IMF asks out of woods India to go for financial sector reforms

By Arun Kumar, IANS,

Washington: Noting that India’s rapid recovery from the global financial crisis has brought fiscal and monetary policy trade-offs to a head earlier than in other countries, IMF has suggested that India set financial sector reforms as its longer-term priorities.

Support TwoCircles

“Longer-term priorities are financial sector reforms to facilitate infrastructure investment, and fiscal consolidation,” the International Monetary Fund said Wednesday after its Executive Board’s Article IV consultation with India last month.

IMF directors congratulated Indian “authorities on their strong record of sound macroeconomic policies and decisive actions leading to India’s early and vigorous recovery from the global crisis”.

They said they “were reassured by the authorities’ vigilant monitoring and action plans to address the challenges ahead”.

Commending the Reserve Bank of India (RBI) for starting the first phase of exit from monetary accommodation, IMF direciors “generally considered that conditions are ripe for a progressive normalisation of the monetary stance”.

They noted that this will require fine judgments by the RBI, and favoured a gradual approach to ensure that the recovery reaches its full potential.

Given long transmission lags and the low policy rates, most IMF directors advised a timely start of the withdrawal of monetary stimulus, which would help anchor inflation expectations and soften the impact on long-term interest rates.

They recognized the challenges the authorities face in managing capital inflows, and welcomed Indian authorities intention to continue to employ a range of measures, IMF said.

Most directors considered that rupee appreciation would help contain inflation and manage capital inflows, although a few directors argued for caution in this area.

Sterilised intervention could help reduce excessive exchange rate volatility, provided it does not generate further inflows, IMF said, supporting “the RBI’s approach to use prudential measures in case asset bubbles were to develop”.

Given the need to develop India’s financial markets, several directors advised a tightening of capital controls only as a last resort.

Noting that India’s financial system has weathered the global crisis well, they supported the initiatives to further strengthen the capital of public banks and financial regulation, and the higher provisioning requirements introduced recently.

“While appreciating India’s self-assessment of the financial sector, they noted that the assessment of financial stability could be further strengthened via multifactor stress tests and an independent evaluation of compliance with international standards,” IMF said.

IMF directors welcomed India’s announcement to lower the deficit starting from the next budget.

“With the recovery becoming entrenched and given India’s high debt, they encouraged the authorities to lay out a concrete strategy for reducing debt through durable reforms, which would boost credibility and foster growth.”

Most directors considered that anchoring India’s medium-term fiscal framework with a debt target would be helpful, IMF said.

IMF directors looked forward to the introduction of the Goods and Services Tax and the new Direct Tax Code and encouraged the authorities to phase out regressive subsidies and introduce market-based pricing for petroleum products.

Over time, the subsidies on products consumed predominantly by the poor should be replaced with targeted support, IMF suggested, welcoming the Indian “government’s focus on raising the quality of public spending and service delivery, and the announcements regarding privatisation”.