Exchange rate flexibility is a key shock absorber for India: IMF

Source: The post is based on the article “Exchange rate flexibility is a key shock absorber for India: IMF” published in “The Indian Express” on 20^th December 2023. 454285671

UPSC Syllabus Topic: GS Paper 3 – Economy – Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment

News: The International Monetary Fund (IMF) has recently reclassified India’s exchange rate regime from “floating” to “stabilized arrangement”. It was due to the rupee’s narrow trading range between 80.8 and 83.4.

The article explains different views between the IMF and Indian authorities over reclassification and provides forecast and recommendations given by the IMF for the Indian economy.

What are the different views of the IMF and the Indian authorities on India’s foreign exchange rate regime?

IMF: The IMF believes India should prioritize exchange rate flexibility to absorb external shocks. It suggests that foreign exchange interventions should be limited to situations of disorderly market conditions. It has been instrumental in India’s economic resilience, allowing for more effective management of high capital inflows and market fluctuations.

India: Indian authorities believe that India’s exchange rate stability reflects improvements in India’s external position and that interventions have been used to prevent excessive volatility.

What are some of the findings of the IMF on India’s economy?

Positive Findings

Foreign Exchange Reserves: It has reached a record high of $606.8 billion due to the capital inflows.

Financial sector: It has become stable and resilient with sustained bank credit growth, low non-performing assets, and enough capital buffers. The sector remains strong and largely unaffected by global financial stress in early 2023.

Economic Growth: India’s economy exhibited robust growth over the past year, with moderated but volatile inflation.

Employment: Employments have exceeded pre-pandemic levels, and despite the ongoing dominance of the informal sector, there has been progress in formalizing the economy.

Negative Findings

Widening Current Account Deficit: India’s current account deficit widened in FY23 due to the post-pandemic recovery in domestic demand and temporary external shocks.

High Public Debt: Although the budget deficit has improved, the public debt remains high which requires the rebuilding of fiscal buffers.

What are the recommendations given by the IMF for India?

Monitoring: IMF suggests monitoring financial stability and addressing emerging vulnerabilities, especially the increase in unsecured personal loans.

Strengthen Financial Reserves: It suggested for the enhancement of regulatory and supervisory standards and encourage public banks to strengthen financial reserves.

Structural Reforms: It also emphasized the need for comprehensive structural reforms to leverage India’s demographics for inclusive and sustainable growth.

Terms Used

Floating Exchange Rate: In a floating exchange rate regime, the value of a country’s currency is determined by market forces, i.e., supply and demand in the foreign exchange market.

Stabilized Arrangement: This suggests that the central bank has actively manage the exchange rate to maintain stability within a certain range.

Question for Practice: India is experiencing strong economic growth, despite an expanding Current Account Deficit and high public debt. Discuss the reasons behind it and also highlight the concerns in the context of the latest IMF report.