Rapid growth promising prospects for India

With robust growth spurring elevated levels of inflation, India should speed up its return to pre-crisis monetary and fiscal policies to keep the economy in check, suggests the IMF in its annual assessment of one of the world's fastest growing economies.

In its report on the Indian economy-known as the Article IV consultation-IMF economists said they expect the South Asian country to grow above trend this year, with high levels of growth continuing over the medium term.

"We expect real GDP to grow 8 3/4 percent in 2010/11, with robust growth supported by high investment in infrastructure and productivity gains," IMF's India mission chief Masahiko Takeda said.

India weathered the recent global financial crisis well, and since mid-2009 domestic demand has powered a vigorous recovery. The country's growth rate remains among the strongest in the world. Toward a more normal policy stance.

In its report, the IMF backed the authorities' policy of exiting from the stimulus implemented in the past two years. But this exit strategy remains incomplete. Given the high level of government debt, existing strong domestic demand, and large capital inflows, IMF economists said that fiscal policy is the preferred method for tightening.

In their assessment, the report's authors welcomed the authorities' renewed commitment to fiscal consolidation: the government has laid out an ambitious roadmap to reduce public debt and deficits, and high growth is expected to contribute toward this goal as well.

The IMF also supported the objective to raise public investment, especially in infrastructure, and to improve social outcomes. The challenge will be to make savings elsewhere to meet these objectives while remaining on the consolidation path.

With tax reforms designed to be revenue neutral, IMF economists see the need for subsidy reforms-particularly a liberalization of diesel and fertilizer prices-coupled with more efficient spending.

"A commendable first step in fuel price liberalization has been taken and promising tax reforms are in the works,-notes the report.

Strengthening the budget framework will be important to minimize risks to fiscal consolidation, while the government's strong revenue position this year presents an opportunity to reconstitute fiscal space faster and reduce the risk of overheating, say the economists. The IMF report also recommends further tightening monetary policy to meet the authorities' inflation objectives and anchor inflation expectations.

With little or no spare capacity in the economy, coupled with the threat of rising food prices, inflation is currently elevated in the range of 8 1/2 - 10 1/2 percent.

Inflation is expected to come down slowly as last year's high food prices caused by poor rainfall drop out of the inflation calculation, but underlying price pressures are still strong, say IMF economists.

Over the last year, the authorities have raised policy rates and the cash reserve requirement, but further increases in policy rates would help bring real short-term interest rates in line with historical norms, and help contain inflation, they add.

A more rapid withdrawal of fiscal stimulus at an earlier stage would have helped contain demand, 'but in its absence, a greater burden falls on monetary policy to cool the economy and counter the perception that inflation has shifted to a higher level, "said Takeda said.

(IMF Survey online)