India Must Tighten Monetary Policy, Former Governor Jalan Says

Dec. 21 (Bloomberg) -- India’s central bank needs to drain cash from the economy to check speculation in commodities, former Governor Bimal Jalan said, after food price inflation climbed to an 11-year high this month.

“Reduction in availability of money may help in reducing the speculative pressure on retail prices,” Jalan, who headed the central bank between 1997 and 2003, said in an interview in New Delhi on Dec. 18. “Monetary policy could give a signal that it is worried about inflation.”

Reserve Bank of India Governor Duvvuri Subbarao said he discussed the country’s economic situation with Finance Minister Pranab Mukherjee on Dec. 18, fueling expectations he may tighten monetary policy soon. Indian bonds and stocks fell last week as investors bet the central bank may raise interest rates.

“The market has begun to price in a monetary policy action in the near term to anchor rapidly escalating inflation expectations,” said Shubhada M. Rao, chief economist at Yes Bank Ltd. in Mumbai.

The yield on the benchmark 10-year government bonds rose 14 basis points to 7.72 percent last week. The key Sensitive stock index fell 2.3 percent to 16,719.83 on the Bombay Stock Exchange during the same period.

Food prices are rising after the June-to-September monsoon rains, the main source of irrigation in Asia’s third-largest economy, were the weakest this year since 1972, hurting output of rice, pulses and wheat.

Surging Food Price

Production of monsoon-sown rice may total 71.65 million metric tons this year, less than the 84.58 million tons reaped a year ago, according to government estimates. Sugar crop in India, the biggest grower after Brazil, fell 9.6 percent in the first two months of the season that started Oct. 1 to 1.7 million metric tons from a year ago.

An index of food articles compiled by the commerce ministry advanced 19.95 percent in the week ended Dec. 5, the highest since Dec. 1998. India’s key wholesale-price inflation accelerated to 4.78 percent in November from a year earlier, following a 1.34 percent gain in October, the ministry.

“You don’t need a stark action because inflation is confined to food prices,” said Jalan. “According to one school of thought, some indicative monetary action is worth considering, a mild one.”

Tighter Policy

Even though the central bank’s next monetary policy statement is due on Jan. 29, Subbarao can make changes to interest rates before the scheduled date.

In his last policy announcement on Oct. 27, the governor ordered lenders to keep a greater proportion of their deposits in government bonds, taking the first step toward withdrawing monetary stimulus. Before the move, Subbarao had injected 5.85 trillion rupees ($125 billion) of cash since September 2008 to protect the economy from the global recession.

Subbarao has kept the key reverse repurchase rate unchanged at 3.25 percent since April.

Australia and Vietnam are the two countries in Asia Pacific that have already raised rates to rein in inflation.

The Organization for Economic Cooperation and Development said last month that India must tighten its monetary policy “fairly soon” to stem inflation.

Jalan, who served as a member of parliament until August this year after his stint at the central bank, said India must also step up import of food items that are in short supply.

Political Pressure

“In addition to the drought, what’s complicated the situation is that we didn’t make arrangements for import of rice,” Jalan said. “And, this could partly be because of overestimation of the likely output.”

Glencore International AG, Louis Dreyfus Corp. and Olam International were among companies that offered to sell rice to India last month.

Political pressure is mounting on Indian Prime Minister Manmohan Singh to arrest the price rise in a nation where two- thirds of the 1.2 billion people live on less than $2 a day.

A parliamentary panel on finance on Dec. 17 warned the Ministry of Finance for failing to act in a timely manner to curb inflation. A day earlier, opposition lawmakers accused the government of being ineffective in tackling prices and disrupted parliament proceedings.

Inflation is gathering strength in India as its economy recovers from the global recession. The $1.2 trillion economy expanded 7.9 percent in the three months ended Sept. 30 from a year earlier, the quickest pace in six quarters. The growth lagged behind only China among the world’s major economies.

“With a strong growth in GDP and inflation accelerating at the same time, pressure is building on the Reserve Bank to partially retract the monetary stimulus,” said Rahul Bajoria, an economist at Barclays Capital in Singapore.