Policy framework: Sustained improvement will boost economic confidence

The broad assessment in the International Monetary Fund’s (IMF’s) country report, released on Wednesday, reflects India’s macroeconomic stability and provides some useful pointers for policy discussion. The IMF expects the Indian economy to grow 6.6 per cent in the current year. Growth is expected to moderate to 6.2 per cent in 2026-27. The IMF’s baseline assumption reckons on a prolonged 50 per cent American tariff, which the government has rightly objected to. India is negotiating with the United States (US) with the objective of arriving at a deal soon. The IMF further notes that the corporate and financial sectors have remained resilient with an adequate capital cushion. The government is moving forward on fiscal consolidation, and the current account deficit has remained moderate and manageable.

 

The report also has suggestions for India’s macroeconomic managers. Some are worth discussing here. In the context of currency management, the IMF has argued that allowing greater flexibility will help absorb external shocks and reduce the need for foreign-exchange accumulation. The IMF in 2023 had classified India’s foreign-exchange management as a “stabilised arrangement”. Although the IMF notes that the intervention has declined, it has still classified the arrangement as “crawl-like”.  The Reserve Bank of India’s (RBI’s) stated position is that it does not target any level and intervenes in the market only to contain volatility. It is worth noting that India witnessed large inflows during the pandemic because big central banks reduced policy interest rates to near-zero and flooded the system with liquidity.  It also witnessed large outflows in 2022 as global central banks raised interest rates in a coordinated fashion to combat high inflation. It can be argued that if the RBI had not intervened as it did on both these occasions, the rupee would have seen large volatility, negatively affecting businesses.  Thus, a lot of what the RBI does in the foreign-exchange market is to insulate India from policy externalities of the West. But it must also be accepted that some amount of volatility is necessary, and the RBI’s intervention should not impede the development of a deeper foreign-exchange market.

 

In the context of fiscal management, the IMF noted that with a revision in the gross domestic product base in 2026, India should revisit debt targets to make them more ambitious. It’s hard to quibble with the idea of a faster reduction in public debt. It will help create policy space and improve spending quality. It has also been recommended that the debt anchor should be broadened to include state-government debt. This would require some adjustment in the current framework to also focus on reducing the state-level debt stock. Further, an annual fiscal-adjustment path will inform financial markets as to how the medium-term targets will be achieved. The IMF has also argued in favour of an independent fiscal oversight body. An independent fiscal body indeed is a missing piece in India’s overall policy architecture, which has improved significantly over the years. Such a body would be a major confidence booster for financial markets and should be actively considered by the government. Overall, some of the recent reforms, such as the simplification of goods and services tax and the Labour Codes being made effective, will support growth. The government is negotiating agreements with various trading partners, including the European Union, apart from the US. An early conclusion of these agreements will improve medium-term growth prospects.