India sticks with stimulus plan

December 11, 2009

, NEW DELHI, Dec 11 – India\’s car sales are racing ahead, mobile phone sales are booming and share prices have rocketed, but policy makers are signalling a go-slow approach to ending economic stimulus and hiking rates.

Even with inflationary pressure returning, central bankers and the government are suggesting only a gradual roll-back of stimulus steps, fearful of jeopardizing economic recovery in Asia\’s third-largest economy.

"With higher growth, more hawkish rhetoric might have been expected from the Reserve Bank of India," said HSBC economist Robert Prior-Wandesforde.

"However, if anything, recent comments from (central bank) governor (Duvvuri) Subbarao suggest he is in less of a hurry to move," said Prior-Wandesforde, who does not expect any interest rate rises until March.

On Thursday, data showed food prices had risen by 19 percent from a year ago, driven by the driest monsoon in nearly four decades, which has hit farm output. Potato prices had more than doubled while pulses were up 42 percent.

India\’s government and central bank face a tricky balancing act in fighting inflation and keeping economic recovery on track, economists say.

"One has to be very careful in withdrawing stimulus as the upturn has been totally domestically driven" by India\’s nearly 1.2 billion population, said the director-general of the Confederation of Indian Industry, Chandrajit Banerjee.

"There are huge challenges on the export front" with advanced economies still in a slump.

Government stimulus measures currently account for some 12 percent of GDP, while the central bank has injected 120 billion dollars into the economy since October 2008 by slashing rates and taking other measures to boost business.

Central bank governor Subbarao this week called tightening monetary policy "an ineffective instrument" to tame food prices but added such action might be needed to contain inflation.

"If inflationary pressure persists for a long time it can fuel inflation expectations," he said.

But he also pledged the bank would not "exit from the accommodative monetary policy unless we are assured recovery is secure".

Overall wholesale price inflation, released monthly, is still relatively muted at 1.34 percent. But the bank forecasts inflation will hit 6.5 percent by the end of the fiscal year in March, fuelled by food prices and an economy showing a robust recovery from the global crisis.

India reported its best quarterly growth in 18 months as the economy expanded by 7.9 percent in the quarter to September.

In other recovery signs, monthly car sales are up by 61 percent — their sharpest ascent in over five years — India added a record 16.67 million mobile users in October and the stock market is up around 80 percent.

"The extent of resilience in the Indian economy has surprised us," said Deepak Lalwani, India director at London investment house Astaire and Partners.

But unwinding stimulus measures too early could jeopardize recovery, especially as the effects of the weak monsoon are likely to be felt hardest in the third and fourth quarters of this financial year, economists say.

Top government economic planner Montek Singh Ahluwalia has pushed for the continuation of stimulus measures.

"The policy has worked…. We should let it have its full effect," he said, adding that the time for unwinding the expansionary stance would be in the next fiscal year.

The central bank has cut borrowing costs six times since October 2008, pushing its benchmark repo rate, at which it lends to commercial banks, to a record low of 4.75 percent.

Analysts expect the bank to start draining some liquidity from the financial system in January by raising the amount of cash commercial banks must hold in reserve.

The central bank should "gradually withdraw the substantial monetary accommodation starting from January," said Goldman Sachs economists Tushar Poddar and Pranjul Bhandari in a report.

But economists expect the bank to hold off for a couple more months before joining such countries as Australia and Vietnam in raising rates.

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