Reserve Bank of India: better to act now as pressures can build

Demand-side pressure on the Indian economy can build up further and it is better to take some action now, the Reserve Bank of India governor said on Wednesday, days after it surprised markets by raising interest rates.
             
The Reserve Bank of India, citing inflationary pressures and an improving economy, hiked key rates by 25 basis points late on Friday, a month earlier than expected, and another increase is seen at its policy review on April 20.

"It is better to take some action now and continue with the exit strategy," Duvvuri Subbarao said on the sidelines of a convocation ceremony, referring to debate over whether the central bank should opt for small, gradual policy moves to quell inflation or act more aggressively.

In the medium term, high inflation would threaten sustained economic growth, he noted.

Referring to emerging pressures in Asia''s third-largest economy, Subbarao said factory capacity utilisation in India had risen to 72 percent, slightly off the record level of 76 percent scaled in 2007-08.

"Contribution of food to inflation was at 100 percent in November. By February, contribution of food to inflation has come down to 52 percent. So, these numbers say even if food inflation is high, non-food inflation is building up."

Real estate prices were reaching pre-financial crisis levels, reflecting a further increase in demand-side pressures, he added.                                           

Economists polled by Reuters after Friday's rate hike say the Reserve Bank is likely to raise policy rates to a slightly higher level this year than earlier expected. Most now see rates being raised by a total of 100 basis points by the end of 2010.

Kaushik Basu, chief economic adviser to the finance ministry, said did not expect the Reserve Bank's rate move on Friday to curb India''s growth.                                           

"In Q4 (Jan-March), I expect it to be 8.5%," Basu said at the same event as the Reserve Bank of India chief.

The government expects the economy to grow by about 8.5% in 2010-11 and at 9% after that, he added.

India's wholesale price index rose a faster-than-expected 9.89% in February from a year earlier, driven by firm food prices. But many officials hope inflation will ease somewhat in coming months as winter-sown crops come onto the market.

"I expect inflation to come down. It may just go up for one more month in March as the base effect is strong," Basu said, adding that average inflation for 2009-10 will not cross 4%.