India Can Lock in Good Fortune with Private Investment, Structural Reforms

Favorable outlook; growth projected at 7.5 percent this fiscal year

Goods and service tax a priority

Further reform of energy sector and labor markets would boost growth potential

“The collapse in global oil prices is a large windfall gain for India,” said Paul Cashin, head of the IMF team for India. “The windfall has made room for more spending on goods and services, helped improve the external and fiscal positions, and allowed a sharp decline in inflation.”

India’s growth recovery also reflects improved economic management, the IMF said in its annual assessment of the economy. The government has taken policy measures to help reduce fuel and fertilizer subsidies, continue with fiscal consolidation, bolster the financial system, and strengthen the business climate, all of which have helped enhance confidence in the economy.

As a result, India’s growth outlook is favorable, with GDP growth projected to strengthen from 7.3 percent in this fiscal year to 7.5 percent in the upcoming fiscal year (see Chart 1).

Even so, the economic recovery has been uneven. The pick-up in the investment cycle is yet to gain strength, the banking system is weighed down by bad loans, and the weaker global economy has hit India’s exports.

There are also external risks. A further deterioration of the global growth outlook could weigh on the country’s growth prospects. In addition, “spillovers from global financial market volatility could be disruptive, including from unexpected developments in the course of U.S. monetary policy normalization or China’s growth slowdown,” said Cashin.

Reviving investment and broadening growth

As private investment continues to show only a few signs of revival, the challenge for India is to sustain its growth momentum. An increase in public infrastructure investment and government initiatives to unclog stalled investment projects are helping bolster investor sentiment and having a positive impact on private investment (see Chart 2).

“Nonetheless, project implementation and supply-side challenges have been a drag on corporate investment for several years and they have chipped away at the financial strength of core industrial sectors, so the investment recovery is likely to be sluggish,” Cashin observed. Weakened bank asset quality and profitability means that banks are also becoming more cautious in their lending, which could hobble economic growth, he added, welcoming the Reserve Bank of India’s recent steps toward more stringent...