Christine Lagarde, managing director of the International Monetary Fund, makes a speech at Seoul National University. The IMF yesterday said India needs to raise borrowing costs, narrow its fiscal deficit and remove supply bottlenecks if it is to pick up lagging economic growth.

AFP/Reuters/Mumbai


India needs to raise borrowing costs, narrow its fiscal deficit and remove supply bottlenecks if it is to pick up lagging economic growth, the International Monetary Fund warned yesterday.
Dealing with its worst slowdown in a decade, India faces both external risks from volatile global markets as well as key domestic concerns, such as persistently high inflation, the IMF said after consultations with the government.
It produced a report and accompanying press release based on these consultations.
Despite three interest rate hikes by the Reserve Bank of India since September, the authorities should prepare for further raises to tackle worrying consumer prices, the IMF said in the release.  The country should “stand ready to raise the policy rate further so as to bring down inflation to more sustainable levels,” it said.
Asia’s third-largest economy grew at 4.5% last year.
It is facing shrinking manufacturing, low employment growth, and sizeable current account and fiscal deficits.
In the interim budget announced on Monday, the government announced that it had successfully cut expenses to keep the fiscal deficit at 4.6% of the gross domestic product against estimates of 4.8%.
But the IMF said there was more work to be done.
“Further fiscal consolidation is needed. Tax and subsidy reforms will be required to durably lower fiscal imbalances,” it said.
The Congress-led government of Prime Minister Manmohan Singh is expected to receive a severe drubbing in the upcoming elections and is desperate to control inflation and improve public finances while trying to boost growth.
India’s finance minister P Chidambaram had described the lifting of “140mn people out of poverty” as the 10-year-old government’s greatest achievement.
But the IMF said that India could grow faster if a range of reforms were implemented.
“Directors stressed that reviving growth and raising the long-term growth potential require broader structural reforms to improve infrastructure, the business climate, and the pricing and allocation of natural resources,” said the note.
“They also saw as key priorities reforms aimed at boosting agricultural productivity and supporting formal job creation, by relaxing labour laws and addressing skills mismatches.”
The IMF said however that the biggest risk to the country came from global financial market volatility, such as the US tapering its stimulus programme, leading to billions of dollars being pulled from emerging markets.
The Reserve Bank of India will need to continue raising its policy interest rate given the sticky nature of inflation, the Fund said.
“The ingrained nature of inflation and inflation expectations mean that reducing inflation – even over a protracted horizon – will require significant increases in policy rates, which will weigh on growth,” the IMF said.
“Should high inflation expectations persist and inflation remain sticky, a more front-loaded path of interest rate increases may be needed,” the IMF said.
Rajan, a former IMF chief economist, has raised the key repo rate by 75 basis points to 8% since becoming head of India’s central bank in September. He has made consumer prices its key inflation barometer, a shift away from using wholesale price inflation.
The latest 25 basis point increase, which surprised the market, was on January 28. Rajan, a former IMF chief economist, said in his last policy review that further rate hikes were not anticipated if the inflation trajectory remained subdued.
The consumer price index touched a two-year low in January at 8.79% as food prices cooled but was still much higher than the wholesale price index of 5.05%, an eight-month low.
The IMF expects India’s consumer price index to remain near double digits well into next year driven by food prices.
It endorsed giving more emphasis to consumer prices for making policy decisions.
“Headline CPI should provide the principal nominal anchor for monetary policy, as food and fuel price shocks propagate rapidly into core inflation, and inflation expectations and wage formation are closely linked to CPI inflation,” the IMF said.
The IMF expects India’s economy to grow at 4.6% in the current fiscal year ending in March, picking up to 5.4% in the fiscal year that starts in April, which is in line with the RBI’s expectations.