The old perspective of the IMF and our policy challenges

The International Monetary Fund (IMF)’s long-awaited update on global growth was released on April 6, 2020 in the World Economic Outlook (WEO). Its estimates have been revised slightly upwards compared to its WEO January update. The world is now projected to grow by 6% in 2021, up from 5.5% earlier, and 4.4% in 2022, compared to the previous 4.2%. This is due to the fact that the global economy will slow to 3.3% in 2020, compared to the previously estimated 3.5%, and a strong recovery in the US.

India’s IMF estimates for 2021 and 2022 also increased from 11.5% and 6.8% to 12.5% ​​and 6.9%, respectively. It has to be seen in the right perspective that India is the fastest growing major economy in these two years. This rebound is the root cause of the statistical illusion, which is projected to fall sharply to -8% (according to the Central Statistics Office of India -7.7%) in 2020-21. In the three years from 2020 to 2022, India’s average growth will be less than 4% compared to 4.2% in 2019. Production loss in relation to pre-Kovid growth projection is the largest in major economies. There is a strong rebound to the adage that a dead cat bounces — the harder the fall, the bigger it hits the floor.

On April 7, Reserve Bank of India (RBI) Governor Shaktikanta Das announced that the Central Bank Monetary Policy Committee (MPC) had decided to suspend its key policy rates. It needs to balance the conflicting goals of rising pressure on inflation and support the recovery from the Kovid-related financial crisis. Raising rates at this point is not questionable. Reducing the repo rate is currently at 4%, as that level is already very low — actually negative — compared to consumer price inflation, which is on an upward trend. Taking into account the average of wholesale price inflation (which is a very low trend) and consumer price inflation in India, the real repo rate of RBI is less than 1%.

The economy has been weakening for the past four years. Before the fall of 7.7% in 2020-21, the gross domestic product (GDP) growth continued to decline from 8.2 per cent in 2016-17 to 4.2 per cent in 2019-20. The burden of stimulating the economy fell heavily on monetary policy during this period as nominal and real repo rates fell. However, this accommodation monetary policy did not do much to stimulate credit growth and private investment as its transmission lines were closed due to the ‘twin balance sheet’ issue. The banking system is burdened with large amounts of non-performing assets, which are expected to grow well again in the current year, according to the RBI’s latest financial stability report. This makes banks very careful in extending the latest loan. The replica of illiquid loans is sadly on the corporate balance sheets, which makes companies hesitant to take out loans. Under these circumstances, monetary policy is far more effective in stimulating growth and investment than monetary policy. The IMF’s WEO points out that large production losses and weak recovery in emerging markets in relation to sophisticated economies are due to weaker economic responses to the Kovid crisis. The pre-Kovid crisis in the Indian banking system needs to be addressed quickly to improve the power of monetary policy.

The conflicting goals of growth and inflation must also be balanced. The RBI expects inflation to be above 5% above the 4% +/- 2% target. Therefore, its price-stability worries are unlikely to decrease. It is noteworthy that the government has been advised to reduce taxes on petroleum products to reduce some of the pressure. It flagged concerns over India’s economic recovery in view of the current Kovid revival. It is pertinent to note that RBI’s growth projection for the year 2021-22 is 10.5%, 2 percentage points lower than what the IMF estimated in its WEO April update. IMF predictions are not conducive to Kovid resurgence in India. It is also surprising that the RBI has reiterated its growth forecast for 1021% for the year 2021-22, which was made two months ago, ahead of the Kovid wave which is currently on the rise. The output loss is much worse than indicated by the IMF figures. The average growth from 2020-21 to 2022-23 will be less than 3.5%.

As the IMF highlighted in its latest WEO, responding to capital inflows arising from strong US recovery, inflationary pressures and rising interest rates in the US is another monetary policy headache. If that happens, the RBI may be left in a position where it will not be able to tackle the ‘impossible trinity’, balance the second contradictory targets and pull domestic and external policy requirements in opposite directions.

The monetary policy statement dated April 7 also shows the priority given by the RBI to the government’s massive borrowing program in the current financial year. Central lenders do not like to take out private borrowers when India’s economy is still in recovery mode. It indicated a readiness to intervene aggressively in the bond market in support of government debt needs, and to raise higher liquidity if necessary.

Alok Sheel is RBI Chair Professor in Macroeconomics at ICRIER

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