India must boost credit, labour to raise growth potential, says IMF

India needs to generate more jobs and credit to power its economy back toward its growth potential, which has been hamstrung by a strained financial sector and the pandemic, according to the International Monetary Fund’s mission chief for India.

The South Asian nation’s gross domestic product growth potential over the next five years has slipped to 6.2%, from an earlier projection of up to 7%, following a crisis in India’s shadow banking sector and the outbreak of Covid-19, the mission chief, Nada Choueiri, said in an interview Wednesday.

Faster expansion is possible “if there are reforms in the financial sector to get credit going strongly again, and labor market reforms to support greater labor force participation and employment,” Choueiri said, referring to capital and labor as “important inputs.”

The IMF this week lowered its projection to 8.2%, from 9% in January, for India’s GDP growth in the fiscal year that started April 1, flagging risks to demand from a sharp rise in commodities prices and supply chain disruptions. It sees the pace slowing to 6.9% next year.

“We had lost two years of growth” because of the pandemic, Choueiri said in a separate interview Friday with Bloomberg Television’s Kathleen Hays. “There is still catch up growth happening in India.”

While India continues to remain the world’s fastest-expanding major economy even at that pace, surging inflation could begin to drag on activity. The IMF sees consumer price increases averaging 6.1% this year, higher than the central bank’s projection of 5.7%. The Reserve Bank of India in its policy decision earlier this month signaled a pivot toward prioritizing rising costs, and away from supporting growth.

Price pressures driven by a global supply squeeze and a surge in energy costs are denting demand in India, hurting consumption that accounts for nearly 60% of India’s gross domestic product.

Inflation coming from the supply shock driven by the war in Ukraine could last for a long time, which could trigger second round effects on prices, Nada said. However, the RBI has recognized the dangers of it by adopting a less accommodative stance in the April policy, she added. Now, “the RBI will have to be really data dependent and nimble to see the impact of its announcements and communications on the market and decide if it must shift the course earlier than it plans.”

While monetary policy is the right tool to ensure the second-round effects don’t take hold in the economy, the first round from supply shocks is better dealt with fiscal policies, according to Nada.

Here’s what Nada said on other issues:

Inflation Targeting: “The flexible inflation targeting is still relatively a new framework for India and has helped India a lot by anchoring expectations.”

External Shocks: “India has very good level of foreign exchange reserves of around $600 billion, which covers about eight months of imports. This is a very comfortable war chest that can help in reacting to external shocks.”

Fiscal Deficit: “What we would like to see though is a little bit more detail, and specificity around this consolidation plan.”

Debt Sustainability: “We don’t have serious concerns about the high level of debt, but if the government can put together a clear plan and communicate it for the medium term, that would be helpful.”