IMF pushes for a more aggressive tone from RBI

IMF pushes for a more aggressive tone from RBI

New Delhi: Pushing for more aggressive policy tightening by the central bank ahead of its policy review on 3 May, the International Monetary Fund (IMF) on Thursday cautioned that countries such as India—where the inflation rate exceeds the policy rate, so-called negative real interest rates—may be vulnerable to macroeconomic instability.

In its latest Asia-Pacific regional economic outlook, IMF said real policy rates are still negative when adjusted against inflation in several regional economies, including China, South Korea and India. “Even if signs of overheating are mixed, keeping real interest rates too low for too long could contribute to financial instability, through a deterioration of the quality of capital spending, resource misallocation, higher leverage, and asset price bubbles," it added.

IMF said several Asian economies have increased policy rates more slowly than in the past. “Policy rates in March 2011 were generally below the levels predicted by IMF staff estimated rules, particularly in India, Indonesia, Korea, and Thailand," it said.

IMF projected India’s policy (repo) rate should be closer to 8% instead of 6.75% at present, signalling that the Reserve Bank of India (RBI) is behind the curve in monetary tightening.

RBI, which has raised policy rates eight times in the last financial year, is scheduled to undertake its quarterly monetary policy review on 3 May.

However, analysts feel signs of an economic slowdown may prohibit the central bank from more aggressively tightening policy rates.

Rajeev Malik, senior economist at CLSA Singapore, said in a policy note that key issues for RBI in its upcoming annual policy will be dissecting the growth-inflation trade-off, taking a closer look at demand versus supply-driven factors affecting inflation, and deciding whether to raise policy rates by 25 or 50 basis points (bps).

“Growth is already moderating and aggressive rate hikes from here on will risk a far greater slowdown than what is needed, especially since monetary measures work with a lag and we have not seen the full impact of the tightening done so far," Malik said.

Malik added that RBI had stayed away from a one-step 50 bps hike in the current tightening cycle, and it is not necessary to alter that approach, especially since it meets every six weeks.

However, inflation has surprised on the upside and there is a valid case for a 50 bps increase, Samiran Chakraborty, Standard Chartered Bank chief economist, said in a report.

“We believe that growth concerns are likely to keep the central bank in gradual tightening mode," he said.

IMF said that due to the base effect and policy tightening, India’s growth may slow from 10.5% in 2010 to a more sustainable 8.25% in 2011 and 7.75% in 2012. IMF releases economic growth data at market price, while India measures growth in terms of factor cost.

IMF staff estimate that a further 40% increase in oil prices in 2011 relative to baseline forecasts in the April 2011 World Economic Outlook (to $150 per barrel) would shave between 0.5 and 0.75 percentage points off annual 2011 gross domestic product growth in China and Japan, while it would have a smaller negative impact up to 0.25 percentage points in India and Indonesia.

Following the higher-than-expected headline inflation rate of 9% in March as against RBI’s projection of 8%, Malik raised his annual average inflation forecast for 2011-12 to 8.3% from 7.4%. Chakraborty expects headline inflation to average 8.4% during the current financial year.