While several demand and supply-side factors have resulted in a sharp fall in inflation and have given the Reserve Bank of India space to cut interest rates, there are several factors that could drive inflation up again, the International Monetary Fund (IMF) has warned in its latest edition of the World Economic Outlook (WEO).
The government must continue on its fiscal consolidation path and focus on reforms, especially in the labour and infrastructure sectors, the WEO report said. It also projected that India’s current account deficit would widen sharply to $94.7 billion by 2021. The report does not indicate how the IMF has arrived at the figure. Consumer inflation would be at 5.3 per cent for the next two years and would ease by 2021.
“...lower commodity prices, supply side measures, and a relatively tight monetary stance have resulted in a faster-than-expected fall in inflation, making room for nominal interest rate cuts, but upside risks to inflation could necessitate a tightening of monetary policy,” it said. Consumer price inflation has eased to 4.8 per cent in March.
The report predicted that India would achieve its inflation target of 5 per cent in the first half of 2017, though it warned that an unfavourable monsoon and the effect of public sector wage increases (due to the adoption of the Seventh Pay Commission’s recommendations) could pose risks.
However, India Meteorological Department has said it is expecting an above-normal monsoon, with rainfall at 106 per cent of the long-term average. This, economists agree, should boost economic growth and keep inflation in check.
“Fiscal consolidation should continue, underpinned by revenue reforms and further reductions in subsidies,” the WEO report said. “Sustaining strong growth over the medium term will require labour market reforms and dismantling of infrastructure bottlenecks, especially in the power sector.”
The WEO data show India’s CAD, which was at $26.2 billion or 1.3 per cent of GDP in 2015, will widen to $51.8 billion (2.1 per cent of GDP) by 2017. The CAD is projected to hit $94.7 billion by 2021.
The IMF has retained its GDP growth forecast for India, adding that the main driver of this growth will be private consumption and investment. “In India, growth is projected to notch up to 7.5 per cent in 2016-17, as forecast in October,” the report said. “Growth will continue to be driven by private consumption, which has benefited from lower energy prices and higher real incomes. With the revival of sentiment and pick-up in industrial activity, a recovery of private investment is expected to further strengthen growth.”
While the IMF predicted that India’s GDP growth rate will be at 7.5 per cent in 2016 and 2017 (a shade higher than the 7.4 per cent predicted by the Asian Development Bank recently), it projected that this would accelerate to 7.8 per cent by 2021.
