The best way for monetary policy to support growth will be if the central bank keeps the interest rate unchanged “until inflation is clearly on a downward trend,” the IMF said in a staff report after Article IV consultations.
The measures taken by the Indian authorities recently in the direction of some structural reforms “have boosted confidence,” but the recovery is “subdued” while inflation is “still elevated”; investment was “significantly hit” and supply bottlenecks “will ease only slowly,” the report also said.
At the end of January, the Reserve Bank of India (RBI) cut its policy rate by a quarter of a percentage point to 7.75%, the reverse repo rate to 6.75% and it reduced the cash reserve ratio – the percentage of the value of deposits that banks must keep with the RBI – to 4% from 4.25%.
Analysts said at the time that the central bank would tread carefully in the future as inflation was still not under control - and the IMF report is likely to confirm expectations that no rate cuts are to follow.
“What we say is that the inflation reduction should be sustained, and while it is true that inflation pressures - looking at wholesale prices - have come down, including for core inflation, consumer price inflation remains above 10%,” Laura Papi, IMF Mission Chief to India, said in a conference call about the staff report.
”What we have noticed is that when you have consumer prices that remain elevated, partly due to food prices but not only, you see that the reduction in wholesale prices is not sustained.”
“That’s because CPI prices are much more important than wholesale prices in forming inflation expectations and also because food price inflation transfers into non-food price inflation fairly quickly in a country like India. For example we have seen this in the fairly rapid growth of rural wages.”
“Our sense is that this decline in inflation in wholesale prices may not be sustained,” Papi added.
POWER SECTOR KEY FOR GROWTH
Several causes of India’s weaker growth have to do with the reforms that need to be carried out by the government.
“In terms of reforms, there’s no one reform, there’s no silver bullet, but the key ones are to solve the problems in the power sector,” said Papi. The Indian government has announced plans to restructure the debt of power distributors, which have financial difficulties that triggered a massive power blackout last year and often cause smaller power outages.
There are also problems in supplying the necessary fuel to the power producers, with shortages of coal because of lack of reforms in the pricing of the commodity but also in the logistics – the actual getting of the coal to the power plants. Coal production has also slowed down because of environmental concerns.
“The issue of power we think it’s very critical because it affects so many other sectors, but there are other reforms which are important; the whole approval process of investment projects has slowed significantly, so implementation times have increased,” Papi said.
“All these reforms are going to take some time, that’s one reason why we see growth very subdued by Indian standards for the next few years.”
The Indian government has taken steps towards implementing reforms but analysts worry that, with elections coming next year, these will be delayed.
The government has also put some of the blame for the economic slowdown on the weak global economy, suggesting repeatedly that the central bank should lower the interest rate to help the economy.
“We looked at trading partners’ demand and how much that has dropped and how much India’s demand has dropped and what we noticed was that India’s GDP growth dropped by more than could be explained by trading partners’ demand,” Papi said.
“On the other hand, the financial channel, which was very powerful during the 2008-2009 global financial crisis, in the last couple of years has not been at work, in the sense that financing conditions have remained fairly favourable.”
“We would say that domestic factors have dominated this slowdown.”