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IMF paper doubts India's growth sustainability

G. Srinivasan

NEW DELHI, July 11

EVEN as the Indian economy is yet to get out of the pronounced slowdown and downturn in manufacturing activity, a new research dissertation by the International Monetary Fund (IMF) has posed the query as to whether India's rather strong economic performa nce could be sustained ``without fiscal policy adjustment.''

In its latest IMF Research Paper, an article by the Fund economist, Mr Tim Callen, contends that India has had an impressive economic performance over the past decade. Its growth rate has been among the highest in the world, inflation has been relatively well-contained and the balance of payments has been maintained at comfortable levels.

This performance has been achieved despite the Asian financial crisis, the international sanctions that were imposed following the nuclear tests in 1998 and a series of adverse weather-related shocks and natural disasters. While poverty has declined over time, it remains at a high level, with more than one-quarter of the population living below the poverty line.

Moreover, macro-economic imbalances, particularly on the fiscal side and slow progress in key structural policy areas appear to be dampening growth prospects, Mr Callen added.

The IMF research paper on India has come at a significant juncture when the debate centres around how to unleash growth impulses to get the recovery going rather than get stuck with any overly obsessive concern over fiscal consolidation through compressi on of expenditure and reduced public sector outlays.

Against this backdrop, recent IMF research on India -- much of which is gleaned in a new tome, India at the Crossroads: Sustaining Growth and Reducing Poverty -- has focused on what policies are needed to sustain the rapid growth that is essential to red ucing poverty.

Providing an overview of the research, Mr Callen noted that India achieved considerable fiscal consolidation during the first half of the 1990s, but subsequent policy slippages, at both Central and State Government levels, resulted in the consolidated pu blic sector deficit ``ballooning to over 11 per cent of GDP and public debt rising to 80 per cent of GDP by the end of the decade.''

IMF staff research has focused both on the reasons for the deterioration in the fiscal position and on the sustainability of current fiscal policies. A paper by the Fund economist, Mr Muhleisen (1998), assessed the revenue impact of tax reforms implement ed by the Central Government during the 1990s.

He found that, while elasticity estimates point to a small improvement in the revenue-generating capacity of the tax system, overall tax revenue declined relative to GDP due to the substantial cuts in tax rates. It is small wonder that Mr Muhleisen concl uded that the disappointing revenue performance reflected the partial nature of the reforms.

On the sustainability of fiscal policies, another economist, Mr Reynolds (2001), used a simple growth model to demonstrate that despite the high deficits incurred in recent years, India has been able to preclude a fiscal crisis largely because of the con ducive differential between real interest rates and overall economic growth rates.

However, Mr Reynold's simulations suggested that a continuation of recent fiscal policies would risk putting India on an explosive debt path.

An alternative approach to assessing Indian fiscal policy was adopted by the economists, Messrs Cashin, Olekalns and Sahay (1998), who used an intertemporal model to demonstrate that policy has been consistent with tax-smoothing behaviour.

They also found, however, a significant bias toward deficit financing -- which has led to excessive government borrowing, as well as resorting to seniorage and financial repression -- and Government debt was estimated to be in excess of levels considered optimal or consistent with intertemporal solvency.

On India's external sector, Messrs Cerra and Saxena (2000) estimated the causes of the 1991 balance of payments crisis and since then India has maintained a sustainable external position and a number of papers have looked at the factors behind the succes s.

Mr Towe (2001) assessed the factors that helped insulate India from the turmoil of the Asian financial flu, attributing the success to ``effective exchange rate management, generally sound macroeconomic fundamentals and the presence of capital controls.' '

The financial sector has also been a key focus of the reform agenda in recent years. Two papers by Fund economists, Messrs Mohanty (1998) and Ilyina (2001) explored issues pertaining to the mutual fund and non-bank financial company (NBFC) sectors respec tively. Both sectors have faced recent difficulties that highlighted weaknesses in their regulatory milieu; the papers assessed the reforms that have been undertaken by the authorities to strengthen these sectors and made recommendations for further acti on.

These include, among others, further beefing up financial sector regulation and supervision, reductions in problem loans, steps to increase competition among institutions and measures to reduce the role of government in the financial sector.