious path.

23. Regarding the recording of bank recapitalization costs in the fiscal accounts, the authorities noted that they had followed international best practice in pricing the government’s bond-financed equity stakes in the PSBs. Market prices, as per the applicable formula mandated by the Securities and Exchange Board of India regulations, were paid. Being consistent with a preferred shareholder acquiring a large allotment of equity, the recapitalization was recorded below the line as a financing transaction.

B. Monetary and Exchange Rate Policy—Consolidating Credibility

24. Monetary policy tightening in early June was appropriate and further gradual tightening will be needed. The policy rate had been on hold since August 2017 (6 percent). Staff’s assessment is that after the June rate hike (to 6.25 percent), monetary policy conditions are broadly neutral based on staff estimates of the natural rate of interest (about 1.45 percent) and one-year ahead inflation expectations (4.8 percent). Headline and core inflation are rising and forecasted to be above the mid-point of the headline inflation target band in the near and medium term, raising the probability that adverse shocks could push headline inflation above the RBI’s target range and calling for a tighter stance. Persistently elevated inflation could also lead expectations to become entrenched—household expectations were revised higher in the RBI’s latest survey. Inflation risks are tilted to the upside—including from higher oil prices, potential changes to MSPs, exchange rate depreciation, possible fiscal slippages, second-round effects from state-level increases in HRAs, and recently-announced increased import duties. Tighter monetary policy will, however, make it more challenging to revive the credit cycle.

Monetary Policy Stance and Real Interest Rates

(In percent, quarterly)

Sources: Haver Analytics, IMF Staff Calculations, Osorio-Builtron and others (forthcoming) “The natural rate of interest and its drivers: A cross-country analysis”.

1/ Stance = Natrural Real Interest Rate – Real Policy Interest Rate

25. To enable the RBI to achieve the medium-term inflation target on a sustained basis continued action to improve the monetary transmission mechanism is needed. Having established a robust institutional framework for monetary policy, key next steps include enhancing competition in the banking system, encouraging banks to streamline credit pricing, addressing fragmentation of interbank markets, and continuing to enhance communication. Accordingly, PSB governance reform and reducing the government’s footprint in the banking system would play an important role in leveling the playing field, thereby promoting competition and market efficiency. Important gains can be expected from addressing banks’ NPAs, operationalizing corporate debt restructuring processes, and agriculture sector reforms to help stabilize food prices and contain households’ inflation expectations.

26. India’s external position is assessed to be broadly consistent with fundamentals and desirable policy settings (Appendix VI). External debt at around 20 percent of GDP is moderate compared to other emerging market economies. External financing looks sustainable, but could be affected by domestic and external volatility. In the past year, a number of changes affecting FDI and portfolio flows were implemented, largely moving in the general direction of capital account liberalization. Further liberalization of portfolio inflows should be considered, while considering risks of capital flows volatility. Gross reserves, at more than 160 percent and about 210 percent of the standard and capital flow measures-adjusted IMF metrics at end FY2017/18, respectively, appear adequate for precautionary purposes.

27. India should continue to rely on exchange rate flexibility.

  • Experience in other fast-growing emerging market economies suggests that the real effective appreciation of the rupee is mostly inevitable over the longer term. Overly restricting currency appreciation would lead to opportunity and sterilization costs from foreign exchange interventions and slow the development of the foreign exchange market, including for hedging instruments. Accordingly, interventions should be two-way and limited to disorderly market conditions.
  • In the event of severe external pressures or further increases in oil prices, continued exchange rate flexibility complemented by tighter fiscal and monetary policies would help ease the shock. Based on the Debt Sustainability Analysis and FSAP stress tests, negative balance sheet effects from a rupee depreciation would likely be contained.

Authorities’ Views

28. The authorities indicated that forward-looking monetary policy will continue to be calibrated to achieve the medium-term inflation target. Considering inflation data available through April 2018, at the time of the consultation mission, their forecast of headline inflation in FY2018/19 was 4.6 percent, below that of staff, partly because the authorities had not yet factored in the upside risks from higher MSPs, state HRAs, and possible fiscal slippages. The authorities noted that monetary policy would look through the direct effect of the HRA, were confident that food inflation in the medium term would remain subdued, and emphasized that headline inflation is the official target. Although there was broad agreement with staff’s assessment of the output gap, the authorities emphasized significant uncertainty around these estimates. The authorities agreed with staff on the importance of continued supply-side reforms to contain food inflation and the need for stability-oriented macroeconomic policies to help anchor inflation expectations.

29. The authorities concurred that the external position is broadly consistent with fundamentals and desirable policy settings. They agreed with the assessment of a CA norm of -2.5 percent of GDP and felt strongly that a CAD above 3 percent of GDP may pose financing difficulties. A more negative CA norm would also give the wrong signal for macroeconomic management. The authorities confirmed that exchange rate flexibility would continue, but argued for proactive rather than reactive intervention to prevent disorderly market conditions and noted that intervention should be assessed across a full capital inflow-outflow cycle. They planned to continue using foreign exchange interventions to smooth rupee movements and augment external buffers during episodes of sustained inflows to be used during outflows, which tended to occur in spurts.

C. Financial and Corporate Sector—Addressing the Twin Balance Sheet Problem

30. A range of complementary initiatives has been taken to address India’s twin balance sheet problem and resurrect PSB’s financial intermediation. In addition to the AQR, recognition of NPAs, implementation of the new PCA framework, and PSB recapitalization, the RBI directed banks to refer two batches of large corporate accounts in July and December 2017, representing about 40 percent of PSBs’ outstanding NPAs by value, to the time-bound resolution process under the IBC. Importantly, there is a sense that the implementation of the IBC could shift the power balance between debtors and creditors and improve corporate repayment discipline. Five of the 12 accounts from the first batch are now resolved or nearing the final stages of resolution. Ongoing efforts to build institutional capacity for the effective functioning of the IBC are welcome and could be complemented with designing an out-of-court regime that offers a flexible, speedy, and low-cost alternative to the in-court process under the IBC.

31. In recent months, the RBI introduced a new, simplified framework for the resolution of stressed assets. The new framework involves a more proactive approach in identification, monitoring, and supervision of problem assets and their reference to the IBC process. Accordingly, banks have begun to reclassify a large share of restructured loans (e.g., PSBs reduced these loans from 2.7 percent in September 2017 to 1.1 percent of total loans in March 2018) as NPAs, pushing up the NPA ratio further. The higher provisioning coverage (40 percent required for NPAs compared to 5 percent for restructured loans) will cause weaker PSBs to continue to report losses in the coming quarters.

32. Staff welcomes the various initiatives but urges the authorities to further strengthen governance and accelerate implementation as part of a broader package of financial reforms. In addition to speeding up NPA resolution and completing PSB recapitalization, this includes improving bank governance, reducing the role of the public sector in the financial system, and enhancing bank lending capacity and practices, thereby reducing the fiscal contingency risks arising from PSBs in the future.5 The Banking Reforms Roadmap, announced by the government in January 2018, indicates that the recapitalization will be contingent on measures to strengthen governance and operations. However, the plans remain vague, and staff recommends that the authorities pursue more far-reaching governance reforms, for instance removing the RBI representatives from banks’ boards and defining better the terms of reference for board members, including the Ministry of Finance representative, to strengthen the quality and independence of banks’ boards. More aggressive PSB disinvestment and privatization would address some of the structural issues in governance, such as incentives and efficiency of PSBs.

33. Promoting private-sector based alternatives to PSBs is needed over the medium term. The recent successful IPO of a private bank that had started out as a microfinance institution, the vibrancy of India’s non-bank financial corporations, and the rapidly-developing fintech space illustrate the viability of market-based solutions to India’s access-to-finance and financial-inclusion challenges. The government should also continue to gradually reduce the SLR to help deepen markets and encourage lending and reexamine priority sector lending (PSL) targets, which apply equally to private banks. These targets distort resource allocation, result in contingent and actual fiscal liabilities that have repeatedly been associated with PSBs, and lead to financial repression.

34. Staff encourages the authorities to follow up on the FSAP recommendations, including to amend the legal framework to provide the RBI full regulatory and supervisory powers over PSBs to make banking regulation and supervision ownership-neutral. The recent large fraud at Punjab National Bank—the second largest PSB—underscores the importance of steps needed to improve PSB governance and internal controls. At the same time, the strong growth of credit to households from private banks and non-bank finance companies calls for vigilance on the part of RBI supervisors, to make sure that these institutions uphold underwriting standards.

Authorities’ Views

35. The authorities agreed on the importance of focusing on the implementation of the reforms. While acknowledging some initial teething problems in its operationalization, the authorities expected the implementation of the IBC to contribute to the speeding up NPA resolution. Accordingly, the banking sector’s NPA ratio was expected to peak within a year. Banks’ provisioning is improving, and early indications from some of the large cases subject to the IBC process suggest that the provisioning requirements may be sufficient. For instance, lower-than-provisioned haircuts in the steel industry—the largest contributor to overall NPAs—are expected to release capital and support further credit growth. The authorities recognized the importance of the PSB governance reform and reiterated that it is an integral part of the recapitalization plan with a reporting framework in place to monitor progress. The RBI was reviewing supervisory processes and frameworks to strengthen fraud prevention and assessment of operational risk.

36. The authorities stressed the key role played by PSBs in the economy and argued for a gradual pace of reducing the government’s presence in the financial sector. Although the PSL requirements apply equally to private sector banks, PSBs are critical in providing financial access more directly to underserved populations. The authorities are encouraging PSBs to diversify and differentiate their business models, while improving risk management. The RBI has been progressively reducing the SLR and it was noted that: (i) the ratio was currently not binding, with banks maintaining SLRs well in excess of the requirement; and (ii) banks were allowed to use part of their qualifying assets to satisfy the liquidity coverage ratio.

D. Structural Reforms—Boosting Investment and Inclusive Growth

37. To support inclusive growth, key structural challenges need to be resolved. Since the 1980s, wide-ranging structural reforms to deregulate, open, and make the economy more competitive have contributed to vastly improved living standards, with the share of the population in poverty decreasing significantly. However, income per capita remains relatively low, and income disparities are widening. Moreover, unlike some other emerging market economies, India’s manufacturing sector remains relatively small, reflecting major rigidities in labor, land, and product markets.

38. Comprehensive reforms will help raise productivity and reduce vulnerabilities, setting the stage for higher and more sustainable growth. Labor market reforms could complement the GST in terms of promoting the formal economy and creating fiscal space for needed social and infrastructure spending. Improving the business climate combined with trade liberalization would also complement the GST in creating a more integrated, domestic market for goods and services, linking India’s states also to the rest of the world. This, in turn, would reduce external vulnerabilities and generate more stable sources of financing, supporting the fiscal position.

39. The government continues to pursue growth-friendly policies, but the recent focus has shifted to implementation of reforms that have been already initiated. Steps taken in recent years continue to bear fruit. For example, on FDI liberalization, caps on foreign investments in different sectors have been largely relaxed. The Foreign Investment Promotion Board, which was responsible for clearing FDI proposals in cases where government approval was required, has recently been abolished. Most foreign investments are now allowed to enter sectors of the Indian economy under the automatic route. As a result, FDI inflows to India have been strong. Nevertheless, progress in other areas has been more limited, particularly on further deregulating labor markets and agricultural reforms.

Trade Policy Issues

40. Further trade liberalization and reforms to facilitate trade and investment will ultimately benefit India, and expand its role in the world trade system. Trade barriers remain significant.6 Trade documentation and procedures are cumbersome, and lengthy processing times are burdensome. India’s average most favored nation applied tariff rate (at 13.4 percent as of 2016) is higher than in some peer countries, though with relatively large differentiation between agricultural and non-agricultural products. In addition, tariffs are being changed frequently, including in the FY2018/19 budget. Trade in services is also restricted. Restrictions on foreign entry, barriers to competition, and lack of regulatory transparency are reportedly the main obstacles. Reducing non-tariff barriers, stabilizing and then subsequently decreasing tariffs, and implementing supply-side reforms to improve the business climate would help increase India’s integration in global markets. The recent liberalization of FDI policies is a positive step in this direction.

41. Several trade-related issues concerning India are currently being considered at the WTO.

  • The United States has challenged India’s export subsidy schemes at the WTO, as creating an uneven playing field. India has recently crossed the income threshold, above which a country becomes subject to the prohibition on export subsidies.
  • The United States questioned India’s methodology related to calculations of the market price support for wheat and rice at the WTO Committee on Agriculture, raising concerns on possible underreporting of the support’s size.
  • Following the announcement of the imposition of large steel and aluminum tariffs by the United States on several countries’ imports, including for India, the Indian authorities sought consultations on their consistency with the WTO norms. While a direct impact on India’s exports from the tariffs is likely to be relatively small, the authorities are concerned about their possible impact on the global trade system.

Labor Market Reforms

42. An important priority is modernizing labor regulations and other measures to help increase formal employment and employment of women. Analytical work on structural reform priorities and sequencing, featured in the 2017 Article IV consultation, found that labor market reforms are the top priority since they maximize gains while minimizing short-run costs, given India’s large informal sector. With growth recovering and greater progress in product market reforms, now is the time to shift attention to labor market reforms. Notwithstanding the recent extension of fixed-term labor contracts to all sectors, labor laws remain numerous, outdated, and restrictive, including at the sub-national level. Staff’s analytical work highlights the linkage between labor market rigidities and misallocation of resources in manufacturing. By providing disincentives for firms to hire more and expand, these rigidities stifle productivity growth and formal sector job creation.

43. Further labor reforms will help reap the full benefits of the demographic dividend and economies of scale from the national GST. Reforms to the Industrial Disputes Act of 1947 and restrictive clauses under the Factories Act of 1948, including reforms to job protection for permanent workers, are key to enhance labor market flexibility and allow firms to expand and reach economies of scale. Labor laws, which currently number around 250 including both the center and states, need to be streamlined and reduced, building on current efforts to rationalize the various laws into four Labor Codes. Labor market rigidities push down female labor force participation, which is among the lowest in peer countries.7

Infrastructure and Product Market Reforms

44. More emphasis could be put on addressing delays in infrastructure investment. In recent years, the supply side of the economy has been strengthened through large investments in airports, roads, telecom, and power generation. Nevertheless, there is a general recognition that sustainably higher growth will require more action on addressing infrastructure bottlenecks. India’s Project Monitoring Group (PMG) has been empowered to speed up investment approvals, but many projects are still pending PMG approval. The most common delays include environmental clearances and land acquisition issues.

45. Land reforms remain essential to facilitate and expedite infrastructure development. Staff welcomes recent initiatives and schemes to overcome project delays (e.g., Engineering, Procurement, and Construction schemes and the setting up of Special Purpose Vehicles to acquire land and obtain relevant permits and licenses) and transfer risks to the entity that is most capable of handling it (e.g., procedural and administrative risks related to land acquisition to the government and construction and commercial risks to the private sector). Nevertheless, efforts should be enhanced on land reforms to streamline and expedite land acquisition and simplification of procedures.

46. Continued actions to strengthen further the business climate are important. Despite recent simplification efforts, business regulations remain very complex, litigation lengthy, and corruption and bureaucracy reportedly major obstacles for doing business. Further steps could include contract enforcement and judicial reform. In addition, measures to reduce administrative and regulatory burdens, improve governance, shorten regulatory approval timelines, and widen implementation of single-window clearance can support foreign and domestic investments.

47. Sustained inclusive growth requires agricultural sector reforms, as productivity in the sector remains low. The staff’s analytical work highlights the importance of reducing supply-side constraints, building more integrated markets, boosting productivity, and addressing market distortions. As MSPs could skew farmers’ production decisions, add to inflation, and enlarge the fiscal burden, their use (backed by assured procurement) should only be temporary and limited to correcting market failures. Farmers should be supported through other reforms. Despite gradual implementation, recent agricultural policy initiatives such as the assured irrigation system, the introduction of common electronic trading platform for the National Agriculture Market (e-NAM) and the development of Gramin Agricultural Markets (GrAM) are welcome and promise to reduce production risk, increase competitiveness, and improve transparency in state agricultural markets. Building on recent progress, more needs to be done to revamp government procurement processes and the public distribution system (PDS) for food, including to restructure the role of the Food Corporation of India via outsourcing of cereal procurement and stocking operations as well as checking leakages in the PDS. Various agricultural subsidies are being streamlined especially through DBTs, and should be further reduced going forward.

Authorities’ Views

48. The authorities generally recognized the need for further comprehensive structural reforms to make the Indian economy more competitive. They underscored the strong pick-up in infrastructure investment activities through the National Investment and Infrastructure Fund in recent years, which should also help attract more FDI flows into India’s infrastructure sector. While acknowledging that steps need to be taken to further improve the business climate, the authorities pointed at India’s substantial advances in recent years in cross-country rankings regarding the ease of doing business, thanks to the government’s sustained efforts on regulatory reforms. They pointed to ongoing reform efforts at the state level to improve the ease of doing business, thus generating reform momentum through competition among states and setting best practices. On labor reform, the authorities argued that the recent extension of fixed-term labor contracts to all sectors should bring sufficient flexibility. They were also hopeful that recently-announced plans to increase the coverage of healthcare and new welfare provisions which cover the informal sector and enhanced paid maternity leave should improve female labor force participation. The authorities noted that the agricultural sector reforms are underway, including to streamline agricultural subsidies through the application of DBT and to build nationally-integrated agricultural markets through e-NAM and GrAM.

49. The authorities expressed strong support for the multilateral rules-based trade system but had some reservations on staff’s call for trade reforms. The authorities noted their strong support for the WTO dispute resolution mechanism and were concerned about a possible reversal of global trade integration. On trade tariffs, rates have been gradually decreasing on average, and recent increases for some goods were consistent with India’s WTO commitments and were effected in response to developments in the domestic economy. In this context, the authorities noted that India’s tariff rates were not substantially higher than in peer countries with similar income levels. They also objected to the OECD’s services trade restrictiveness indicator on methodology and results. Regarding export subsidy schemes, the authorities believe that an eight-year transition period should be applied for unwinding those schemes.

Staff Appraisal

50. Following transitory disruptions, India is again one of the world’s fastest-growing economies. Cash shortages in the aftermath of demonetization and transitional costs related to the introduction of the national GST exacerbated a growth slowdown in FY2017/18 that had started earlier. But activity picked up in recent quarters with robust contributions from private consumption and gross fixed capital formation. As a result, inflation is now on the rise after moderating to a multi-year low earlier on subdued demand, low food prices, and currency appreciation.

51. Growth is projected to recover in FY2018/19 and strengthen in FY2019/20 as stability-oriented macroeconomic policies and progress on structural reforms continue to bear fruit. India stands to benefit from further implementation of key structural reforms to spur the country’s catch up with advanced economies, including the inflation-targeting monetary policy framework, the IBC, the GST, and steps to liberalize FDI flows and improve the ease of doing business.

52. Risks to the outlook are tilted to the downside. Rising international oil prices will hold back activity. Beyond further oil price increases, other risks derive from tighter global financial conditions, a retreat from cross-border integration including spillover risks from a global trade conflict, and rising regional geopolitical tensions. Domestic risks pertain to tax revenue shortfalls related to continued GST implementation issues and delays in addressing the twin balance sheet problems and other structural reforms.

53. The policy mix should be geared to supply-side measures to promote inclusive growth. With the economy recovering, the output gap closing, and inflation rising, policy space is limited, suggesting a premium on prudent macroeconomic policies.

54. Continued fiscal consolidation is needed to lower elevated public debt levels and allow for easing of financial repression. India has limited fiscal space as debt is close to thresholds that increase the likelihood of debt distress among emerging market economies. Accordingly, the immediate focus should be on achieving the ambitious revenue targets which underlie the FY2018/19 budget targets, while standing ready to take corrective measures if risks to revenues, mainly from the GST, and expenditures materialize. Enhancing GST compliance, including by streamlining filing and refund mechanisms and simplifying the rate structure, are key to relieve the burden on smaller businesses and help deliver on the GST’s promise of formalizing economic activity.

55. The authorities should adopt a more ambitious medium-term fiscal consolidation path and look to upgrade the fiscal reporting framework. The expected acceleration of growth provides room for faster deficit reduction, allowing the authorities to adopt a consolidation path consistent with the FRBM Review Committee’s 60 percent of GDP general government debt target by FY2022/23. In the context of efforts to strengthen macro-fiscal capacity at the state level as well as the work of the recently appointed 15th Finance Commission, state budgetary processes should be harmonized and fiscal-data reporting made timelier. In addition, coverage of expenditures should be broadened to allow for enhanced reporting on the general government’s fiscal position and capture risks stemming from off-budget spending.

56. The recent tightening of monetary policy was appropriate and further gradual tightening will be needed. With the output gap closing, inflation rising and forecasted to be above the mid-point of the target band in the near and medium term, and inflation risks on the upside, further tightening would anchor expectations and build monetary policy credibility. To enable the RBI to achieve the medium-term inflation target on a sustained basis, continued action is needed to improve the monetary transmission mechanism. In this regard, PSB governance reform and reducing the government’s footprint in the banking system can be expected to help promote competition and market efficiency.

57. A key focus of the authorities should be on macro-financial and structural policies to boost investment, jobs, and productivity, and thus inclusive growth over the medium term to harness India’s demographic dividend. Despite wide-ranging reforms in recent decades, income per capita remains relatively low, and income disparities are widening including among the states.

58. More progress is needed in tackling the twin balance sheet problem and resurrecting PSBs’ effective financial intermediation. The simplified framework for the resolution of stressed assets announced by the RBI in February rounds off earlier steps to recognize NPAs, promote a time-bound resolution process under the IBC, and recapitalize the PSBs. Implementation of these pillars needs to be accelerated and backed by a comprehensive plan to improve PSB governance, internal controls, and operations to reduce fiscal contingency risk, including by considering more aggressive disinvestment and privatization. The authorities are also encouraged to follow up on the FSAP recommendations, including to amend the legal framework to provide the RBI full regulatory and supervisory powers over PSBs and make banking regulation and supervision ownership-neutral.

59. India would benefit from further liberalization of trade and reforms to facilitate trade and investment. India’s capital flow management framework is moving in the general direction of capital account liberalization. Most FDI is now allowed to enter sectors of the Indian economy under the automatic route, but there is scope to reduce administrative and regulatory burdens and improve governance. Further liberalization in portfolio flows could be considered, while remaining vigilant to risks of capital flow reversals. As a strong advocate of the multilateral rules-based trade system, India is encouraged to play a bigger role in the world trade system.

60. India’s external position is assessed to be broadly consistent with fundamentals and desirable policy settings, with international reserves adequate for precautionary purposes. Exchange rate flexibility should continue, with foreign exchange intervention being two-way and limited to disorderly market conditions.

61. Modernizing labor regulations and other measures to help increase formal employment and employment of women is a priority. In view also of India’s low female labor force participation, further modernizing labor laws would encourage productivity growth and formal sector job creation, as well as reduce labor market rigidities that push down labor force participation, and allow India to reap the full benefits from the new national GST.

62. Achieving sustainably higher inclusive growth will require addressing infrastructure bottlenecks and agricultural sector reforms. In recent years, important progress has been made in strengthening the supply side of the economy through large infrastructure investments. Notwithstanding new initiatives and schemes to overcome project delays, land reforms remain essential to facilitate and expedite infrastructure development. Similarly, the initiatives to build more integrated markets and address market distortions will raise productivity in the agricultural sector by reducing production risk, increase competitiveness, and improve transparency in state agricultural markets.

63. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Box 1.Demonetization and its Aftermath

A surprise announcement in November 2016 to withdraw 87 percent of currency in circulation introduced an acute monetary shock, exacerbating the growth slowdown that had started earlier. To date, remonetization is largely complete and growth is recovering. Despite increased digitization, more needs to be done to make sustained gains in reducing the informal economy. Tax compliance has improved somewhat, also aided by GST implementation.

Remonetization is largely completed. The RBI collected 99 percent of the cancelled notes. Currency in circulation has risen above pre-demonetization level and appears to be growing slightly faster than the pre-demonetization trend.

Currency in Circulation

(Rs, billion)

Source: Reserve Bank of India and staff estimates

GDP Growth

(Percent, solid line indicates actual data and dashed line indicates forecasts)

1/ The growth forecast considered the negative growth impact of demonetization and was based on the old GDP series.

2/ The current growth forecast s based on the new GDP series and factored in the negative growth impacts from demonetization and GST implementation.

The abrupt money supply shock due to cash shortages exacerbated the growth slowdown:

  • Uncertainty and disruptive cash shortages put a damper on consumer and business sentiment. As a result, high-frequency indicators for consumption (e.g., sales of two-wheelers) and production (e.g., industrial production, manufacturing and services PMI, and production of cement) saw strong declines. These indicators suggest that the effect of demonetization largely ended by May 2017.
  • The impact on growth appears to have been more severe and longer-lasting than anticipated at the time of the 2017 Article IV consultation with a disproportionate impact on the informal sector. Considering the national accounts revisions starting in the first quarter of 2017/18, growth slowed steadily by about 180 basis points from the announcement of demonetization to May 2017, compared to about 100 basis points projected in the previous Article IV staff report. The uncertainty created by the implementation of the GST likely prolonged the growth slowdown.

Demonetization’s digitalization and formalization objectives remain a work in progress. One objective of the demonetization exercise was to drive consumers and businesses away from cash-based transactions in the informal economy. Digital and formal channels of transactions did rise and should help raise tax compliance and formalize the economy:

  • Digitization. Electronic payments rose considerably in the immediate aftermath of demonetization and then fell somewhat but appear to be on an increasing trend.
  • Tax compliance. Efforts are being made to identify and legitimize the source of deposits made in the months after demonetization, complemented by a campaign against tax evasion. As a result, the Indian Ministry of Finance estimates that the growth of new taxpayers reached 45.3 percent in FY2016/17, compared to 25.1 percent in the previous fiscal year.

Number and Balances of “no frills” Accounts

(Number of accounts in millions, LHS)

Source: PMJDY, CEIC

Box 2.The Short-term Economic Impact of GST Implementation

Transitional costs related to the national GST introduction led to a sharp slowdown of economic activity. The Parliament passed the GST Constitutional Amendment Bill in August 2016, enabling replacement of a plethora of cascading center, state, inter-state, and local taxes with a single, nationwide, value-added tax on goods and services. The GST came into effect on July 1, 2017. Late decisions on the GST rate structure and exemptions created uncertainty and confusion among businesses and caused consumers to delay spending. Transitional effects of GST implementation contributed to a slowdown in growth to 6 percent (y/y) in the first half of FY2017/18.

High frequency indicators

(50+=Expansion; Not Seasonally Adjusted)

Sources: Haver Analytics and IMF staff calculations.

While the GST sets a uniform tax rate across states, other elements of the GST structure are less streamlined than recommended. Uniform tax rates across states is a major achievement. Nevertheless, the GST in India includes four non-zero tax rate tiers (and additional rates and cesses for specific goods) and a broad array of exemptions such as on alcohol and petroleum, which goes against Fund advice of having as few tax rate tiers as possible and minimal exemptions.

As the new regime normalizes, high frequency indicators point to a recovery from the third quarter of FY2017/18. With GST implementation issues being addressed and businesses and consumers adjusting to the new system, short-term supply- and demand-side indicators rebounded strongly, and growth recovered to 7.2 percent (y/y) in the third quarter of FY2017/18. Medium-term growth is expected to improve owing to efficiency gains from the GST that improve intra-Indian trade in goods and services.

GST Implementation Issues and Support Measures
IssuesDescriptionsSupport Measures Taken
Supply-chain disruptionsUncertainty related to the rate structure of the GST led to de-stocking in the run-up of the GST rollout. Implementation glitches such as regarding IT systems and invoice matching caused delays and increased businesses’ compliance costs.Deadlines for the submission of tax returns were extended. All businesses with a turnover of Rs 15 million or less a year, can opt into a composition scheme where a flat rate is paid on turnover, no input credit is claimed, and taxes are filed and paid on a quarterly basis instead of a monthly basis.
Liquidity shortagesExporting firms faced delays in receiving their input tax credit from states, causing liquidity and working capital shortages. One reason for the delay was the division of responsibility between the state and the center in issuing the returns. The use of duty credit scrips was limited under the GST.An e-wallet, which would include an advance refund for input tax credits, has been set up and was rolled out from April 1, 2018. The issuance of GST refunds to exporters was also streamlined to a single authority. The validity period of duty credit scrips increased to 24 months from 18 months and the GST on their sale and purchase declined to 0 percent.
Tax efficiency and complianceThe multiple rate structure of the GST remains complicated.To be addressed.

Box 3.PSB Recapitalization Plan

The Government of India (GOI) is undertaking a significant recapitalization of PSBs to enhance regulatory capital and provide “growth capital” to boost lending to the economy. The two-year recapitalization plan of INR 2.1 trillion (1.3 percent of GDP) was initially announced in October 2017. A subsequent announcement in January 2018 detailed the allocation of 0.5 percent of GDP to 20 PSBs during FY17/18, 59 percent of which was slated for 11 weak PSBs currently under the RBI’s PCA framework. The bulk of the recapitalization in the first year was financed by recapitalization bonds. The total capital injection envisaged is broadly in line with the capital needs estimated by the 2017 FSAP, which ranged from 0.75 to 1.5 percent of GDP.

India: Bank Recapitalization Plan(percent of GDP)
FY17/18Total
Recapitalization bonds0.50.8
Budget transfer0.00.1
Capital-raising from the market0.10.3
Total0.61.3
Source: Government of India.
Source: Government of India.

The Banking Reforms Roadmap, announced alongside the recapitalization, lacked details on measures to improve PSB governance and operations. The roadmap lists six “reform themes”, including strengthening PSBs; increasing credit supply; and deepening financial inclusion and digitalization. Measures to strengthen PSBs include more rigorous underwriting and loan loss recovery practices and rationalization of non-core assets and overseas operations. Bank boards are tasked with approving the plans for implementing the reform agenda and monitoring their progress. The government indicated that the recapitalization will be contingent on reform progress, without specifying the milestones to be met for each tranche.

The plan’s impact on banks’ credit provision is unclear and implementation delays have been costly

  • The sizable recapitalization is a positive development, but further analysis is needed to assess how much capital could be directed to increasing lending. Much will depend on the capital needs from the ongoing NPA resolution proceedings and their implications for the sufficiency of provisioning. Other uncertainties pertain to other stresses on asset quality including from a recent fraud case; and pressures on banks’ profitability from mark-to-market losses on holdings of government bonds.
  • The market initially reacted positively to the October 2017 recapitalization announcement, but PSBs’ share prices have fallen to pre-announcement levels with the majority of PSB shares trading at a discount to book value and some well below 0.5.

Nifty Bank Index1/

(end-Sep 2017 = 100)

Source: National Stock Exchange of India.

1/ Nifty PSU Bank index consists of 12 PSBs. and Nifty Private Bank index consists of 10 private banks.

Box 4.Potential Output

Potential growth for India is increasing gradually, and is estimated at 7.3 percent in FY 2017/18. Estimates are derived from a combination of statistical and multivariate filters. A production-function decomposition of the potential-growth estimates indicates that much of the recent acceleration is due to improvements in total factor productivity (TFP) growth, which have more than offset a dwindling contribution from the physical capital-stock, attributable to the prolonged period of subdued investment growth.

Contribution to Potential Growth

Sources: CSO, UN, and staff calculations

Positive impacts of ongoing reforms will likely boost potential growth to around 7¾ percent over the medium-term.1/ The most notable contribution comes from the introduction of the GST. Despite its complicated structure, efficiency gains are anticipated to increase internal trade and boost growth in coming years.2/ There remains considerable scope for potential output to increase even further—above 8 percent—though important additional reforms in the areas of land and labor, which could generate a rebound in investment, would be needed, along with simplifying and streamlining the GST. To date, progress on such reforms has been limited and weak credit growth is holding back investment growth.

Output Gap

(Percent of potential output)

Sources: IMF staff estimates based on CSO data

The output gap is small and closing. The estimated output gap for FY 2017/18 is about -0.3 percent. Following last year’s demonetization economic slack was assessed to have increased somewhat, though recent indicators, including elevated core inflation and expectations, suggest only limited slack remains.

1/ To be revisited, once the authority publishes the back-cast GDP series in November 2018.2/ Drawing on the experiences of countries implementing GST and the estimates from Van Leemput, E. and E. Wiencek, “The Effect of the GST on Indian Growth,” Board of Governors of the Federal Reserve System, International Finance Discussion Paper Note, March 2017.
Table 9.India: High Frequency Economic Activity Indicators
% y-o-y20142015201620172018
H1H2H1H2Q1Q2Q3Q4JanFebMarAprMayJunJulAugSepOctNovDecJanFebMarAprMay
Consumption
Domestic passenger vehicle sales-2.94.95.010.42.56.717.81.814.49.110.014.78.7-11.215.113.811.3-0.314.35.27.67.86.47.519.7
Aviation: Passenger traffic4.314.219.820.924.320.424.523.225.615.414.414.817.420.012.215.616.319.916.517.418.223.326.925.0
Cellular subscribers9.16.6-2.31.510.38.27.67.119.019.718.121.222.222.722.621.420.922.222.422.29.110.313.911.9
Consumer credit14.114.616.417.618.919.118.915.212.912.016.414.413.714.115.015.716.816.017.318.920.020.417.819.1
Rural wages (male)25.415.37.06.15.96.35.65.96.26.25.86.15.75.46.25.96.15.75.35.14.85.1
Domestic two-wheeler sales13.19.60.21.58.614.320.6-4.6-7.40.00.37.311.94.013.714.79.1-2.823.541.533.423.818.316.99.2
Investment
Railway traffic: Net tonne km2.27.12.2-4.9-8.4-8.6-8.0-4.7-3.4-0.73.43.14.52.54.06.14.96.86.612.38.75.97.511.87.5
Government Capex (YTD)-20.2-12.645.142.116.5-16.423.5-23.17.212.862.056.160.752.347.137.525.941.139.639.022.378.4-74.3-45.0
External sector
Visitor arrivals10.110.43.75.39.76.612.69.516.412.711.821.35.922.57.411.018.818.114.415.28.410.113.44.45.1
Exports value3.81.1-15.3-18.6-7.8-1.6-1.06.15.518.627.918.17.21.62.67.324.6-2.230.015.011.64.5-0.75.220.2
Export (ex-oil) value3.43.1-7.3-10.9-5.60.90.55.72.617.323.315.86.43.92.56.123.3-3.827.513.27.01.51.06.59.1
Imports (ex-oil, gold) value-3.812.33.9-5.9-3.8-8.2-4.47.25.58.720.941.920.816.913.623.421.26.324.412.924.07.312.2-0.113.1
Industry
Industrial production4.94.l1.83.35.47.14.53.83.51.24.43.22.9-0.31.04.84.11.88.57.37.57.04.64.9
Manufacturing PMI*51.753.652.150.251.951.152.351.749.850.754.052.551.950.346.852.351.650.553.154.550.052.051.652.251.7
Corporate (industry) credit13.37.86.15.56.13.85.l0.9-0.4-0.74.90.60.21.11.61.72.43.45.96.95.76.06.08.6
Coal output3.810.05.64.44.65.3-4.22.83.56.610.6-3.3-3.2-6.70.615.410.43.90.70.43.81.39.116.0
Steel output9.96.9-1.9-3.64.59.010.812.911.38.711.09.03.86.09.42.23.78.614.50.41.75.04.73.5
Cement output6.17.0-0.23.211.85.83.4-0.8-13.3-15.8-6.8-5.2-1.4-3.31.00.70.1-1.316.917.719.623.013.016.6
Electricity generation12.516.45.75.59.210.03.16.15.21.26.25.38.22.26.68.33.43.23.94.47.74.66.02.2
Services
Services PMI*52.951.350.952.553.052.052.648.149.453.151.850.853.153.843.546.451.952.945.450.951.446.851.852.749.9
Light commercial vehicles-22.9-7.3-3.11.313.912.68.1-0.60.0-0.63.6-7.91.01.020.15.810.310.926.134.044.933.931.962.734.9
Medium & heavy commercial vehicles-6.332.524.731.627.721.6-16.74.3-1.2-9.91.7-55.9-58.0-20.81.510.923.716.53.449.911.926.315.7180.0176.3
Railway traffic: passenger3.1-5.6-6.61.92.00.00.61.51.4-0.72.22.43.21.41.8-2.5-1.44.6-4.61.41.01.02.11.2-1.2
Airline: cargo traffic10.212.57.84.810.27.08.411.113.79.418.317.417.213.910.916.318.65.219.613.89.79.63.96.1
Deposits14.412.011.110.59.19.210.113.612.812.015.410.910.312.79.58.98.28.72.93.64.55.46.68.18.5
Bank Credit13.910.89.49.310.49.59.76.94.33.78.24.94.88.15.66.36.66.89.310.510.210.810.312.513.1
Other indicators
Gross tax (ex-service tax) (YTD)7.68.615.821.36.930.97.119.811.215.417.919.720.016.617.821.523.024.924.625.647.533.619.326.3
OECD Composite leading indicators*99.299.8100.0100.099.999.899.599.299.299.299.299.299.399.499.599.699.899.9100.1100.3100.5100.7100.9
Sources: CEIC Data Company Ltd., Haver, OECD, and IMF staff estimates.

Index values. Note: The cell is highlighted in dark green if the growth is above average. The cell is highlighted in dark red if the growth is below average. The average for each data series covers data points since 2012 H1 to latest month.

Sources: CEIC Data Company Ltd., Haver, OECD, and IMF staff estimates.

Index values. Note: The cell is highlighted in dark green if the growth is above average. The cell is highlighted in dark red if the growth is below average. The average for each data series covers data points since 2012 H1 to latest month.

Appendix I. Key Policy Actions 2017–181
Financial Sector
May 4, 2017Banking Regulation (Amendment) Act, 2017: The government amended the Act to provide special power to the RBI to issue directions to any banking company to initiate the insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC).

RBI’s First List of Defaulters (June 14, 2017): Armed with special power, the RBI sent a list of 12 defaulting companies to commercial banks with specific direction to send these cases to the National Company Law Tribunal (NCLT) under the IBC.

RBI’s Second List of Defaulters (August 30, 2017): The RBI sent a second list of 26 defaulters to commercial banks with instructions that the accounts first be resolved through any of its schemes before December 13, 2017, failing which they should be referred to NCLT under the IBC before December 31, 2017.
June 7, 2017Rupee Denominated Bonds Overseas (Masala Bonds): The RBI excluded issuances of Masala Bonds from the limit for investments by foreign portfolio investors in corporate bonds, effective from October 3, 2017.
August 10, 2017Financial Resolution and Deposit Insurance Bill, 2017: The government introduced the Bill in Parliament which has been referred to a Joint Committee for its consideration. The Bill seeks to create a framework for resolving bankruptcy in financial firms such as banks and insurance companies.
October 24, 2017Public Sector Bank (PSB) Recapitalization: The government unveiled a INR 2.1 trillion PSB recapitalization plan. Of the total of INR 2.1 trillion to be funded over two years, the bulk of the recapitalization is to be financed through the issuance of recapitalization bonds (INR 1.35 trillion). While the budget would provide INR 181.39 billion, the government expects PSBs to raise an additional amount of INR 103 billion from the market.
January 24, 2018PSB Reforms: Following its October 24, 2017 announcement, the government made public its capital infusion plan for 2017/18, which included INR 800 billion through recapitalization bonds and INR 81.39 billion as budgetary support. The government also unveiled a detailed roadmap across six themes that cover 30 action plans to improve the efficiency and better customer services in PSBs.
February 1, 2018Merger of Public Sector Insurance Companies: The government has decided to merge three public sector general insurance companies: National Insurance Company, United India Assurance Company, and Oriental India Insurance Company into a single insurance entity and subsequently list it in the stock exchanges.
February 12, 2018Revised Framework on NPA Resolution: The RBI withdrew all existing instructions on resolution of stressed assets such as: (i) Framework for Revitalizing Distressed Assets, (ii) Corporate Debt Restructuring Scheme, (iii) Flexible Structuring of Existing Long-Term Project Loans, (iv) Strategic Debt Restructuring Scheme, (v) Change in Ownership outside the Strategic Debt Restructuring Scheme, and (vi) Scheme for Sustainable Structuring of Stressed Assets and also discontinued the institution of Joint Lenders’ Forum for resolution of such assets.

According to the revised framework banks are directed resolve their stressed assets of INR 20 billion and above, with their own board approved strategies within a period of 180 days; failing which the banks will be mandated to approach the IBC process within a period of 15 days.
March 13, 2018Letters of Understanding/Letters of Comfort Discontinued: Following an investigation of reports of fraudulent misuse of letters of undertaking and letters of comfort for trade credits for imports into India by banks, the RBI directed discontinuation of both these instruments.
April 2, 2018Regulatory Forbearance for Banks from Mark-to-Market losses: The RBI allowed banks to spread over four quarters their bond-trading mark-to-market losses, incurred in the December 2017 and March 2018 quarters due to the sharp rise in government bond yields. The central bank also advised banks to create an Investment Fluctuation Reserve from the year 2018/19 that could be dipped into in case there was a need to provide for bond losses in the future.
April 6, 2018Virtual Currency: The RBI prohibited entities regulated by it from dealing in virtual currencies, or facilitating any person from dealing in virtual currencies. Regulated entities which already provide such services have been directed to exit the relationship within three months.
April 27, 2018Foreign Portfolio Investment (FPI): The RBI permitted FPI investment in Government securities (G-secs) and State Development Loans (SDLs) in all maturities, subject to the condition that investment in residual maturity below one year shall not exceed 20 percent of the total investment in that category. Prior to this, investment by FPIs was restricted to maturities of three years and above. The RBI also allowed FPIs to invest in corporate bonds with minimum residual maturity of above one year.
Concentration Limit: Investment by any FPI in each of the three categories of debt, G-secs, SDLs and corporate debt securities, shall be subject to the following concentration limits: (i) Long-term FPIs: 15% of the prevailing investment limit for that category; and (ii) Other FPIs: 10% of the prevailing investment limit for that category.
Single/Group Investor-wise Limit in Corporate Bonds: FPI investment in corporate bonds shall be subject to the following requirements: (i) Investment by any FPI shall not exceed 50% of any issue of a corporate bond; and (ii) No FPI shall have an exposure of more than 20% of its corporate bond portfolio to a single corporate (including exposure to entities related to the corporate).
May 1, 2018FPI: The RBI permitted FPI investment in corporate bonds with residual maturity below one year, subject to the condition that amounts will not exceed 20% of the total investment. FPIs also permitted to invest in treasury bills issued by the Central Government.
Monetary Policy
April 6, 2017Narrowing of the Monetary Policy Rate Corridor: The RBI narrowed the policy rate corridor around the policy repo rate to +/-25 basis points from +/- 50 basis points effective April 6, 2017 to ensure finer alignment of the operating target with the policy rate.
June 7, 2017Reduction of the Statutory Liquidity Ratio (SLR): The RBI notified a reduction in the SLR from 20.5 percent of net demand and time liabilities (NDTL) to 20.0 percent effective June 24, 2017. The SLR was further reduced to 19.5 percent effective October 14, 2017. This was aimed at providing greater flexibility to banks to comply with the 100 percent liquidity coverage ratio (LCR) requirement effective January 1, 2019 (October 4, 2017).
June 6, 2018Reversal in Policy Rate: The Monetary Policy Committee raised the policy repo rate by 25 basis points to 6.25 percent. It had previously lowered the rate by 25 basis points on August 2, 2017.
Increase in the LCR Carve-out from the SLR: The RBI permitted banks to include an additional 2 percent of their NDTL under Facility to Avail Liquidity for Liquidity Coverage Ratio within the mandatory SLR requirement, thus raising the total to 13 percent of their NDTL. Scheduled commercial banks are required to reach the minimum LCR of 100 percent by January 1, 2019.
Fiscal Policy
July 1, 2017The Goods and Services Tax (GST) rolled out across the country. Relief for Small and Medium Enterprises:
  • Inter-state service providers with annual turnover less than INR 2 million exempted from obtaining registration (GST Council 22nd meeting, October 6, 2017).
  • Small and medium businesses with annual turnover up to INR 15 million to file and pay taxes on a quarterly basis, starting from October-December 2017. The registered buyers from such small taxpayers to be eligible to avail input tax credit monthly (GST Council 22nd meeting, October 6, 2017)
  • The reverse charge mechanism under Central GST Act, 2017 and Integrated GST Act, 2017 to be suspended till March 2018 (GST Council 22nd meeting, October 6, 2017).
e-Way Bills:
  • The e-way bill system to be introduced in a staggered manner with effect from January 1, 2018 and be rolled out nationwide with effect from April 1, 2018 (GST Council 22nd meeting, October 6, 2017).
  • Nation-wide e-way bills for inter-state movement of goods from April 1, 2018 (GST Council 24th meeting, December 16, 2017). States to choose their own timing for implementation of the e-way bill for intra-State movement.
October 4, 2017Excise Duty on Petrol and Diesel Reduced: The government reduced excise duty on petrol and diesel by INR 2 per liter to reduce the burden on the public following a sharp spike in international oil prices.
December 16, 2017Customs Duty on Electronics Goods Raised: The government raised customs duty on electronics goods such as mobile phones, television sets, digital cameras, microwave ovens, and LED bulbs by 5–10 percent to give protection to domestic industry under its flagship “Make-in-India” program.
February 1, 2018Tax Policy Changes in Budget 2018/19:
  • (i) Reduced corporate tax rate to 25 percent for micro, small and medium enterprises which accounts for almost 99 percent of companies filing their tax returns.
  • (ii) Replaced existing three percent education cess with a four per cent “Health and Education cess” on income and corporate tax.
  • (iii) Imposed a fresh long-term capital gains tax at 10 percent on amounts exceeding INR 0.1 million. However, all gains up to January 31, 2018 are grandfathered.
  • (iv) Raised customs duty on 46 line-items by 5–10 percent in sectors like food processing, electronics, auto components, footwear, and furniture to provide protection to domestic industry.
  • (v) Abolished the education cess and secondary and higher education cess on imported goods, and in their place, imposed a social welfare surcharge of 10 percent on aggregate customs duties to provide for social welfare schemes.
February 1, 2018Government Accepts Recommendations of the FRBM Committee: In the budget speech to Parliament, the finance minister indicated acceptance of two key recommendations of the FRBM Committee report, 2017. These are to: (i) set a medium-term target of debt-to-GDP ratio at 40 percent for the central government; and (ii) adopt the fiscal deficit as the key operational target consistent with achieving the targeted debt ceiling.
April 3, 2018Amended the FRBM Act to require the Central Government to achieve a 40 percent debt-to-GDP ratio by financial year 2024/25; and notified new rules that aim to reduce the fiscal deficit by 0.1 percent or more of GDP each financial year beginning 2018/19, and reach 3 percent of the GDP target by 2020/21.
March 26, 2018Government Guarantee for Indian Railway Finance Corporation bonds Approved: The Ministry of Finance approved a government guarantee of INR 50 billion for Indian Railway Finance Corporation bonds to be subscribed by Life Insurance Corporation (LIC). The guarantee would allow LIC to subscribe to these bonds beyond the exposure limits set by the Insurance Regulatory and Development Authority (IRDA).
FDI Policy
January 10 & 23, 2018Changes to FDI Policy:
  • 1. Allowed 100 percent FDI under the automatic route for Single Brand Retail Trading (the existing policy allowed 49 percent FDI under the automatic route, and FDI beyond 49 percent and up to 100 percent through the government approval route);
  • 2. Foreign airlines allowed to invest up to 49 percent under the approval route in Air India, subject to conditions that (i) such investment shall not exceed 49 percent either directly or indirectly; and (ii) substantial ownership and effective control of Air India shall continue to be vested in Indian nationals.
  • 3. Permitted 100 percent FDI under the automatic route into real-estate broking service.
  • 4. Allowed 100 percent FDI into core investing companies through the automatic route if it is registered with the RBI and accordingly regulated.
  • 5. Foreign Institutional Investment/FPI allowed in power exchanges through the primary market of up to the 49 percent permitted limit under the automatic route (the existing policy restricted these purchases to the secondary market only).
Agriculture Sector
April 24, 2017Model Agricultural Produce and Livestock Marketing Act, 2017: The Model Act provides for progressive agricultural marketing reforms, including setting up markets in the private sector, direct marketing, farmer-consumer markets, de-regulation of fruits and vegetables, e-trading, single point levy of market fee, issuance of an unified single trading license in the state, declaring warehouses/silos/cold storage as market sub-yards, and Market Yards of National Importance so that more markets are available for farmers to sell their produce for better prices. States and Union Territories are encouraged to adopt the Model Act to realize better potential from the sector.
November 22, 2017Pulses Exports: The government removed all restrictions on exports of all varieties of pulses.
December 21, 2017Import Duty on Pulses: To protect the interest of domestic farmers, the government imposed a 30 percent import duty on Chana (Chickpeas) and Masoor (Lentils).
February 1, 2018Minimum Support Prices (MSPs): The government proposed to set MSPs for all crops at one and half times of their production cost. The National Institution for Transforming India (NITI Aayog), in consultation with central and state governments, will put in place a mechanism for operationalizing the new scheme.
February 1, 2018Gramin Agricultural Markets (GrAMs): The government proposed to develop and upgrade existing 22,000 rural haats into Gramin Agricultural Markets (GrAMs) to provide farmers facility to make direct sale to consumers and bulk purchasers. These GrAMs will be electronically linked to e-NAM and exempted from regulations of Agricultural Produce Market Committees.
Agri-Market Infrastructure Fund: The government will set up an Agri-Market Infrastructure Fund with a corpus of INR 20 billion for developing and upgrading agricultural marketing infrastructure in the 22,000 GrAMs and 585 Agricultural Produce Market Committees.
February 2, 2018Minimum Export Price for Onion: The government permitted farmers to export onion without any minimum export price. Earlier government had imposed one of US$850 per ton effective November 23, 2017 and US$700 effective January 19, 2018.
February 6, 2018Import Duties Raised: The government raised the import duty on raw and refined sugar to 100 percent. The government also raised the import duty on chick-peas to 40 percent from 30 percent.
Trade Policy
October 18, 2017Restrictions on Gold Imports: The government imposed fresh restrictions on four-star and five-star export houses with nominated agency certificates from importing gold only for export purposes and not for selling in the domestic market. The move was aimed at curbing duty free gold imports by these houses from countries such as South Korea with whom India has a free trade agreement.
December 5, 2017Mid-Term Review of Foreign Trade Policy 2015–2020:

Exports Zero Rated: On export of finished goods there is an option of either obtaining refund of the GST paid or getting exemption on submission of letter of undertaking/bond.

Issue of Working Capital Blockage: Exporters have been extended the benefit of sourcing inputs/capital goods from abroad as well as domestic suppliers for exports without upfront payment of the GST. An ‘E-wallet’ scheme to be launched from April 1, 2018 to make these schemes operational. Merchant exporters allowed to pay nominal GST of 0.1 percent for procuring goods from domestic suppliers for export.

Duty Credit Scrips: Validity period of Duty Credit Scrips has been increased from 18 to 24 months and GST rates on transfer/sale of scrips has been reduced to zero percent from 12 percent.

Specified Nominated Agency permitted to import gold without payment of the Integrated GST.

Export Incentives: Incentives under merchandise exports from India increased by 2 percent across the board for labor intensive MSME sectors.

Self-Assessment Based Duty-free Procurement of Inputs: A new scheme of self-assessment based duty-free procurement of inputs required for exports has been introduced for authorized economic operators and will get expanded as more exporters join the authorized economic operator program.
Factor Markets
December 15, 2017Special Package for Employment Generation in Leather and Footwear Sector, totaling of INR 26 billion to be spent over the three financial years from 2017/18 to 2019/20.

Introduction of Fixed-term Employment under Sub Section (1) of section 15 of Industrial Employment (Standing Order) Act, 1946 has been proposed.

Enhancing Scope of the Income Tax Act: to allow a deduction of thirty percent of additional wages paid to new regular workmen in a factory for three years from profit & loss account with the provisions of a minimum 150 days of employment in a year, instead of 240 days.

Additional Employment Incentive: The scheme would provide for employers’ contribution of 3.67 percent to the employees’ provident fund for all new employees in leather, footwear, and accessories sector, enrolling within the first 3 years of their employment.
February 1, 2018Labor Policy: The government proposed to contribute 12 percent of wages of the new employees in the employees’ provident fund for all the sectors for next three years.
March 16, 2018Fixed-term Employment: The government extended fixed-term employment to all sectors. This flexibility was earlier applicable to the apparel manufacturing sector only.
Other Policies
March 15, 2017National Health Policy, 2017: The government approved the National Health Policy, 2017 that aims at achieving universal health coverage and delivering quality health care services to all at affordable cost. The policy proposes raising public health expenditure to 2.5 percent of GDP in a time bound manner.
May 17, 2017Maternity Benefit Program: The government decided to extend the pilot Maternity Benefit Program, including INR 6,000 cash compensation for the wage loss of pregnant women and lactating mothers across all districts in the country.
September 21, 2017Affordable Housing: The government proposed eight different models: two models for private investments in affordable housing on private lands and six models for private investments using government lands.
October 25, 2017Bharatmala Project: The government announced the Bharatmala project to construct 83,677 km of roads involving capex of INR 6.92 trillion to be completed in 5 years by 2021–22.
February 1, 2018National Health Protection Scheme: The government approved the launch of Ayushman Bharat-National Health Protection Mission that aims to provide a cover of INR 0.5 million per family per year to about 100 million families belonging to the poor and vulnerable population.
Appendix II. Risk Assessment Matrix
Nature/Source of ThreatLikelihoodImpactPolicies to Minimize Impact
Domestic Risks
Delays in addressing the twin balance sheet problemsMH: Delays or protracted processes in addressing promptly the bank capitalization needs of PSBs, dealing decisively with asset quality problems, and repairing corporate balance sheets may lead to further deterioration of the balance sheets of banks and corporates, thus undermining the capital position of PSBs and hindering banks’ ability to lend to the economy.The announced recapitalization for India’s PSBs should proceed, as planned. The recapitalization plan should be part of a broader package of financial reforms to speed up the resolution of nonperforming assets, improve PSBs’ governance, reduce the role of the public sector in the financial system, and enhance bank lending capacity and practices.
Fiscal revenue shortfalls related to the GSTHH: Protracted GST implementation issues, could cause the center’s revenue expenditure to rise more than budgeted, adding risk to the FY2018/19 deficit target. Borrowing needs and financing costs may rise, putting upward pressure on market interest rates and crowding out private investment.Ease GST compliance including through further simplification of the rate structure and streamlining filing and refund mechanisms, along with strengthening tax administration.
Setbacks in the structural reform processMM: Difficulty in passing key bills (Labor Market and Land Acquisition) and slow progress on reforming factor and product markets, including agriculture, could weigh on investment and growth, add pressure on inflation, and wane investor sentiment.Continue to facilitate state-led reform initiatives, address long-standing supply bottlenecks including through non-legislative measures, and strengthen the business climate.
External Risks
Tighter or more volatile global financial conditionsHM: Against the backdrop of recent large capital inflows into Indian equities and bonds, an abrupt change in global risk appetite including due to higher-than-expected inflation in the U.S. could lead to a sudden and sharp increase in interest rates, a tightening of global financial conditions, and corrections in market valuations.Rupee flexibility and monetary policy tightening. Given adequate level of international reserves, provide foreign currency liquidity to prevent disorderly movements in the exchange rate. Continue to enhance the environment for attracting stable non-debt creating capital flows, particularly FDI.
Retreat from cross-border integrationMM: The United States may tighten imports from trading partners. As the United States is one of India’s major trading partners, goods and services exports would be affected. At the same time, India’s move to protectionism measures, including tariff hikes, could be broadly contractionary, reducing output, investment, and employment. It may also reduce incentives for businesses to compete and improve efficiency.Facilitate trade liberalization, further reduce barriers to trade, and advance export sophistication and quality to better integrate into global value chains. Further supply-side reforms to improve the business climate and enhance the benefits from trade liberalization.
Structurally weak growth in key advanced economiesHM: Low productivity growth in advanced economies could undermine the medium-term outlook of India’s major trading partners; therefore, it could cloud the sustainability of the recovery in India, and prospects for exports and investment.Structural reform will help strengthen domestic sources of growth, support export competitiveness, and attract foreign investment flows.
Rising regional geopolitical tensionsMM: Cross-border tensions with China and Pakistan may damage confidence and further elevate economic and political pressures. If intensified, this may trigger financial market pressures, reduce capital inflows, and cause general tightening of financial conditions.Exchange rate flexibility should continue to be the main shock absorber. Given adequate level of international reserves, provide foreign currency liquidity to prevent disorderly movements in the exchange rate.
“L”=Low; “M”=Medium; “H”=High.The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term (ST)” and “medium term (MT)” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.
“L”=Low; “M”=Medium; “H”=High.The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term (ST)” and “medium term (MT)” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.
Appendix III. Main Recommendations of the 2017 FSAP
RecommendationsAuthorityTime frame
Policies to address vulnerabilities
Improve the governance and financial operations of PSBs and develop a strategic plan for their consolidation, divestment, and privatization.MoFS
Conduct granular assessments of banks’ capital needs and require additional provisions and swift recapitalization and restructuring.RBI, MoFS
Redesign the corporate debt restructuring mechanisms to make them more flexible.RBIS
Financial sector oversight framework
System-wide oversight and macroprudential policies
  • - Retain regulators’ role in collecting firm-level data.
MoFM
Banking supervision
  • - Review loan classification and provisioning rules in the context of IFRS, and with respect to special loan categories.
RBIS
  • - Amend the legal framework to provide the RBI with full supervisory powers over PSBs and clarify its legal independence.
GovernmentM
Insurance supervision
  • - Introduce a risk-based solvency regime and risk-based supervision.
IRDAIS
Securities regulation
  • - Transfer legal authority over public-listed company reporting to SEBI and introduce a risk-based review of company disclosures.
Government, SEBIS
  • - Adopt a strategy to unify regulation of commodities trading markets.
S
Financial markets infrastructure oversight
  • - Improve stress testing scenarios and methodologies.
CCILS
Crisis management framework
  • - Resolution legislation should preserve RBI’s full supervisory authority over going concern banks, and promote equal treatment of domestic and foreign creditors.
GovernmentS
  • - Improve the frameworks for emergency liquidity assistance, deposit insurance, and crisis preparedness.
RBI, GovernmentM
Market integrity
  • - Subject domestic politically-exposed persons to adequate due diligence and qualify domestic tax evasion as predicate offense to money laundering.
MoFS
Market development
Progressively reduce the SLR to help deepen markets and encourage lending.RBIS
Undertake a cost-benefit and gap diagnostic of the PSL program and develop a plan to reduce its scope and ensure it targets underserved segments.RBI, MoFM
S = short term, M = medium term.
S = short term, M = medium term.
Appendix IV. Public and External Debt Sustainability Analysis

India’s debt is high, but favorable debt dynamics and financial repression make the debt path sustainable. Risks are further mitigated because public debt is denominated in domestic currency and predominantly held by residents. The statutory liquidity requirement creates a captive domestic market for debt which limits the interest cost of debt. Under the baseline, the public debt-to-GDP ratio would decline from 70 percent in 2017/18 to 63 percent of GDP by 2022/23, while gross financing needs would decline from about 12 percent to 9 percent of GDP. The primary risk to debt sustainability stems from shocks to real GDP growth and fiscal slippages. India’s external debt at about 20 percent of GDP remains sustainable.

1. India’s debt-to-GDP ratio is high at around 70 percent of GDP. Over the medium term debt is projected to decline to around 63 percent of GDP driven by favorable debt dynamics. Nominal GDP growth is projected to increase from 10 percent to around 12 percent over the medium term and effective interest rates are projected to remain close to 8 percent. Inflation over the medium term is forecast to be stable around 4 percent. India’s debt-stabilizing primary deficit is calculated at 2.5 percent of GDP, and the primary deficit in the baseline assumptions is nearly one percent of GDP lower than that over the medium term.

2. India’s public debt sustainability analysis is based on the following macroeconomic assumptions:

  • Growth assumptions. Real GDP growth is estimated to have bottomed out after the dual shocks of demonetization and disruptions from GST implementation. Growth was 6.7 percent in 2017/18 and is projected to increase to 7.3 percent in 2018/19 and gradually to 7¾ percent in the medium term. Robust growth will be driven by a moderate pickup in investment and increases in intra-Indian trade because of efficiency gains from the GST. The medium-term growth forecast has been revised downward compared to the last DSA because of a GST structure that was more complicated than anticipated and limited progress on land and labor reforms which are needed for a sustained rise in investment and a further acceleration in growth, along with a downward revision to historical growth.
  • Fiscal Assumptions. The central government fiscal deficit deteriorated in 2017/18 relative to 2016/17 (IMF presentation), as non-tax revenue declined sharply, offset partly by a small increase in tax revenue and a reduction in expenditures, mainly lower capital spending. In the IMF’s presentation the deterioration amounted to 0.3 percent of GDP. The government is set to resume consolidation with a planned reduction in the general government deficit by 0.4 percent of GDP (IMF presentation) in the 2018/19 budget. The consolidation is predicated on higher revenues due to base broadening effects and increased GST compliance.

3. Fiscal Risks.

  • The center has committed to fill the gap potentially arising from GST-related revenue shortfalls in states. Specifically, the center has guaranteed states’ annual revenue growth at 14 percent for a period of 5 years from the implementation of GST. Because of this, GST revenue slippages would affect the central government budget through higher transfers to the states.
  • State fiscal deficits have broadly been within the 3 percent limit recommended by the 14th Finance Commission. However, risks remain and stem from announcements of farm loan waivers in several states, the implementation of the 17th Pay Commission (underway), and the taking on of losses from electricity generation corporations as stipulated in the UDAY scheme. Assessing these risks is complicated by the more-than-one-year lag in the availability of data on states’ fiscal positions.
  • The government recently announced a plan to recapitalize public sector banks over two years. The recapitalization will add at least 0.8 percent of GDP to the public debt. This is included in the baseline. The size of the recapitalization is in line with recommendations from the last FSSA. Further recapitalization needs are not anticipated, but the contingent liability shock is included to account for a financing need equivalent to 1 percent of GDP.

4. India’s debt profile is conducive to debt stability. Nearly 95 percent of debt has a long and medium-term maturity, and debt is largely held by residents. Foreign currency-denominated debt is negligible. The composition of debt is set to remain the same over the projection period with the bulk of financing needs met by the issuance of medium and long-term debt denominated in domestic currency and held by residents. The interest bill is substantial with gross financing needs equivalent to nearly 12 percent of GDP. As fiscal consolidation resumes, these needs will decline by around 3 percent of GDP over the medium term. The statutory liquidity requirement creates a captive domestic market for debt which limits the interest cost of debt.

5. Projections over the medium term are reasonable according to the assessment in the template. Assumptions on fiscal consolidation are within the median for surveillance countries and are expected to be met. Past forecast errors in projecting real GDP growth and the primary balance are reasonable with a percentile rank around 50 percent for each. The team’s forecast of inflation has been better than the median for other surveillance countries.

6. The primary risk to India’s debt sustainability is low growth, though the risks remain contained. The stress test corresponding to a growth shock yields a deteriorating debt path with debt-to-GDP reaching a peak of 71 percent of GDP and gross financing needs reaching a peak of 12 percent of GDP. The combined macro-fiscal shock yields slightly worse outcomes though the debt path would return to a downward trajectory.

7. Elevated vulnerabilities in the heat map stem from a high baseline debt-to-GDP ratio. Since debt-to-GDP is slightly above 70 percent, the baseline threshold is breached and the heat map for the debt level is red. Gross financing needs are below the 15 percent of GDP threshold and do not deteriorate in shock scenarios. Risks stemming from market perception (measured by EMBI global spreads) and external financing requirements (defined as the current account balance and amortization of short term external debt) are limited.

Figure 1.India Public Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as general government.

2/ Based on available data.

3/ Long-term bond spread over U.S. bonds.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 2.India Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

Source: IMF staff.

Figure 3.India Public DSA—Realism of Baseline Assumptions

Source: IMF Staff.

1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.

2/ Projections made in the spring WEO vintage of the preceding year.

3/ Not applicable for India, as it meets neither the positive output gap criterion nor the private credit growth criterion.

4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Figure 4.India Public DSA—Stress Tests

Source: IMF staff.

Figure 5.India Public Debt Sustainability Analysis (DSA)—Baseline Scenario

Source: IMF staff.

1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.

4/ Long-term bond spread over U.S. bonds, an average over the last 3 months, 13-Dec-17 through 13-Mar-18.

5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Figure 6.India: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2010.

Table 1.India: External Debt Sustainability Framework, 2013–2023
ActualProjections
20132014201520162017201820192020202120222023Debt-stabilizing non-interest current account 6/
Baseline: External debt24.023.323.120.720.420.820.620.320.220.420.6-3.7
Change in external debt1.6-0.8-0.2-2.3-0.40.4-0.2-0.2-0.10.20.2
Identified external debt-creating flows (4+8+9)-0.6-4.4-1.6-3.2-2.5-1.0-1.5-1.7-1.6-1.4-1.3
Current account deficit, excluding interest payments1.30.90.60.11.41.91.41.31.41.71.8
Deficit in balance of goods and services4.03.42.91.93.24.03.73.63.53.63.8
Exports25.323.320.019.519.420.420.520.420.420.220.0
Imports29.426.622.921.522.524.524.224.023.923.823.7
Net non-debt creating capital inflows (negative)-1.4-3.5-1.5-1.9-2.0-2.2-2.3-2.4-2.4-2.4-2.5
Automatic debt dynamics 1/-0.4-1.8-0.6-1.3-1.9-0.7-0.6-0.6-0.7-0.7-0.7
Contribution from nominal interest rate0.40.40.50.60.50.70.80.80.80.70.7
Contribution from real GDP growth-1.4-1.6-1.8-1.5-1.2-1.4-1.4-1.4-1.4-1.4-1.4
Contribution from price and exchange rate changes 2/0.5-0.60.7-0.4-1.2
Residual, incl. change in gross foreign assets (2–3) 3/2.23.71.40.92.11.41.31.51.51.61.5
External debt-to-exports ratio (in percent)94.8100.0115.3106.1105.1101.5100.299.599.2101.0102.9
Gross external financing need (in billions of US dollars) 4/219.1216.1215.5216.8252.8301.2329.1365.7411.3451.9512.2
in percent of GDP11.810.610.39.59.710-Year10-Year10.910.810.911.111.111.5
Scenario with key variables at their historical averages 5/20.821.221.922.623.324.0-3.5
Key Macroeconomic Assumptions Underlying BaselineHistorical AverageStandard Deviation
Real GDP growth (in percent)6.47.48.27.16.77.01.77.37.57.77.77.77.7
GDP deflator in US dollars (change in percent)-4.52.2-4.71.07.30.86.1-0.92.22.42.22.12.1
Nominal external interest rate (in percent)1.91.92.12.62.62.40.63.64.34.54.24.04.0
Growth of exports (US dollar terms, in percent)4.00.9-11.45.613.47.813.912.210.29.99.89.08.9
Growth of imports (US dollar terms, in percent)-6.5-0.3-11.41.520.17.413.915.48.89.29.69.89.6
Current account balance, excluding interest payments-1.3-0.9-0.6-0.1-1.4-1.91.4-1.9-1.4-1.3-1.4-1.7-1.8
Net non-debt creating capital inflows1.43.51.51.92.02.20.92.22.32.42.42.42.5

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Appendix V. Recent and Planned IMF Capacity Development

1. The Fund’s capacity development (CD) activities with India have been scaled up in recent years. IMF technical assistance (TA) and training have supported the authorities’ efforts to enhance the formulation and implementation of sound macroeconomic and financial policies as well as build institutions and capacity. Examples include the introduction of the inflation targeting framework, banking sector stress testing, the modernization of the insolvency regime, the design of the Goods and Services Tax (GST) and the fiscal responsibility framework, and the strengthening of macroeconomic statistics.

2. Upon its inauguration in February 2017, the South Asia Regional Training and Technical Assistance Center (SARTTAC) has become the focal point for the delivery of IMF CD services to India and South Asian countries. In FY2018, SARTTAC extensively provided training and TA in the Fund’s core areas of expertise such as training on national accounts (June 2017, November 2017, and April 2018), BOP/IIP statistics (July 2017), strengthening budget institutions (September 2017), public financial management (June 2017), and a government finance statistics workshop (September 2017), as well as a course on managing capital flows (September 2017). To date, 235 Indian officials received training through SARTTAC.

3. In line with the Fund’s CD strategy,

  • Recent activities and collaboration with Indian authorities has improved targeting to country needs. At the request of the 15th Finance Commission, APD and FAD have planned a pipeline of TA missions to provide the Fund’s analysis and assistance in developing approaches to handle issues on fiscal federalism. These issues include assisting on constraints on state budgets, achieving vertical fiscal balance, and incentivizing greater fiscal discipline among states, including through market discipline. In addition, an APD/SARTTAC monetary policy workshop is being planned to provide a forum for knowledge sharing on evolving monetary policy frameworks in India, Nepal, and Bhutan.
  • CD activities have been further integrated with surveillance and IMF policy advice. Based on FSAP recommendations, LEG has conducted a workshop jointly with the Insolvency and Bankruptcy Board of India to discuss practical and operational challenges faced under the new Insolvency and Bankruptcy regime, including insolvency of enterprise groups and cross-border insolvency. SARTTAC has also started working bilaterally with the Reserve Bank of India (RBI), with possible workshops and TA on the accounting of NPLs under the IFRS and an early warning exercise. A customized training on External Sector Assessment was delivered for the RBI in October 2017. This will support IMF surveillance on exchange rate assessments. Statistics TA in various areas provided through both SARTTAC and IMF headquarters is benefiting surveillance and supports the authorities’ CD needs.
Appendix VI. External Sector Assessment
IndiaOverall Assessment
Foreign asset and liability position and trajectoryBackground. India’s net international investment position (NIIP) has improved slightly since 2014, going from -18.1 percent of GDP at end FY2014/15 to -17.3 percent of GDP as of end-2017. Gross foreign assets and liabilities were 24 and 42 percent of GDP, respectively, at end-2017. The modest level of foreign liabilities reflects India’s gradual approach to capital account liberalization, which has focused mostly on FDI. The bulk of assets are in the form of official reserves and FDI, while liabilities include mostly FDI and portfolio equity.

Assessment. With current account (CA) deficits of about 2½ percent of GDP projected for the medium term, the NIIP-to-GDP ratio is expected to slightly deteriorate. India’s external debt, at about 20 percent of GDP, is moderate, compared to other emerging market economies. 48 percent of the external debt is denominated in U.S. dollars and another 37 percent is dominated in Indian rupees. The debt maturity profile is favorable, as long-term external debt accounts for about 81 percent of the total, and the ratio of short-term external debt to foreign exchange (FX) reserves is low.
Overall Assessment: The external sector position in 2017/18 is broadly consistent with fundamentals and desirable policy settings. India’s low per capita income, favorable growth prospects, demographic trends, and development needs justify running CA deficits. External vulnerabilities remain, although they have been reduced since 2013. India’s economic risks stem from more volatile global financial conditions, oil price volatility, and a retreat from cross-border integration. Progress has been made on FDI liberalization, while portfolio flows remain controlled. India’s trade barriers remain significant.

Potential policy responses: An increase in non-debt creating capital flows through FDI will help improve the CA financing mix and contain external vulnerabilities. Gradual liberalization of portfolio flows should be considered, while monitoring risks of portfolio flows’ reversals. Exchange rate flexibility should remain the main shock absorber, with intervention limited to addressing disorderly market conditions. Continued vigilance is needed, given potential external shocks. Going forward, further structural reform efforts to revamp the business climate, ease domestic supply bottlenecks, and facilitate trade and investment liberalization are essential to improve competitiveness and investment prospects, attract FDI, and boost exports.
Current accountBackground. The CA deficit is estimated to have increased to 1.9 percent of GDP in FY2017/18 from 0.7 percent of GDP in the previous year. Reflecting a recovery in commodity (especially oil) prices, imports surged by 19 percent in FY2017/18, following a slight decline in the previous year. Export growth also picked up to 10 percent in FY2017/18, from 5 percent in FY2016/17, in line with the global growth recovery. Over the medium term, the CA deficit is expected to increase to about 2½ percent of GDP, on the back of strengthening domestic demand.

Assessment. The External Balance Assessment (EBA) cyclically-adjusted CA deficit stood at 2.3 percent of GDP in FY2017/18. The EBA CA regression estimates a norm of -3.2 percent of GDP for India in FY2017/18, with a standard deviation of 0.5 percent, thus implying an EBA gap of 0.9 percent. As discussed in previous External Sector Reports and Article IV Staff Reports, in Staff’s judgment, a CA deficit of about 2.5 percent of GDP is a more appropriate norm and consistent with the External Sustainability (ES) approach. Based on India’s historical cash flows and restrictions on capital inflows, global financial markets cannot be counted on to reliably finance a CA deficit above 3 percent of GDP. While FDI flows have increased in recent years, they are not sufficient to cover CA deficits for this and outer years. Portfolio flows are highly volatile and susceptible to changes in the global risk appetite as demonstrated in the Taper Tantrum episode. Thus, based on the staff-assessed CA norm, the CA gap is in the range of -0.8 to +1.2 percent of GDP. Positive policy contributions to the CA gap from a negative credit gap, larger-than-desirable intervention in the FX market, and a relatively closed capital account are offset by a negative unexplained residual, which likely captures underlying competitiveness problems.
CA Assessment 2017Actual CA-1.9Cycl. Adj. CA-2.3EBA CA Norm-3.2EBA CA Gap0.9Staff Adj.0.7Staff CA Gap0.2
Real exchange rateBackground. The average REER in 2017 appreciated by about 4.3 percent over its 2016 average. As of April 2018, the REER depreciated about 3 percent relative to its 2017 average.

Assessment. The EBA Index REER and Level REER regression approaches estimate a gap of +10.2 and +8.5 percent for the 2017 average REER, respectively. However, these approaches have large estimation errors for India. Based on the CA gap, the REER is assessed to be in line with fundamentals with the range of -7 to +5 percent for FY2017/18.
Capital and financial accounts: flows and policy measuresBackground. The sum of FDI, portfolio, and financial derivatives flows on a net basis is estimated at 1.9 percent of GDP in FY2017/18, slowing from 2.3 percent in FY2016/17 despite larger portfolio inflows. Net FDI flows moderated to 1.2 percent of GDP in FY2017/18, from 1.6 percent in FY2016/17. Portfolio inflows into government and corporate securities were strong in 2017, almost fully exhausting the ceilings on non-resident investment. That said, in line with global trends, there were some portfolio outflows so far in 2018.

Assessment. Given that portfolio debt flows have been volatile and the exchange rate has been sensitive to these flows and changes in global risk aversion, attracting more stable sources of financing is needed to reduce vulnerabilities. Implementation of structural reforms to improve business climate would help to attract FDI.
FX intervention and reserves levelBackground. The evolution of the rupee is generally consistent with a floating arrangement. Spot foreign exchange intervention was US$28 billion (1.1 percent of GDP) and net forwards increased by US$28.5 billion in 2017. International reserves reached $424.5 billion at end-March 2018, increasing by about $55 billion since March 2017. Reserves declined to about $412 billion as of end-May 2018. Reserve coverage currently is about 16.3 percent of GDP and about 7.5 months of prospective goods and services imports. Assessment. Reserve levels are adequate for precautionary purposes relative to various criteria. International reserves represent about 190 percent of short-term debt and more than 160 percent of the IMF’s composite metric. 1/
Technical Background Notes1/ Reserves stand at about 210 percent of the metric adjusted for capital controls, the construction of which is explained in the IMF policy paper, Assessing Reserve Adequacy—Specific Proposals. While the adjusted reserve metric uses a composite index to measure capital account openness that is based on de jure capital control indices, staff analysis indicates that India’s capital account is not as closed as suggested by traditional measures. See Annex IV in IMF (2016), India: Staff Report for the 2016 Article IV Consultation, IMF Country Report No. 16/75 and Chapter 5 in IMF (2016), India: Selected Issues, IMF Country Report No. 16/76.
1

“Asia: At Risk of Growing Old before Becoming Rich? (Chapter 2 of the May 2017 IMF Regional Economic Outlook: Asia and Pacific) discusses the implications of demographic trends for the Asia and Pacific region, including India.

2

PSBs raised INR 120 billion of the planned INR 580 billion in late FY2017/18 through the equity market and the sales of non-core assets.

3

International oil prices are now projected to average US$72 per barrel in FY2018/19, up from US$62/barrel in the Spring 2018 IMF World Economic Outlook (WEO).

4

The difference between the authorities’ and IMF presentations primarily reflects higher-than-budgeted privatization proceeds, which are recorded below the line in the IMF presentation.

5

A panel was set up to study asset management companies to resolve the NPAs. The FSAP advised focusing on further promoting private asset reconstruction companies, and recommended against establishing public ones given the heterogeneity of cases, difficulties in setting transfer prices, challenges related to governance and expertise, and the fact that the largest cases are already being addressed under the IBC.

6

Trade barriers are documented in IMF WP 18/32 “A Multidimensional Approach to Trade Policy Indicators.”

7

See the Selected Issues Paper prepared for the 2017 Article IV Consultation.

1

Starting April 2017.

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