INTERVIEW: India RBI: May Exit Stimulus Sooner Than Others
By Natasha Brereton Of DOW JONES NEWSWIRES
BASEL, Switzerland (Dow Jones)--The Reserve Bank of India may have to reverse its easy monetary policy sooner than most other countries as inflationary pressures are mounting quickly, the head of the central bank said.
"Inflation has come upon us sooner than we had expected," Reserve Bank of India Gov. Duvvuri Subbarao told Dow Jones Newswires in an interview late Monday. "The debate about exit policies all around the world is a debate in India too. But the contours of the debate are different, because we may have to decide on this sooner than most other countries."
India's strong fundamentals, which helped drive its strong growth before the global financial crisis, remain intact, and will accelerate any future upturn, Subbarao said.
His remarks are the RBI's most specific warning to date about a change to tighter monetary policy. Late last month the central bank signaled growing discomfort with rising prices, saying keeping monetary policy loose could engender inflation, which could constrain economic growth "in the medium term."
Subbarao also reiterated that India's surge in government borrowing for its economic stimulus, which amounted to 3.8% of gross domestic product was necessary but that it could boost inflationary pressures.
The RBI chief was in Europe to attend a meeting of finance ministers and central bankers from the Group of 20 emerging and industrialized economies in London, and meetings at the Bank for International Settlements in Basel. He said the mood among world central bankers is more upbeat than before, but they are cautious about early signs of global recovery, which may be very gradual.
G20 finance officials agreed over the weekend to develop "cooperative and coordinated" exit strategies but said the scale, timing and sequencing of action would vary across countries.
The RBI has cut its benchmark lending rate by 425 basis points since October and reduced the ratio of deposits that banks must set aside by 400 basis points. It is expected to be one of the first major Asian central banks to begin unwinding its easing. In July, the bank raised its inflation forecast for the fiscal year through March to 5%, from 4% previously.
Many analysts predict the RBI will start to withdraw liquidity in the October-December quarter and raise rates in the first half of next year. Macquarie Securities forecasts the first rate hike will be in April, while Bank of America-Merrill Lynch expects rate hikes to start in January.
Subbarao declined to comment directly on such views, but he was clear about the need to return to more standard monetary conditions.
"The current expansionary fiscal policy stance and monetary accommodation does not constitute the steady state," he said. "We need to go back to a steady state," he said.
In judging the appropriate timing for doing so, the RBI will be looking primarily at inflation, especially in the manufacturing sector, using the wholesale and consumer price indexes and disaggregated inflation. It will also monitor credit growth, capital flows and conditions in agriculture and industry, he said.
India's economic growth of 6.7% last fiscal year gave rise to optimism that the country had decoupled from the rest of the world exiting the crisis, but that positive sentiment has somewhat eroded in past weeks, Subbarao said.
That reflects the fact that last year's strong growth was mainly on the back of large government stimulus, but private consumption and investment have slowed and concerns about rising inflationary pressures have stirred. Another concern is a lack of rain, especially in India's food-growing areas, with the monsoon currently 3% below its long-term average overall. Farm output accounts for around 18% of the country's GDP.
The drought, Subbarao said, would likely affect inflation more than drag on growth - which could result if a poor harvest damps rural demand.
Industry and infrastructure data for the April-June quarter, were "positive," he said, and domestic-linked services subsectors are doing well, although service subsectors related to the external economy have yet to pick up.
"As much as we expect 6% growth with an upward bias, getting back to the high-growth trajectory that we had before the crisis - 8.5%-plus - we need the world to recover enough to get back there," Subbarao said. Still, "the fundamentals that drove the high growth in the Indian economy in the years 2004 to 2008 - the growing savings rate, improved productivity, the widened entrepreneurial base - those drivers of growth are intact, and once the world recovers, I think our recovery's going to be swift."
Subbarao said the burst in government spending was "demanded by the extraordinary crisis" but that it required "deviating from the discipline of the fiscal responsibility...at the central government level and at the state level."
India's Finance Minister Pranab Mukherjee "has indicated that he will return to a path of fiscal consolidation," Subbarao said. "Having said that, I must also say that because of this sudden, abrupt and large increase in government borrowing, the credit markets had experienced pressure, yields had gone up, and that (acted) against the monetary-policy transmission. And also it had implications for inflation."
The RBI is struggling to cope with the government's record INR4.51 trillion borrowing program for this fiscal year. A INR120 billion bond auction had to be scrapped and the last few bond sales had to be underwritten by primary dealers. The yield on the benchmark 10-year bond has surged more than 212 basis points so far this year.
Subbarao said the central bank aims to manage government borrowing in a "non-disruptive manner," adding he was not planning any "radical changes" in how the RBI manages auctions. But he noted that the borrowing was front-loaded into the first half of the year.
At the meetings in Europe, Subbarao said, the overall tone among central bankers was more upbeat than before. But he cautioned that some big issues remain, including global imbalances, changes in financial regulation and reform of the international financial institutions.
"The general impression I got was that the current situation in the advanced economies is more positive than anyone had expected three to six months ago," Subbarao said.
"There is generally a feeling that the worst is behind us and we are on the upward trend. But there is also caution about reading too much into this," he said. Central bankers feel "the recovery might be slow, halting, and that we may have several challenges on the way forward. Unless we meet those challenges on a continuous basis, we cannot get back to where we were."