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Dilemma on timing of rate hikes: Subbarao

Dilemma on timing of rate hikes: Subbarao
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First Published: Tue, Oct 06 2009. 09 40 PM IST

Strong signals: RBI governor D. Subbarao will unveil the central bank’s next monetary policy statement on 27 October. The bank kept borrowing costs unchanged in its last review on 28 July. Indranil Bh
Strong signals: RBI governor D. Subbarao will unveil the central bank’s next monetary policy statement on 27 October. The bank kept borrowing costs unchanged in its last review on 28 July. Indranil Bh
Updated: Tue, Oct 06 2009. 09 40 PM IST
New Delhi/Mumbai: India faces a dilemma on when to raise borrowing costs to contain inflation pressures as the economic recovery remains weak, Reserve Bank of India (RBI) governor D. Subbarao said.
“While there is a broad agreement that we need to exit from the present excessively accommodative monetary and fiscal policies, there is less agreement on when and how we should exit,” Subbarao said in Istanbul on Monday. “An early exit on inflation concerns runs the risk of derailing the fragile growth, while a delayed exit may endanger inflation expectations.”
Strong signals: RBI governor D. Subbarao will unveil the central bank’s next monetary policy statement on 27 October. The bank kept borrowing costs unchanged in its last review on 28 July. Indranil Bhoumik / Mint
Consumer-price inflation in India is running above 10% and may accelerate further as the weakest monsoon rains since 1972 creates food shortages. Subbarao wants to ensure that the money pumped into the economy to protect it from the global recession, amounting to more than 12% of gross domestic product, doesn’t create excessive demand for cars, mortgages and other products and worsen inflation.
“Inflation in India remains at elevated levels, thanks to persistently high food price rises,” said Robert Prior-Wandesforde, senior Asia economist at HSBC Holdings Plc in Singapore. “Although the Reserve Bank of India has been sounding more hawkish recently, we doubt it will make a rate move this year.”
India’s 10-year bonds fell, driving up yields from the lowest level in more than a week, after Subbarao signalled he may tighten policy before advanced economies.
“We may need to exit from accommodative monetary policy earlier than advanced economies,” Subbarao said. “This calls for careful management of trade-offs: growth concerns warrant a delayed exit, but inflation concerns call for an earlier exit.”
Subbarao, who will unveil the central bank’s next monetary policy statement on 27 October, kept borrowing costs unchanged in its last review on 28 July and signalled an end to its deepest round of interest-rate cuts on concern that inflation will creep up from October.
RBI reduced interest rates six times from October 2008 to April 2009 and slashed the cash reserve ratio, injecting about Rs5.6 trillion into the economy. The key reverse repurchase rate is at a record low of 3.25%.
In July, the bank forecast India’s economy to grow about 6% in the year ending 31 March, the weakest pace since 2003. It raised its key wholesale price inflation forecast to 5% from 4% by end of the financial year. The wholesale price index rose 0.83% in the week to 19 September.
The consumer prices index for agriculture labour jumped 12.9% in August from a year earlier while the index for industrial labour advanced 11.9%, according to government data. While India uses the wholesale price inflation data as its key price measure, it also calculates consumer price indices for rural and urban workers.
Subbarao said the confidence-restoring steps taken by major central banks around the world have encouraged foreign investors to return to emerging market equities. In India, foreign institutional investors bought $13.6 billion from 1 April to 18 September, compared with outflows of $5.2 billion in the same period a year ago, reflecting a turnaround of $19 billion.
Therefore, if India raises interest rates ahead of other central banks, the differential in borrowing costs may attract more capital flows into the country, Subbarao said, questioning the impact of that on the rupee.
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First Published: Tue, Oct 06 2009. 09 40 PM IST
More Topics: D Subbarao | RBI | Bonds | Inflation | Monetary policy |