IMF-External Sector Report

August 6, 2022
Posted by: OptimizeIAS Team
Category: DPN Topics

IMF-External Sector Report

Subject: Economy

Section: External Sector

Context:

The International Monetary Fund (IMF) suggested India withdraw fiscal and monetary policy stimulus gradually in its External Sector Report.

Details:

It has projected India’s current account deficit (CAD) to widen to 3.1 percent of GDP in FY23 from 1.2 percent of GDP in FY22.
- It would stabilise over the medium term.

India’s net international investment position (NIIP), has improved to –11.1 per cent of GDP from –13.5 percent of GDP at the end of 2020.
Gross foreign assets and liabilities were 30.5 percent of GDP and 41.7 percent of GDP, respectively.
- The bulk of assets were in the form of official reserves and (outward) FDI, whereas liabilities included mostly FDI and other investments.
- India’s external debt liabilities are moderate compared with peers as it is focused primarily on attracting FDI rather than the volatile FPI.
India’s official forex reserves reached a record high of about $638.5 billion at the end of 2021 given the current account surplus.
- The reserves decreased in subsequent months but remained at a comfortable level given the eight months of import coverage, 223 per cent of short-term debt (on residual maturity) and 195 per cent of the IMF’s composite metric.
Suggestions to maintain external sector balance in medium term:
- India needs to develop export infrastructure.
- Enter into free trade agreements with key trading partners to boost exports.
- Further liberalization in the investment regime.
- Reduction in tariffs, especially on intermediate goods.
- Gradual withdrawal of fiscal and monetary policy stimulus.
  - Exchange rate flexibility should act as the main shock absorber, with limited intervention to disorderly market conditions.

Concept:

Fiscal and Monetary Policy Stimulus:

In general, stimulus measures are aimed at boosting demand either by government spending on its own account or increasing disposable incomes of households through cash transfers or tax concessions.
It revives business confidence, restarts stalled projects, helps in job creation and sets off a virtuous cycle of demand and growth.
Both the Monetary and Fiscal stimulus packages are rolled out during a recession or when the production and employment levels are well below sustainable levels.
- Fiscal stimulus refers to increasing government consumption or lowering of taxes.
  - Example- during the COVID-19 pandemic, the central government announced a fiscal stimulus package of Rs. 20 Lakh crore.
- Monetary stimulus refers to lowering interest rates or other ways of increasing the amount of money or credit.

Fiscal stimulus	Monetary stimulus
Fiscal stimulus is a government-controlled measure that involves changing government spending and taxation to revive the economy	The monetary stimulus is controlled by central banks to stabilise the economic growth by changing the amount of money available and cost of borrowing i.e. the interest rate
The government used fiscal stimulus packages to influence overall supply and demand by cutting down on taxes, increasing spending and boosting economic growth	A monetary stimulus is a policy model adopted by central banks to manage the supply of money in the country. The primary tool of a monetary stimulus is reducing the interest rates
Fiscal stimulus is carried out by the government through direct spending and increase the hiring process to promote employment and growth	Monetary stimulus works in the following ways Encouraging investments by businesses through the reduction in marketing interest rates. Increasing the money supply by injecting more cash into the economy
Fiscal stimulus packages are the last resort to increase demand and economic activity during recession.	A monetary stimulus puts extra money into people’s hands during times of recession

Why does it need to be withdrawn?

As per the Tobin Funnel model, a nation-state has control over two taps; one for net government spending and another for money supply.
The water rushes through a common funnel into a tank below. The moment the tank below the funnel gets full, it overflows in the form of inflation.
The extra government borrowing creates huge public debt.
- For example, in the case of India, the bond market believes that the Centre’s borrowing program in the next fiscal year is too high. Along with this, there is inflation and RBI is the inflation manager of the economy as well as debt manager.
It puts RBI into the dilemma whether it should raise interest rates to tackle inflation or keep them low to support the government budget.
So, given the rising inflation and limits to financing the debts the stimulus should be withdrawn gradually.

The External Sector Report

It analyzes global external developments and provides multilaterally consistent assessments of external positions of the world’s largest economies, representing over 90 percent of global GDP.

The report includes:

an overview chapter that emphasizes multilateral issues;
an analytical chapter that covers topics relevant to the analysis of external sector dynamics and adjustment mechanisms; and
a final chapter that provides details of the external assessment of each of the 30 economies considered.

The External Sector Report, produced annually since 2012, is a key part of the IMF’s surveillance.