Some capital will flow out of India if US Fed does any tapering, warns IMF

The International Monetary Fund (IMF) has cautioned that any tapering by the US Federal Reserve and similar action by other central bankers would lead to some capital flow out of India even as the country has enough foreign exchange at the moment, amid high foreign direct and portfolio investments. The IMF has also cut India's potential growth rate in the medium term to six per cent from earlier 6.25 per cent due to the impact of Covid on investments and labour markets.

To a query whether hot money would outflow from India as the Federal Reserve tapers and commodity prices rise, Alfred Schipke, mission chief for India, Asia and Pacific department, IMF, said the Fund's downside risk is that tightening of conditions globally could lead to some capital outflows from India.

"Having said that, I think what we have seen is that FDI (foreign direct investment) continues to be strong. We have seen that after some volatility earlier in the year, portfolio flows have also resumed. But of course, part of the flow can go out again," he said. He was speaking to reporters virtually on the IMF report on India under Article IV.

However, he said that India has a high level of foreign exchange reserves. "Based on our metrics, we think it (forex reserves) is appropriate in the current context," Schipke said.

He said amid fears of capital outflows, it is very important to have the right policy mix in place starting with a clearly communicated medium term strategy.

According to minutes from the September meeting released on Wednesday, the Federal Reserve could begin reducing the pace of its monthly asset purchases as soon as mid-November.

The minutes indicated the tapering process could probably see a monthly reduction of $10 billion in treasuries and $5 billion in mortgage-backed securities.

FDI inflows into India rose 168 per cent to $17.6 billion during the Covid-imapcted first quarter of the current financial year on a low base of $6.4 billion during the corresponding period of the previous financial year, also impacted by the pandemic.

Total FPI inflows, including equity, debt and hybrid, stood at $5.3 billion till October 18 of the current financial year against 36.2 billion in the previous financial year. It contracted by $3 billion during 2019-20.

The country's foreign exchange reserves rose by $2.039 billion to $639.516 billion in the week ended October 8, according to the Reserve Bank of India (RBI).

Schipke also informed that the Fund has lowered India's potential economic growth in the medium term. He attributed this to a big hit that investments took from Covid and disruptions in the labour markets. "This means that the capital stock is somewhat lower than it would have been," he said.

And of course, there was some damage to the labour market, he said, adding," So we have reduced potential growth rate by 25 bps."

Jarkko Turunen, deputy division chief, Asia and Pacific department, IMF, said human capital is an important component here. "We have seen reduced education and training due to the pandemic and would expect that it would weigh on human capital growth, going forward. This would have an adverse impact on labour markets. I think it is quite important to address," he said.

Schipke said if India fully implements the structural reforms and moves forward with privatisation plans, then that could be upside risks to the Fund's own growth projections.

He said if vaccination pace accelerated further and therefore confidence resumes more quickly, that will also be an upside risk to the growth projection.

The IMF had earlier retained India's economic growth projection at 9.5 per cent during the current financial year.

To a query on why the IMF has flagged the issue of inflation at a time when the retail rate of price rise fell to a five-month low of 4.3 per cent in September, Schipke said there are supply bottlenecks which can always spill over into inflation. "So it is very important to keep an eye on inflation," he said.

The good news, he said, is that the inflation rate has been falling in the last couple of months which allows the RBI to continue with its monetary policy.

He said even though the headline inflation rate, including that of the food items, has been falling, the Fund also looks at inflationary expectations.

On crypto currency, he said the Fund is talking to Indian authorities and other member countries to find the equilibrium between ensuring innovation and minimizing risks associated with them.