‘No consensus on timing, mode of easy-policy exit’

India needs to exit from excessively accommodative monetary and fiscal polices but there was no consensus on when or how given competing concerns about growth and inflation, the head of the central bank said on Monday.

Governor D Subbarao also said high food price inflation reflected structural demand-supply imbalances and the cyclical impact of the weakest monsoon rains since 1972, which have lowered crop output.

In a speech at the IMF-World Bank annual meeting in Istanbul, Subbarao said while there was broad agreement India needed to wind back some of its easy policy stance, there were risks if the move was mistimed.

“We may need to exit from accommodative monetary policy earlier than advanced economies. This calls for careful management of trade-offs: growth concerns warrant a delayed exist, but inflation concerns call for an earlier exit,” he said.

“An early exit on inflation concerns runs the risk of derailing the fragile growth, while a delayed exit may engender inflation expectations.”

The wholesale price index rose 0.8% in the year to September 19, higher than expected, having fallen in annual terms in the three months to the end of August.

The WPI’s food articles index rose an annual 16.3%, and Subbarao noted consumer price inflation was in double digits because of food prices.

“While the buffer stock of foodgrains and better supply management could mitigate the adverse effects to an extent, imports are not an easy solution given the requirement,” he said.

India’s growth slowed to 6.7% in 2008-09 as the global downturn hit harder than expected, after growing at 9% or more in the previous three years, and the central bank expects it to slow towards 6% in 2009-10.

In the wake of the global credit crisis and economic downturn last year, the Reserve Bank pumped markets with liquidity and cut banks’ reserve requirements. It also cut its key lending rate by 425 basis points between October and April to shore up growth in Asia’s third-largest economy. Subbarao said given risk appetite was returning and central banks around the world have added unprecedented amounts of liquidity to markets, a rate rise in India could increase capital inflows with a concern that they could turn into a flood as in 2007.

“In India, the current account is in modest deficit. Hence, large and volatile capital flows can impose macroeconomic costs,” he added.

Foreign funds have been net buyers of about $12.7 billion of stocks in 2009, including more than $4 billion in September. The stock market has risen 75% this year.

The government’s fiscal deficit has widened on increased spending and cuts in taxes and duties to support industry and keep the economy growing. The 2009-10 deficit is forecast at a 16-year high of 6.8% of gross domestic product.

“A large part of our fiscal deficit is structural and not cyclical,” he said, saying that growth and tax increases would not deliver fiscal consolidation on a platter.

“We need to work seriously on expenditure compression. This is going to be politically challenging both at the Centre and in the states, but it needs to be done regardless,” he said.