Check money supply to contain inflation: IMF

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Washington, Jul 6: With high inflation not expected to abate this year, a senior International Monetary Fund (IMF) official said the RBI should further tighten money supply to minimise the ripple effect of price rise. Kalpana Kochhar, senior advisor in the Asia Pacific Division and mission chief for India, said that the options available before RBI are to raise interest rates, use exchange rate mechanism to allow rupee to appreciate and give guidance to markets about future inflation rate.

“Our advice is to look past the first round of effects and try to minimise the second round effects of inflation. What this means is that, in the first round you have higher fuel and higher food prices... The so-called second round effects are when they spill over into wages and to other more general prices,” she said.

That is where the monetary policy has to play a role in terms of tightening to signal that the authorities are not going to allow the second round effects to become entrenched. “In that sense, we do think there is further tightening to be done in India, notwithstanding the most recent interest rate increases with the repo rate increased from 8% to 8.5%,” the IMF official said.

On using exchange rate, Kochhar said, “In countries where there is appreciating pressure, our advice is generally to allow the exchange rate to appreciate because it is an easy shock absorber for fighting inflation.”

The more appreciated the currency is, the cheaper the imports are and any given international oil price will translate to lower prices in domestic currency, she said.

She also added that inflation is actually going to continue to rise, until about the end of this year because of a low base.

Besides short-term lending repo rate, the RBI had recently announced a rise in mandatory deposits of banks with the central bank by 50 basis points to suck out excess liquidity from the system. RBI is scheduled to come out with its quarterly review of credit policy on July 29. She said markets are fully expecting tightening of steps and further rate hikes, given the high inflation.

“There is scope to do more in terms of tightening policies,” she said. After administered increase in price rise of petrol, diesel and LPG is reflected in the inflation data, the rate of price rise has remained at 13-year high. It reached 11.63% for the week ended June 21. She said inflation in India is not a unique phenomenon, as it has risen everywhere in the world. “In India, as elsewhere, it is being driven by food and fuel, even though only a few components of fuel prices (naphta, aviation fuel, etc) had been adjusted previously. Now that prices of other components are also being adjusted, you will see the effect in the WPI a bit more,” Kochhar said.

While prices of certain of petroleum products like petrol, diesel, LPG, kerosene are fixed by the Government, prices of certain others like Naphtha, aviation turbine fuel, light diesel oil are market driven.

The IMF official said, “But inflation in India is not concentrated only in food and fuels. For example, manufactured goods’ inflation excluding metals has also gone up. “Even if the so-called volatile items of prices like food and fuel are taken out, you still have core Inflation, the non-volatile parts of inflation, running at pretty high levels in India, she said.

“So, part of the run up in inflation is a global phenomenon. However, in India, inflation is a combination of the supply shocks as well as Indias still strong underlying demand momentum,” the senior IMF official said.