IMF Says India Can Raise Rates Gradually as ‘Conditions Ripe’

Feb. 5 (Bloomberg) -- India can gradually start raising interest rates as Asia’s third-largest economy is among the first to recover after the global financial crisis, the International Monetary Fund said.

“The conditions are ripe for a progressive normalization of the monetary stance,” the IMF said in a report on its Web site yesterday. “India’s economy is one of the first in the world to recover” and the central bank should take “a gradual approach to ensure the recovery reaches its full potential.”

The steepest interest-rate cuts in eight years between October 2008 and April 2009 and stimulus worth 12 percent of gross domestic product helped the $1.2 trillion economy weather last year’s global recession. Central bank Governor Duvvuri Subbarao on Jan. 29 told lenders to set aside more cash as reserves, signaling tighter credit, as growth accelerated and inflation raced to a 13-month high.

The IMF forecasts India’s GDP will increase 8 percent in the year starting April 1, from 6.75 percent, and cautioned a widening budget deficit “could put breaks on the recovery.” Fitch Ratings this week said it would be “encouraged” to downgrade should there be any further slippage in targets and maintained India’s foreign- and local-currency rating at BBB-, its lowest investment grade.

Rising Demand

India’s economy expanded 7.9 percent in the three months to Sept. 30, the fastest pace in 18 months and in line with China among the major emerging economies. Finance Minister Pranab Mukherjee in December forecast growth of about 8 percent for the current financial year.

“As growth picks up and becomes more broad-based, we do believe that it’s time to unwind” fiscal stimulus measures, Kalpana Kochhar, a Washington-based deputy director at the IMF, said in a conference call yesterday.

Recent data indicate that demand is gaining traction as companies including Bajaj Auto Ltd., the nation’s second-largest motorcycle maker, and Tata Motors Ltd., the country’s biggest maker of trucks and buses, reported sales growth of more than 70 percent in January.

India’s manufacturing output as measured by an index compiled by HSBC Holdings Plc and Markit Economics’ rose to 57.6 last month, the highest in 17 months and overseas sales of goods rose for the second straight month after a yearlong decline.

“Prompt fiscal and monetary easing, combined with the fiscal stimulus already in the pipeline and the return of risk appetite in financial markets, have brought growth close to pre- crisis-level,” the fund said in the report.

Bright Prospects

India’s medium-term growth prospects remain bright, mainly reliant on domestic drivers, the IMF said. “India’s rapid recovery has brought fiscal and monetary policy trade-offs to a head earlier than in other countries,” it said.

The Reserve Bank of India on Jan. 29 raised the cash reserve ratio, the proportion of deposits banks are required to set aside as reserves, by 0.75 percentage points to 5.75 and said the recent data confirms “the assessment that the economy is steadily gaining momentum.”

“Given the long transmission lags and the low policy rates,” the Reserve Bank should adopt a “timely start of the withdrawal of monetary stimulus, which would help anchor inflation expectations and soften the impact on long-term interest rates,” the IMF said.

Food inflation accelerated for a second week to a near 11- year high. An index measuring wholesale prices of lentils, rice, vegetables and other food articles compiled by the commerce ministry increased 17.56 percent in the week to Jan. 23 from a year earlier, a separate government report showed yesterday.

The rupee can be used “with caution” as a tool to stem inflation, the IMF said.

“We believe that the economy is in a fast recovery mode and that the RBI will need to start lifting policy rates toward normalized levels,” as inflation surges, said Chetan Ahya, a Singapore-based economist at Morgan Stanley, which yesterday revised its economic growth estimate for the year starting April 1 to 8.5 percent from an earlier forecast of 8 percent.