India’s monetary tightening should continue

India’s monetary tightening should continue

New Delhi: The Reserve Bank of India (RBI) should continue monetary tightening measures as inflation and inflationary expectations remain high, the International Monetary Fund (IMF) said ahead of the mid-year monetary policy review by the Indian central bank.

In August, headline inflation based on the Wholesale Price Index (WPI) rose to 9.78% from 9.22% a month earlier.

Inflation is expected to moderate later this fiscal year on the back of a good monsoon. Many businessmen have urged the central bank not to raise policy rates further as it may slow economic growth.

But IMF does not agree.

“Against the backdrop of unusual uncertainty, a key policy issue is whether this warrants a pause in the pace of monetary tightening in many economies," IMF said in its regional economic outlook report for Asia and Pacific, released on Thursday. “In economies where such overheating pressures remain high, inflation remains above target, and inflation expectations have continued to rise, such as in China, India, and (South) Korea, the current pace of monetary tightening remains appropriate."

The report said India’s core inflation has increased as commodity price rise pressures become more generalised.

“Inflation has been driven by commodity prices, but also in many economies by sustained demand pressures. Indeed, core inflation has increased in Hong Kong, India, Indonesia, Korea, Malaysia, and Thailand, as second-round effects of previous commodity price rises have fed through to generalized inflationary pressures," it said.

IMF, however, added that in economies where inflation is within target and face greater vulnerability to a global slowdown, a pause in monetary tightening may be warranted until the risks to growth abate.

Though economists see RBI nearing the end of its tightening cycle, they say a rate increase is imminent in the mid-year review of monetary policy, scheduled on 25 October. The government will release the WPI inflation numbers for September on 14 October.

With factory output growing at a slower pace than expected in August, RBI will also have to address concerns about weakening growth. India’s index of industrial production was at 4.1% in August, the second lowest in 17 months.

RBI has maintained a premature change in its anti-inflationary stance could harden inflationary expectations, diluting the impact of its past policy actions. In its mid-quarter review last month, it said its stance going forward will depend on “signs of downward movement in the inflation trajectory".

RBI revised the baseline projection for WPI inflation for March 2012 upward to 7% in July from 6%.

The central bank is likely to continue with monetary tightening in the upcoming policy, said Samiran Chakraborty, head of India research at Standard Chartered Bank.

“The RBI’s focus is still on inflation management as it’s of the view that only lower inflation can generate sustainable growth. It has accepted that near-term growth may have to be sacrificed," he said. “Once inflation numbers start declining, RBI’s focus will shift first to maintaining the balance between growth and inflation and then to supporting growth."

The IMF report said sluggish demand in advanced economies will adversely impact the growth prospects of Asian economies. “The impact would be smaller for domestic-demand based economies, such as China, India, and Indonesia. Private consumption remained robust in India on account of rising disposable income."

In its world economic outlook report released last month, IMF had forecast India’s growth to average 7.5-7.75% during 2011–12. “Investment is expected to remain sluggish, reflecting, in part, recent corporate sector governance issues, drag from the renewed global uncertainty and less favourable external financing environment," it said.