India Must Raise Rates ‘Fairly Soon’ to Tame Prices, OECD Says

Nov. 20 (Bloomberg) -- India’s central bank must tighten its monetary policy “fairly soon” to stem inflation, the Organization for Economic Cooperation and Development said.

“Given the magnitude of easing and the speed at which inflation has bounced back, monetary policy will need to be tightened fairly soon,” the Paris-based OECD said about India in a report released yesterday.

Expectations of higher interest rates have sent Indian bond prices down by 5.9 percent in 2009, the worst performance among 10 Asian local-currency debt markets tracked by HSBC Holdings Plc. The central bank took the first steps to raise borrowing costs last month by ordering lenders to set aside a bigger proportion of their deposits in government bonds.

India’s consumer price index for industrial workers may average 5.4 percent in the 12 months starting April 1, more than double the rate in the current year, the OECD said. During the same period, India’s economic growth may accelerate to 7.3 percent from 6.1 percent, it estimates.

Central bank Governor Duvvuri Subbarao has injected 5.85 trillion rupees ($126 billion) of cash into the economy since September 2008 to protect India from the worst financial crisis since the 1930s.

In the last monetary policy announcement on Oct. 27, Subbarao raised the statutory liquidity ratio to 25 percent from 24 percent and kept the benchmark policy rates unchanged. He maintained the central bank’s economic growth forecast for the year ending March 31 at 6 percent “with an upward bias.”

Inflation Pressures

“Given that activity is expected to strengthen relatively quickly and that the recovery is likely to have begun with only a modest level of slack in the economy, delayed fiscal consolidation will also contribute to higher inflationary pressures,” the OECD said.

India also loosened the fiscal policy to stimulate the economy amid the global recession, cutting excise and customs tax rates, raising government salaries and stepping up spending on roads and power.

As a result, India’s national budget deficit, including federal and state government finances, may reach 10.1 percent of gross domestic product in the year ending March 31 from 4.2 percent of GDP two years ago, the OECD said.

The OECD said it projects only a “modest narrowing” in the budget shortfall because much of the increase in expenditure in the past year, such as the rise in salaries of government workers, is permanent in nature.

The deficit is forecast by the OECD to narrow to 9 percent of GDP in the next financial year starting April 1.