Indian monetary policy still loose: Economist

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Mumbai, June 12:: Indian monetary policy is still very accommodative and interest rates need to rise more to prevent global supply-side shocks from seeping into the broader economy, a former IMF chief economist said on Thursday.

Raghuram Rajan said the Reserve Bank of India's (RBI) recent tightening measures were steps in the right direction, a day after the central bank raised its key lending rate by 25 basis points to 5-1/2-year high of 8 percent.

"On most counts real interest rates in India are negative, which means that monetary policy is still accommodative and it has to be tightened much more," he said in an interview on the sidelines of a banking conference.

The RBI said its move late on Wednesday was to contain inflation expectations.

Economists have said annual inflation could hit double-digits by mid-June, which would be its highest in more than 13 years, as last week's increase in state-set fuel prices cascade through the economy.

Wholesale price inflation, the most widely watched measure in India, touched 8.24 percent in mid-May, far above the central bank's comfort zone of 5.5 percent for 2008/09.

The central bank held off outright rate increases for a year, opting instead to keep cash availability tight, as prices pressures largely came from supply constraints and record commodity prices rather than demand.

Rajan said if the supply shocks remained for long it would lead to a rippling effect and create demand-side pressures.

"They (RBI) must accept that it is a supply side issue and focus on that not spreading out to the other sectors of the economy, something that happened to the industrialised economies in the 1970s after the oil shock," Rajan, who was IMF chief economist from September 2003 to January 2007, said.

Rajan chairs a panel on financial sector reforms in India whose draft report has said the central bank should have the single objective of controlling inflation, rather than focus sometimes on the exchange rate and sometimes on inflation.

The 229-page draft said the RBI should set a target range for inflation and move to a single instrument such as short-term rates to achieve that goal. The final report is due in June.

The twin objectives of monetary policy in India have evolved as maintaining price stability and ensuring adequate flow of credit to facilitate the growth process.