INDIA IN ASIA

by Anoop Singh

Asia continues to lead the global recovery and India, the second fastest growing major economy in the world, has remained in the vanguard. In the International Monetary Fund’s recently released Asia-Pacific Regional Economic Outlook, we predict that, on average, Asia will grow by 8% in 2010. While economic activity in the region has moderated towards a more sustainable pace in recent months, it remains robust. We are, therefore, projecting Asia as a whole to grow by 7% next year, compared with global growth of about 4%.

During the calendar year 2011, we project that India will remain above the regional average, growing by 8.5% (gross domestic product, or GDP, at market prices), which translates to about 8% at factor costs (the headline measure in India) for the Indian 2011-12 fiscal year.

Notwithstanding India’s higher growth rate, it has several similarities with others in the region. The strength of private domestic demand has been a key part of the story this year all over Asia, including India. Spending on consumer durables has been robust here, while investment has also been buoyant, with infrastructure investment playing a particularly important role in the past year. Impressive export growth and strong, but somewhat volatile, capital inflows have been other common themes that India has shared with the other countries in the region. And, although the recovery started earlier in India, the growth cycles have been broadly synchronous since then: Forward-looking indicators such as purchasing manager surveys suggest that growth in India likely peaked recently, as it did in the rest of the region.

Common economic positions imply some common risks. A deterioration of the external environment represents the most significant risk to the region. A weaker-than-expected recovery of final demand and an exacerbation in sovereign and banking vulnerabilities in advanced economies would adversely affect Asia, including India, through the real, financial, and confidence channels. It is important to note that while India’s gross exposure to external demand is less than that in many other Asian countries, its integration with the global economy has been especially rapid in recent years, raising external risks in proportion.

The main short-term policy challenge for Asian policymakers is to manage the exit from policy stimulus now that a recovery is under way across the region.Closing output gaps—actual growth is fast nearing or, in some instances, exceeding the economy’s potential growth—and emerging pressures in both goods and asset prices suggest that the time has come to normalize fiscal and monetary policy stances in most of Asia (outside of Japan). Monetary policy stances, however, still remain generally accommodative, although several countries have started taking steps to normalize them. And, normalizing the fiscal stance now would allow governments to create policy space to cope with adverse shocks in future.

On this front, India has started ahead of the rest of Asia. Reflecting its earlier recovery from the crisis, India began the exit—in particular on the monetary front—before other countries. Inflation has posed a particular challenge for India, where it picked up earlier and has been significantly higher. Our analysis suggests that both supply and demand conditions have affected inflation in India. In particular, food prices tend to transmit to generalized inflation in developing countries such as India faster than in more advanced economies.

Further, our analysis also suggests that the closing output gap has adversely affected core inflation— minus food and fuel—in India. With inflation inertia also especially high in India, it was appropriate for the Reserve Bank of India to start tightening early and in a consistent but gradual fashion.

Somewhat higher inflation is not the only feature that sets India apart from many other Asian countries. India also has twin deficits—one on the external current account and the second, a fiscal one. The external deficit (which measures India’s excess of investment over savings) has widened mainly because of increases in investment, especially in much-needed infrastructure. A large share of the deficit remains financed through equity capital inflows. This, however, underscores the importance of proceeding apace with financial sector reforms to create deep and resilient domestic capital markets and to help direct capital inflows to their most productive uses: India’s increase in the foreign investment limits in long-term local bonds last month is an example of such measures.

In addition, India’s exchange rate has become increasingly flexible, which provides an adjustment mechanism to the current account deficit and to manage capital flows. As for the stance, the multi-year commitments spelt out in the 2010 Budget to reduce the deficit—by trimming subsidies, for instance—are key to ensuring the continuation of high levels of investor confidence.

It’s clear not just that Asia is well placed to continue to lead global growth but also that India will remain among the leaders in Asia. Despite some of the differences and unique macroeconomic challenges India faces, it shares with Asia the common theme of continued economic integration with the rest of the world—something that brings both sizeable benefits and some risks. That’s why prudent monetary and fiscal policies, combined with structural reforms, remain key.

Anoop Singh is director of the International Monetary Fund’s Asia and Pacific department.