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Monetary policy needs tightening

Monetary policy needs tightening
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First Published: Fri, Jul 23 2010. 11 34 PM IST

Graphic: Ahmed Raza Khan / Mint
Graphic: Ahmed Raza Khan / Mint
Updated: Fri, Jul 23 2010. 11 34 PM IST
Inflation is the most serious short-term threat to high growth and monetary policy has to be tightened further to deal with it, the Prime Minister’s economic advisory council (EAC) said on Friday.
“We cannot have a sustainable growth rate of high level unless inflation is contained,” EAC chairman C. Rangarajan said at a press conference to announce the current fiscal’s economic outlook. “Inflation is almost twice our comfort level.”
Graphic: Ahmed Raza Khan / Mint
“Monetary policy has to operate with a bias towards tightening. This is essential to promote conditions for sustainable growth in the medium term,” the EAC report concluded, before the central bank announces its quarterly monetary policy on 27 July.
The body of independent economists, each serving a three-year term and constituted to provide the Prime Minister with a second opinion on the economy, has projected a wholesale price inflation rate of 6.5% at the end of the current fiscal.
This projection is higher than the 5.5% estimated by the Reserve Bank of India (RBI) in April and finance minister Pranab Mukherjee’s estimate of 5-6% earlier in the week.
According to EAC, the food inflation of last year has pushed up inflationary expectations. This, in turn, has translated into higher wages and is the main driver of the current round of inflation in manufactured products.
“A major contributing factor, and perhaps the most important one, is the increase in money wages that is a direct consequence of higher food prices reflected in high double-digit consumer price inflation,” said the advisory body’s report on inflation in manufactured goods.
EAC supplemented its call for a tightening bias in monetary policy with a recommendation that the Union government should continue to move out of an expansionary fiscal policy and keep trimming its fiscal and revenue deficits. The government should work on rationalizing its food and fertilizer subsidy, the EAC report said.
Inflation, as measured by the Wholesale Price Index, in June was 10.6%. Inflation in non-food manufactured items in June had increased to 7.3%, from 0.8% recorded in December 2009.
Recent research reports by private sector economists have said RBI is likely to increase interest rates in its 27 July policy announcement. On Friday, Sonal Varma and Ketaki Sharma of Nomura Financial Advisory and Securities (India) Pvt. Ltd, in a report, said RBI is likely to increase policy rates by 25 basis points
One basis point is one-hundredth of a percentage point.
EAC had identified inflation as short-term threat to growth, and low productivity in agriculture and infrastructure deficit as medium-term threats.
The nature of the current spell of inflation has made some economists anxious. “If inflation is only a cyclical issue, then I would not put it as a priority item,” said Samiran Chakraborty, regional head of research (India) at Standard Chartered Bank Plc. “If inflation is a more structural problem, then we need to address it urgently.”
Other than its forecast on inflation, EAC also presented its macroeconomic perspective. The council forecast economic growth to be 8.5% in the current fiscal and 9% in the subsequent fiscal, and said robust domestic saving and investment rates would be the growth engines. The council’s growth forecast for the current fiscal is in line with that of the government.
EAC was concerned about the level of the country’s current account deficit, but emphasized capital inflows were more than enough to cover the gap.
According to Rangarajan, given the council’s estimates on the level of inflows, exchange rate movements would be within acceptable range.
EAC forecast current account deficit for the ongoing fiscal would be 2.7% of gross domestic product and would increase to 2.9% next fiscal.
sanjiv.s@livemint.com
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First Published: Fri, Jul 23 2010. 11 34 PM IST