India’s economy may slow more than expected if inflation remains above the central bank’s target, the Organization for Economic Co-operation and Development (OECD) said.
Inflation in the world’s second-fastest growing major economy has exceeded the Reserve Bank of India’s (RBI’s) “tolerance” level of 5% since September, even after it raised its key interest rate to a five-year high and the government cut import taxes on cement, wheat and other products to cap price gains.
“The longer the more publicized measures of inflation continue to be above the government’s target, the more likely it is that inflation expectations will increase, making the eventual slowdown in the economy even greater,” the OECD said in its semi-annual Economic Outlook released in Paris on Thursday.
RBI’s rate increases haven’t damped the enthusiasm of consumers, who last year received the biggest wage rises in Asia.
India’s 300 million middle-class population are taking loans to buy motorbikes, cars and homes, powering the $854 billion (Rs35 trillion) economy and stoking inflation. Loans growth has averaged about 30% a year since 2004.
Prime Minister Manmohan Singh on Tuesday had said his administration will remain “vigilant” on inflation to ensure the poor are not affected by high prices.
Finance minister P. Chidambaram recently said the government’s goal is to contain inflation at between four and 4.5%.
Inflation is likely to ease as food prices stabilize, OECD said. It said “rapid increases” in food and commodity costs had distorted some indices. The benchmark wholesale price inflation slowed to 5.44% in the week ended 5 May after reaching a two-year high of 6.69% in January.
RBI governor Yaga Venugopal Reddy left the benchmark overnight lending rate unchanged at 7.75% last month to support growth, relying on the lagged impact of past increases to rein in price gains. RBI raised rates nine times since October 2004 to damp consumer demand for manufactured goods.
The central bank may be approaching the end of its policy of raising rates, nine of 11 analysts in a Bloomberg survey said last month.
Still, the higher borrowing costs will slow the growth momentum this year and in 2008, the OECD said. The economy expanded a record 9.2% in the fiscal period ended 31 March, according to government estimates.
Growth will ease to 8.5% in 2007, OECD said, a prediction similar to the central bank’s forecast. The rate willdecelerate to 8% in 2008, the report said.
“The rate of investment growth seems likely to slacken given interest rate increases,” the OECD said. “Export growth may also slacken, especially in the goods sector.”
Moody’s Investors Service last month said the economy was showing “classic signs of overheating” including higherthan-acceptable inflation and rapid rupee appreciation driven mainly by strong capital flows.