Mumbai: An adjustment in policy interest rates is not warranted for now but liquidity tightening may be needed, the Prime Minister’s economic adviser said ahead of a Reserve Bank of India (RBI) policy meeting later this month.
The adviser, C. Rangarajan, does not have a direct role in setting monetary policy, but he was the second government official in as many days to play down the need for an increase in policy rates as inflation rises.
The RBI is scheduled to hold its quarterly monetary policy review on 29 January and is widely expected to tighten the cash reserve ratio (CRR) requirements for banks, but economists are divided on when it will raise interest rates.
“I do not think any change in policy rates is required at the moment but some reduction in liquidity may bring about some moderation in price expectations,” Rangarajan told news channel CNBC-TV18 on Tuesday.
“We should watch how 2010 proceeds, but if there is a moderation in the inflation rate, there would be no need to raise the policy rates,” said Rangarajan, who is a former RBI governor.
Bond yields edged down 2 basis points after his comments. The most-traded 6.35% bond maturing in 2020 was at 7.59%, from 7.61% before the comments. It had closed on Monday at 7.63%.
Shyamala Gopinath, one of the four RBI deputy governors, said last week that monetary policy focus was shifting to managing the recovery and containing inflation from fostering growth after the global downturn.
Her comments had pushed up investor expectations for a rise in interest rates in January or soon thereafter. India and South Korea are expected to be among the first Group of 20 nations to follow Australia and raise rates.
Some economists also said it is too soon to raise rates.
“I don’t think tightening of rates is warranted, we have been saying all along that CRR hike ought to precede any rate tightening. While credit pick up has been seen in recent fortnights, the current liquidity overhang has room for some correction,” said Shubhada Rao, chief economist at Yes Bank.
“Too much liquidity in the system than required distorts pricing in financial markets to some extent,” she added.
Kaushik Basu, chief economic adviser to the finance ministry, also said on Monday that no monetary policy tightening measures are expected now.
Inflation is being driven by high food prices that are the result of supply-side constraints and largely beyond the scope of monetary policy.
Indian food price inflation returned to near 20% in mid-December, with prices surging following the weakest monsoon in 37 years and as floods in some parts of the country hit crops.
Rangarajan said the inflation rate could rise above 6% by the end of the fiscal year in March. The central bank’s inflation projection stands at 6.5% with an upward bias for end-March, while some private economists expect it to reach about 8%.
Some policymakers have said recently that food prices may drop in coming months and ease the pressure on the central bank to hike rates.
“With rabi (winter-sown) crop into the market, pressures will ease from items like cereals and pulses. We are already seeing an easing of prices in perishables. Of course we need to monitor the demand side of inflation now. It is not yet very evident, but is seen picking up gradually,” Yes Bank’s Rao said.
In the runup to the RBI’s last quarterly policy review in late October, top officials in Prime Minister Manmohan Singh’s government made frequent statements urging the central bank not to raise rates.
At that policy meeting, the RBI began unwinding emergency liquidity measures but did not raise rates.