RBI must step up inflation fight: finance ministry

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Aug 19: India’s central bank should raise interest rates to tame 16-year-high inflation, the finance ministry said, after the government handed out a 21% salary increase to civil servants ahead of elections. “Monetary policy has to focus on inflation,” the ministry’s chief economic advisor Arvind Virmani said in an interview in New Delhi on Monday. “The political system doesn’t tolerate inflation beyond a certain point.” The government is relying on the central bank to tame prices after Prime Minister Manmohan Singh’s cabinet last week decided to pay more to five million civil servants than was recommended by a wages panel. Inflation jumped to 12.44% this month as soaring food and fuel prices make life tougher for the poor in the world’s second-most populous nation.

“The government has put the ball in the Reserve Bank’s court for inflation management,” said NR Bhanumurthy, an economist at the Institute for Economic Growth in New Delhi. The timing of the pay rise for state employees “coincides with elections nearby.” The Reserve Bank of India last month raised its inflation forecast for the year to March 31 to 7% from a previous target of between 5% and 5.5%, even after increasing its benchmark interest rate three times since June.

The central bank’s key repurchase rate will rise to between 9.25% and 9.5% by the end of October from 9%, according to eight of 12 economists surveyed by Bloomberg after the last monetary policy announcement on July 29. Inflation may accelerate further after Singh’s cabinet approved a salary rise for government employees, backdated to January 2006. The Rs 15,700 crore cost of the pay increase in the financial year to March 2009 is almost twice the Rs 7,995 crore recommended by a panel which reviews wages for civil servants every 10 years or so.

The pay increase will widen this year’s fiscal deficit by about 0.5% of gross domestic product, according to HSBC Group Plc economist Manas Paul. HSBC estimates this year’s fiscal shortfall at 3.5% of GDP, compared with a government estimate of 2.5 percent. Higher government wages “will be mildly inflationary and are counter to what the Reserve Bank is trying to do,” said Dharmakirti Joshi, an economist at Mumbai-based Crisil Ltd, the local unit of Standard & Poor’s. The central bank “may raise rates again to offset any impact due to higher salaries.”