India’s external indicators consistent with fundamentals, says IMF

30th july 2018

The International Monetary Fund said India’s external indicators are consistent with its macro economic fundamentals, but risks could emerge due to volatile global financial conditions, higher oil prices and a retreat in cross-border integration.

The Indian rupee has depreciated 7 percent so far this year—the most in Asia—on concerns that external risks are building. A rising current account deficit and slowing portfolio flows have been seen as key concerns.

The IMF, in a report on external sector assessment of global economies released on Tuesday, said that a current account deficit of about 2.5 percent of the GDP is broadly consistent with India’s fundamentals. A gap of closer to 3 percent, however, would be tough to finance, it said.

“India’s low per-capita income, favourable growth prospects, demographic trends and development needs justify running a current account deficit. External vulnerabilities remain, although they have been reduced since 2013,” said the IMF.

For the current year, economists expect India’s current account gap to be close to 2.5 percent of the GDP compared with 1.9 percent in 2017-18. Over the medium term, India’s current account deficit is seen at 2.5 percent of the GDP due to strengthening domestic demand, said the IMF.

Is The Rupee Overvalued?

Relatively low oil prices and strong portfolio flows led to an appreciation in India’s real effective exchange rate in the last couple of years. Many believe that this led to an overvaluation of the Indian currency, leading to a drop in export competitiveness.

The IMF, however, suggested that based on the current account gap, India’s real effective exchange rate is broadly “in line with fundamentals”.

Data in the IMF report, however, showed that India has seen greater real appreciation in the 2013-17 period. “India’s low per-capita income, favourable growth prospects, demographic trends and development needs justify running a current account deficit. External vulnerabilities remain, although they have been reduced since 2013,” it said.

Adequacy Of Reserves

The IMF sees India’s forex reserves as being adequate. At current levels, reserves can cover about seven-and-a-half-months of expected imports. Relative to short-term debt, reserves are at about 190 percent.

“Reserve levels are adequate for precautionary purposes…,” said the IMF. At last count, India’s forex reserves stood at $405 billion.

Unlike the U.S. Treasury Department, the IMF was not critical of India’s intervention in the foreign exchange markets. However, it said that exchange-rate flexibility should be used as a “shock absorber” and intervention should be limited to addressing “disorderly market conditions.”

Source: BLOOMBERG QUINT