The Reserve Bank of India will need to continue raising its policy interest rate given the sticky nature of inflation, the International Monetary Fund said on Thursday in a report released on its website.
"The ingrained nature of inflation and inflation expectations mean that reducing inflation - even over a protracted horizon - will require significant increases in policy rates, which will weigh on growth," the IMF stated about India's growth that has seen a fall.
"Should high inflation expectations persist and inflation remain sticky, a more front-loaded path of interest rate increases may be needed," the IMF said.
RBI Governor Raghuram Rajan, a former IMF chief economist, has raised the key repo rate by 75 basis points to 8% recently since assuming the post.
He has made consumer prices its key inflation barometer, a shift away from using wholesale price inflation (WPI). The consumer price index touched a two-year low in January at 8.79% as food prices cooled but was still much higher than the wholesale price index of 5.05%, an eight-month low.
The IMF expects India's consumer price index to remain near double digits well into next year driven by food prices. It has endorsed giving more emphasis to consumer prices for making policy decisions.
"Headline CPI should provide the principal nominal anchor for monetary policy, as food and fuel price shocks propagate rapidly into core inflation, and inflation expectations and wage formation are closely linked to CPI inflation," the IMF mentioned in the reports. The IMF expects India's economy to grow at 4.6% in the current fiscal year ending in March, picking up to 5.4% in the fiscal year that starts in April, which is in line with the RBI's expectations as mentioned by the body.
According to IMF's outlook for India, following are the projections:
-The near-term outlook is characterized by relatively weak growth and high and persistent inflation.
- No further policy changes are assumed in the baseline, but slightly stronger global growth, improving export competitiveness, a favorable monsoon, and a confidence boost from recent policy actions should deliver a modest growth rebound in the near term.
- However, fiscal restraint and higher interest rates will act as headwinds, slowing the recovery. India’s trend growth is currently estimated at around 5½ % but is expected to rise to its medium-term growth potential of around 6¾ percent (under current policies) as unblocked investments are implemented and global growth improves.
-As a result of the weak economy the output gap has been widening, and is now estimated at about 1% of GDP.
-Despite the growing output gap, monthly CPI inflation is expected to remain near double-digits well into next year.
-The current account deficit is narrowing fast. The current account deficit reached a record 4.8% of GDP in 2012/13 due to sharply weaker exports, higher imports of oil and gold, and binding supply constraints.
-The principal risk facing India is the inward spillover from a tightening of global liquidity interacting with domestic vulnerabilities.
-Unless binding supply constraints are decisively addressed, high inflation and slow growth will continue to undermine macroeconomic and financial stability, necessitating a tighter monetary policy stance.
-Citing green shoots in the data for power generation and exports, good agricultural performance and robust rural demand, they consider a growth projection of 5 percent to be reasonable for FY13/14, rising to 8 % in 2–3 years.
-The authorities noted that India has demonstrated its ability to respond to shocks and market concerns. While recognizing that more chronic problems—such as persistent inflation—have been allowed to linger, the authorities argued that vigorous policy responses had been forthcoming when actions were urgently needed. For example, when the fiscal deficit became a matter of concern in FY 2012/13, the Ministry of Finance delivered on restraining spending to meet the deficit target.
-Similarly, when markets feared the current account deficit (CAD) was becoming excessive, the government put in place effective measures to rein it in and to mobilize over $34 billion in net capital inflows (largely through NRI deposits).
Authors take: With the US government's decision to taper bonds that affected rupee's value drastically, IMF has clearly mentioned in the report that if any external pressures re-emerge, a well-communicated package of policy measures should be put in place to minimize disruptive movements in the currency and bolster confidence. This is an indication for RBI to make policy amendments to insulate India's economic fabric without external disruptions.
The authorities have lauded India's efforts in curtailing external impact to India's growth story by stating: External vulnerabilities have been greatly reduced, owing in large part to strong policy actions taken. This clearly shows that curtailment in gold imports by Chidambaram and RBI's change in focus (read repo rate and focus shifting from WPI to CPI) has greatly helped the economy.
Keeping in view of the impending Lok Sabha polls, IMF has outlined India's achievements to fiscal consolidation by meeting the budget deficit target. It mentions rise in electricity prices, UID and restructuring of public electricity distribution companies as difficult steps taken by UPA to counter incumbent governance. But, these efforts are not enough for a country that was raged by Phailin and Uttarakhand tragedies and which is under-rated for basic amenities provided such as education, housing and employment.
Repo rate: Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.
Reverse repo rate: Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. It is a monetary policy instrument which can be used to control the money supply in the country.