In its report, the IMF cited red tape, weakening business sentiment, a rising current account deficit and the rupee’s depreciation for the cuts in forecasts. And unlike the rest of Asia, where inflation is expected to fall, the multilateral lender said price pressures in India were elevated.
Ironically enough, the downgrade comes a day after Finance Minister P. Chidambaram asked the country to believe in the India growth story, adding that the country had a “good story to tell” the global economy. At the Economic Editors’ Conference yesterday, Mr Chidambaram said the government would outline a fiscal consolidation path soon.
IMF’s cut follows a raft of reforms announced by the government over September and October. The government braved the wrath of its coalition members and allowed foreign direct investment (FDI) in multi-brand retail and pension, and eased FDI norms in aviation and insurance. The government is also working on containing the rising fiscal deficit in the hope of thwarting a downgrade by rating agencies.
However, on a positive note, the IMF also said the new raft of reforms should help the growth rate bounce back in 2013, albeit a long way short of government expectations. Growth weakened more than expected in the first half of 2012, it noted, adding that the current drags on business sentiment and investment will persist going forward.
The reform measures have sent the stock markets to a 15-month high, and the rupee has gained 5 per cent over the last month.
Adi Godrej, chairman of Godrej Industries, said he does not agree with the IMF esitmates since some projections were done before reforms were launched.
India is no stranger to downgrades, having suffered a spate of negative revisions from international investment banks and rating agencies recently. Last week, the Asian Development Bank said India's growth will slow to 5.6 per cent in 2012, down from 6.5 per cent in 2011. Earlier, Fitch Ratings had cut its 2012 growth forecast for India to 6 per cent from 6.5 per cent. The rating agency said reforms announced in September, including liberalisation of FDI in multi-brand retail, may help restore confidence and lift investment, but the volatile political environment points to implementation risk.
The Indian economy grew 5.3 per cent in the quarter to March and 5.5 per cent in the April-June quarter.
Already, the government has said inflation will stay sticky and food prices high through fiscal year 2013. The headline inflation has stayed stubbornly high, much above the central bank’s stated 5 per cent comfort level. This is a major deterrent for the Reserve Bank of India (RBI) easing its monetary policy to cut key lending rates to boost credit growth in the economy. The central bank left interest rates on hold in September after inflation rose to 7.55 per cent in August.
"Monetary policy should stay on hold until a sustained decrease in inflation materialises," the IMF said.
RBI governor D. Subbarao last Thursday said inflation had to be brought down further, signalling the regulator would stick to its hawkish stance, and the size of the fiscal deficit would be a key factor in determining monetary policy.
The RBI has kept its key policy rate, the repo rate, unchanged since April because of inflationary pressure and widening fiscal and current account deficits.
Many economists expect the rate to remain unchanged at the October 30 policy review.
WILL FOREIGN INSTITUTIONAL INVESTMENT FALL?
The biggest casualty of the most recent downgrade may just be foreign institutional investment (FII) in Indian equities. Over the past few months, FIIs were slowly regaining confidence in India. Overseas investors poured in more than Rs 3,300 crore in the country's stock market last week as the government continued with its reforms.
During October 1-5, FIIs were gross buyers of shares worth Rs 13,094 crore, while they sold equities amounting to Rs 9,714 crore, translating into net inflow of Rs 3,381 crore ($645 million), according to the data available with market regulator Sebi (Securities and Exchange Board of India).
With the most recent steep cut, foreign investors could turn jittery again.
China's economic growth is expected to weaken to 7.8 per cent this year, according to the IMF, which warned of risks to emerging Asia if the euro zone crisis worsens and the United States does not avoid its "fiscal cliff".
Expectations for a twin slowdown in India as well as its rival China has led the IMF to shave its growth projections for developing Asia to 6.7 per cent from 7.1 per cent in July. The growth forecast for next year was trimmed to 7.2 per cent from 7.5 per cent.
Softening growth aside, the IMF also urged Asian countries to guard against domestic imbalances that stifle local consumption and obstruct a rebalancing of the global economy.
It cited five countries—China, South Korea, Malaysia, Singapore and Thailand—as being guilty of running stronger trade surpluses and weaker currencies than desirable.
With inputs from agencies