India's large fiscal imbalances, exceeding 10 per cent of the gross domestic product and the public debt representing almost four and a half years of revenue, are 'reasons to worry' though its credit rating is better than that of many emerging markets, according to an International Monetary Fund working paper.
"India's fiscal problem has deep roots in its federal fiscal system, where multiple players find it difficult to coordinate adjustment," the paper, prepared by Ricardo Hausmann, Professor of Economic Development at Harvard University and Catriona Purfield of IMF's Asia and Pacific Department, said.
"The size and closed nature of the economy, aided by its deep domestic capital market and large captive pool of domestic savings, has disguised the cost of fiscal laxity and complicated the building of a consensus on reform," it said.
The IMF has put the working paper on its Web site with a disclaimer that the views expressed are the authors' and do not necessarily represent those of the IMF or IMF policy.
"India is in an enviable position. Growth is high, the external position is strong, and inflation and nominal interest rates are low. Yet there is a nagging concern about India's large fiscal imbalances," the IMF paper said.
The new Fiscal Responsibility and Budget Management Law (FRBM) establishes a new rules-based system to overcome this coordination failure, Hausmann and Purfield said.
"India is a case in point. A central Fiscal Responsibility and Budget Management Law has been approved and some states are following suit. But in India, the job of convincing the politicians and society, that adjustment is necessary, is made more difficult by the apparent absence of any symptoms of fiscal illness," the IMF working paper said.
On the one hand, the debt burden is comparable only to those witnessed in crisis countries such as Turkey and Argentina. But markets are giving no indication that they find it excessive: nominal interest rates are low and declining; international capital inflows are large; and banks have ample liquidity. Usually, it is politically easier to resolve a crisis, once it happens, than to prevent one.
The authors questioned whether India would be able to garner enough political agreement so that it could use the current good times to correct its fiscal imbalances.
"The lack of symptoms is a double-edged sword. However, it makes crisis less likely for any level of debt, but society is less responsive to fiscal imbalances, thus making the eventual problem much larger," they said.
India's track record suggests that budget estimates have not been unbiased. Over the past ten years, the actual central government deficit overshot its budget target by 0.8 per cent with nominal overruns in eight years.
By international standards, India is one of the most decentralised countries. States' revenue raising powers, however, do not match their expenditure responsibilities.
Current trends suggest that India is on an unsustainable path and will eventually have to adjust, one way or the other, with or without a crisis, the IMF paper said.