Mains Paper: 2 | International Institution
Prelims level: International Monetary fund
Mains level: The lessons from the IMF’s annual assessments over the years are that optimism needs to be taken with a pinch of salt while risks must be heeded.
• The IMF calls for greater competition in the banking sector.
• The International Monetary Fund (IMF) released its annual assessment of the Indian economy as per Article IV of the Articles of Agreement with member countries.
• Along with that report, it released the companion volume, “Selected Issues” that delves deeper into, well, selected issues.
• The government was pleased with the report. The “elephant” metaphor has been unleashed again.
• It is not just lumbering but may even be picking up the pace.
• The economy, in real terms, is projected to grow at 7.3% in the current financial year ending March 2019, and, in the next financial year, it will grow at 7.5%.
• So far, so good. The interesting stuff is always in the details.
What about IMF predictions on India’s Growth?
• In 2007, when optimism about the Indian economy was rife—the elephant had actually morphed into a cheetah, according to some—India’s potential growth was estimated at 8%.
• Take a look at the Article IV assessments for the years 2007 (February 2008) and 2008 (June 2009) to notice the drastic change in tone.
• From one of backslapping all around in 2007, it had turned into virtual panic in 2008.
• In 2007, the IMF had attributed the dream run of strong growth and macroeconomic stability to sound policies and past structural reforms.
• That the tributes were ill-founded was exposed by the fact that by 2012, the IMF had reduced its estimate of India’s potential growth to 6.5%.
• Now, in the report for 2018, the IMF upgraded its estimate of India’s potential growth to 7.3%, with the possibility that it can rise to 7.75%.
• For all the missed opportunities, this government has improved India’s economic growth potential. That must count as an important achievement.
• Even after the crisis of 2008 ended and India’s growth rate rebounded, as late as 2012, the IMF had maintained that India’s potential growth estimate was 8-9%.
• Notwithstanding fancy econometrics, such estimation methods are backwards looking and probably attach a higher weight to recent growth performance.
• In this context, it is worth noting that the risks to the economic growth forecasts for 2018-19 and 2019-20 are entirely on the downside, and that is fair.
• The monsoon may have recovered but the global asset market and economic growth risks are rising by the day, not to mention the risks of geopolitical conflicts.
• India’s savings rate has to increase and the IMF’s projections for India’s savings rates in the years to come do not bode well.
• Improving the savings rate is an endogenous problem and the chain of answers to the problem of low savings is long and extends well beyond economics.
• On other fronts, the good news is that of the estimated recapitalization needs of the banking sector at 1.3% of gross domestic product (GDP), only 0.6% was raised in 2017-18.
• The government has claimed that recovery rates from the steel sector will be higher than provisions and, hence, positive.
What IMF concern for greater competition in the banking sector?
• Competition in the financial sector does not enhance financial system stability. It can actually undermine it.
• It sets off competition for asset growth and risk considerations fail to figure prominently in the hot pursuit of asset growth.
• Throw in executive compensation plans that are tied to short-term top- and bottom-line performance, and the recipe for future banking crises is ready.
• The current crisis is still festering and the public mood is receptive to a comprehensive relook at the banking sector.
• The government should seize the opportunity, formulate plans for restructuring the sector, put them up for discussion and be ready to implement them after the election in 2019.
• In the meantime, making banking supervision ownership-neutral should be possible through executive orders.
• The IMF’s recommendation for more market discipline on state government finances, by removing the implicit federal guarantee, if necessary, evokes a smile.
• Even as debt and leverage ratios mount, the required rates of return have declined. So much for market discipline.
• In sum, the lessons from the IMF’s annual assessments over the years are that optimism needs to be taken with a pinch of salt while risks must be heeded.
• That is asymmetry for you. Second, policy recommendations that appear to stem from ideological considerations must be regarded sceptically.