Prime minister’s Economic Advisory Council recommends hike in interest rates

Ahead of the Reserve Bank of India’s monetary policy, scheduled for July 27, the prime minister’s Economic Advisory Council (PMEAC) has recommended an increase in interest rates.

The PMEAC chairman and former RBI governor C Rangarajan said Friday, “There should be further tightening of the monetary policy in view of the high level of inflation.” Rangarajan was speaking to the media at the release of the Council’s Economic Outlook for 2010-11.

Replying to a query on how a tightening monetary policy would impact growth, Rangarajan said, “It should promote growth and also contain inflation.” 

Meanwhile, finance minister Pranab Mukherjee met top officials of RBI in New Delhi on Friday to discuss the upcoming monetary policy.

“In the backdrop of inflation rates that are more than twice the comfort zone, it is important that monetary policy completes the process of exit and moves towards a bias on tightening, with respect to normal monetary conditions,” the Council’s Economic Outlook has stressed.

It has added that “This is essential to preserve price stability and create conducive conditions for sustainable growth in the medium term.”

When asked to compare fiscal tightening with monetary tightening, in terms of significance to the economy on the whole, Rangarajan said “Fiscal tightening usually happens only once a year-during the budget”. On the other hand, monetary tightening is an instrument that can be used continuously, he added.

As for the desirability of any withdrawal of fiscal stimulus soon, Rangarajan said, “I don’t think any further adjustments will be made during the year.” The next phase of stimulus withdrawal, through tax and duty revisions, can be effected in the next budget now.

On inflation, Rangarajan said that by September, one will see the whole price index (WPI) below the double digit figure. But the inflation will dip significantly only in 2011, he added. According to the Economic Outlook, “Overall WPI headline inflation rate is expected to remain high (7 to 8%) at the end of December 2010, dropping to around 6.5% by March 2011.”

The PMEAC report has stuck with the government forecast of GDP growth at 8.5% in 2010-11. The Indian economy will grow faster at 9% in 2011-12, according to the report. Agriculture, which grew at 0.2% in 2009-10, is projected to grow at 4.5% in 2010-11 and 4% in 2011-12. Industry, which grew at 9.3% in 2009-10, is projected to grow at 9.7% in 2010-11 and 10.3% in 2011-12. Also, services, which grew at 8.5% in 2009-10, is projected to grow at 8.9% in 2010-11 and 9.8% in 2011-12.

Citing high buoyancy in direct and indirect tax collections, telecom auctions and decontrol of petroleum products, the Council has projected that fiscal deficit may be lower than the budgeted consolidated figure of 8.4% of the GDP for 2010-11. Also, revenue deficit, as a ratio of GDP, is expected to decline from 6.3% in 2009-10 to 4.6% in 2010-11.

The PM’s Economic Advisory Council has recommended three measures for attaining economic growth of 9%. These include focus on containing inflation as a short-term measure, and improving farm productivity and closing large physical infrastructure deficit (especially in the power sector) as medium-term steps.