Recently published External Sector Report 2022 by IMF has said that the RBI’s intervention in the currency market should be limited to addressing disorderly market conditions. Produced annually since 2012, External Sector Report analyses global external developments and provides multilaterally consistent assessments of external positions of the world’s largest economies.
Key highlights of the ‘External Sector Report’ –
- The pandemic has continued to have an uneven impact on economies’ current account balances, owing to a shift in consumption from services to goods.
- Commodity prices recovered from the COVID-19 shock and began rising in 2021.
- The medium-term outlook for global current account balances is gradually improving as the pandemic’s impact fades, commodity prices normalise and fiscal consolidation in current account deficit economies continues.
India specific observations –
- The report comes at a time when the Indian rupee and several other emerging market currencies are under pressure.
- The RBI has reduced its forex reserves to prevent a sharp depreciation in the face of repeated rate hikes in developed countries (particularly the United States) and the uncertainty caused by geopolitical tensions.
- As per the report —
- The RBI’s intervention in the currency market should be limited to addressing disorderly market conditions and exchange rate flexibility should act as the main shock absorber.
- India’s official forex reserves are sufficient for precautionary purposes, implying that additional reserves are less warranted.
- According to the IMF, rising commodity prices and the Ukraine conflict will increase India’s current account deficit (CAD) to 3.1% of GDP in 2022, up from 1.2% last year.
- The IMF also stated that the CAD is broadly consistent with India’s per capita income, positive growth prospects, demographic trends and development needs.
- In comparison to peers, India’s low level of foreign liabilities reflects an incremental approach to capital account liberalisation that has primarily focused on attracting Foreign Direct Investment (FDI).
- Policy prescriptions —
- The report proposed a gradual withdrawal of fiscal and monetary policy stimulus, which has already begun and is boosting exports.
- It suggested that the government should negotiate free trade agreements with major trading partners in order to increase exports, liberalise the investment regime and reduce import duties.
- Structural reforms could increase integration in global value chains and attract FDI, reducing external vulnerabilities.
About the ‘International Monetary Fund’ –
- The IMF is an international financial institution (headquartered in Washington D.C., US).
- It works to achieve sustainable growth and prosperity for all of its 190 member countries. It is governed by and accountable to its member countries.
- Formed in 1944 at the Bretton Woods Conference, IMF came into formal existence in 1945 with the goal of reconstructing the international monetary system.
- The IMF has three critical missions —
- Furthering international monetary cooperation,
- Encouraging the expansion of trade and economic growth,
- Discouraging policies that would harm prosperity.
- To fulfil these missions,
- The IMF member countries work collaboratively with each other and with other international bodies.
- The IMF supports economic policies that promote financial stability and monetary cooperation, which are essential to increase productivity, job creation and economic well-being.
- It now plays a central role in the management of balance of payments difficulties (experienced by a member country) and international financial crises.
- Member countries contribute funds to a pool through a quota system from which countries experiencing balance of payments problems can borrow money.