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Strong policy tightening needed, says C Rangarajan

Strong policy tightening needed, says C Rangarajan
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First Published: Fri, Jul 23 2010. 02 48 PM IST
Updated: Fri, Jul 23 2010. 02 48 PM IST
New Delhi: Prime Minister’s Economic Advisory Council chairman C Rangarajan on Friday called for strong monetary policy action to combat high inflation, days before the Reserve Bank of India (RBI) is set to raise rates for the fourth time this year.
Rangarajan said headline inflation would ease to 7% or 8% by December from 10.55% in June.
Still, the projection is above earlier official forecasts of 5% to 6%, striking a more hawkish tone than that suggested by other government officials in recent weeks.
“There must be a bias towards tightening because the demand situation also needs some control,” said Rangarajan, a former RBI governor.
Rangarajan’s remarks came a day after finance secretary Ashok Chawla, the top bureaucrat at the ministry, warned against aggressive tightening that could pose a risk to growth in Asia’s third-largest economy.
“Strong monetary policy action is required,” Rangarajan said when asked if he would be happy if the central bank raised both its policy rates by 25 basis points (bps) on Tuesday.
The economic adviser said he expected the central bank to carry out a series of small policy tightening steps. Rangarajan said inflation was being driven by high food prices, which is usually considered beyond the scope of monetary policy.
“I don’t think the economy is overheating. One of the symptoms of overheating is inflation. This inflation particularly is due to what has happened to the food prices, therefore this is not overheating,” Rangarajan said.
India’s one-year overnight indexed swap rate rose 2 basis points to 5.87%. The benchmark 10-year bond yield rose 1 basis point to 7.67% after Rangarajan called for “strong” action.
“The market is probably ignoring the comments - basically traders are lightly positioned,” said RK Gurumurthy, head of treasury at ING Vysya Bank. “Economic adviser is perceived as a hawk so it is not unusual if market hears hawkish statements.”
‘Calibrated’ exit
The RBI has already raised interest rates three times this year as the economy emerged from the global downturn and inflation picked up.
Wholesale price index (WPI), India’s most closely watched inflation measure, have risen more than 10% from a year earlier for the past five months.
In response, the central bank is widely expected to raise both its repo and reverse repo rates on Tuesday by 25 basis points, taking them to 5.75% and 4.25%, respectively.
The central bank has repeatedly said it favours a “calibrated” exit to loose monetary policy, which economists take to mean 25 basis point interest rate increases at each of the next quarterly policy reviews for the rest of the fiscal year.
That outlook is clouded by a weak global economic recovery and tight liquidity conditions on one hand, and persistently high inflation on the other.
“Liquidity conditions are taut enough for monetary policy signals to be appropriately transmitted to the financial sector. A bias towards tightening is necessary,” a report released by the advisory panel said.
Tight liquidity in the banking system has acted as an effective 150 basis point increase in rates.
“Overall, it looks like he favours monetary tightening in small phases,” said Sreenivasa Raghavan, treasury head at IDBI Gilts in Mumbai.
The panel said wholesale inflation should ease to 6.5% by the end of the fiscal year in March 2011.
It forecast GDP growth in the current fiscal of 8.5%, in line with government forecasts.
The report also said capital inflows will ensure that the current account deficit, which swelled to a three-decade high of $13 billion in January to March, can be managed.
The panel expects the current account deficit to be 2.7% of GDP this fiscal year.
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First Published: Fri, Jul 23 2010. 02 48 PM IST
More Topics: RBI | Inflation | WPI | Economy | Growth |