June 20 (Bloomberg) -- Indian inflation exceeds acceptable levels and restraining it may require sacrificing economic growth, central bank Governor Duvvuri Subbarao said.
“Headline inflation has come down, core inflation has come down to below 5 percent, but WPI inflation is still above our tolerance level at 7.5 percent,” Subbarao said in a speech in Mumbai yesterday, referring to India’s benchmark wholesale-price index. “Consumer-price inflation is running above 10 percent. That is quite disturbing.”
The Reserve Bank of India unexpectedly left interest rates unchanged on June 18 as price pressures narrow scope to bolster the weakest growth in almost a decade. Curbing the nation’s fiscal deficit and the success of the monsoon are among the keys to controlling inflation, Subbarao said.
“India is flirting with stagflation and needs a dose of supply-side reforms to improve medium-term growth potential,” said Prasanna Ananthasubramanian, Mumbai-based chief economist at ICICI Securities Primary Dealership Ltd. “However, the political realities are such that the chances of structural reforms and fiscal consolidation are uncertain.”
Price increases have been stoked in part by costlier imports following a near 20 percent slump in the rupee against the dollar in the past year. The currency tumbled as growth deteriorated and Europe’s debt crisis sapped demand for emerging-market assets.
“We may have to sacrifice growth in the short term to contain inflation which eventually will help us grow nearly as much as our potential rate in the medium term,” Subbarao said. “In the medium term, inflation is inimical to growth.”
The rupee declined 0.1 percent to 55.97 per dollar in Mumbai yesterday, while the BSE India Sensitive Index rose 0.9 percent. The yield on the 8.15 percent bond due June 2022 declined six basis points, or 0.06 percentage point, to 8.11 percent.
Subbarao said the central bank will continue with its policy of intervening in the foreign-exchange market to curb volatility. India has currency reserves to cover eight months of imports, he said.
The nation’s decision to hold its repurchase rate at 8 percent contrasts with cuts in Brazil and China in the past three weeks as the impact of Europe’s turmoil fans through Asia.
Gross domestic product rose 5.3 percent in the three months through March from a year earlier, the least since 2003, weighed down in part by a moderation in investment caused by political gridlock over proposed economic policy changes.
The wholesale-price index climbed 7.55 percent in May from a year earlier, the fastest pace in the BRIC group of largest emerging markets that also includes Brazil, Russia and China.
The government’s projected fiscal deficit of 5.1 percent of GDP in the year through March 2013 is the group’s widest, stoked by a subsidy program ranging from diesel to fertilizers.
India needs to narrow its budget shortfall and enact reforms in governance, domestic taxation and the foreign investment regime, Subbarao said. It also needs to accelerate project clearances and improve infrastructure to boost the pace of economic growth, he said.
“The government must discourage expenditure that is for consumption as it drives up wages and is inflationary,” Subbarao said. “That puts pressure on the fiscal deficit to widen.”
Hours after the Reserve Bank left borrowing costs unchanged two days ago, Fitch Ratings lowered India’s credit outlook to negative, joining Standard & Poor’s in saying the nation is at risk of losing its investment-grade status.
Fitch cited the heightened risk of a deterioration in growth potential and limited progress on paring the budget deficit in its decision to lower the outlook on India’s BBB-rating, which is one step above so-called junk status.
Standard & Poor’s warned on June 11 that it may cut India’s rating after lowering the outlook to negative in April.
“While growth in 2011-2012 has moderated significantly, headline inflation remains above levels consistent with sustainable growth,” the Reserve Bank said after its decision to hold the repurchase rate, an outcome predicted by only four of 25 economists in a Bloomberg News survey.
The expansion in Asia’s third-largest economy has moderated in part after Subbarao raised rates by a record 3.75 percentage points from mid-March 2010 to October last year to try and contain inflation, which exceeded 9 percent for most of 2011.
The central bank in January and March reduced the amount lenders must set aside as reserves by a combined 125 basis points, to 4.75 percent, to ease cash shortages at banks. It said June 18 it will continue to use purchases of government bonds as warranted to “contain liquidity pressures.”
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