IMF says monetary stance might have to be tightened in India

Says developing economies should allow exchange rates to adjust to fundamentals

As if to give a prescription to the new RBI governor Raghuram Rajan for monetary review later this month, the International Monetary Fund (IMF) has said scope of easing monetary stance in India is very limited and it might have to be tightened due to high inflation.

Also, IMF said emerging market economies should allow exchange rates to adjust to fundamentals of their economies, and should curb only volatility, a key advice given the fall in rupee in recent times.

"Where still high inflationary pressures persist, including from supply bottlenecks (Brazil, India and Indonesia), the scope for easing the monetary stance may be very limited or it may need to be tightened," IMF said in its paper released on G-20, which is holding a two-day Summit in St Petersburg in Russia.

After taking charge as the new RBI governor, Rajan postponed the mid-quarter review of its monetary policy by a couple of days to September 20. The US Federal Open Market Committee meeting, scheduled on September 17-18, is expected to indicate when the US Fed might start tapering its stimulus programme.

In this connection, IMF said policymakers in emerging market economies should allow exchange rates to respond to changes in fundamentals but may need to guard against risks of disorderly adjustment.

"Liquidity provision to maintain orderly conditions may be needed where very rapid flows lead to financial market disruption," it said.

Risks of disorderly conditions in currency markets are likely to be less acute for those economies that have strong policy frameworks, deeper financial markets, sound balance sheets, and limited non-resident portfolio investment.

The government has claimed that fundamentals of India's economy are strong despite the fall in economic growth below the global financial crisis level of 2011-12. The GDP grew by a decade low of 5% in 2012-13. It logged in over four-year low of 4.4% in the first quarter of the current financial year.

However, India's stock markets are heavily dependent on portfolio investments and much of the woes in India's markets including currency markets are linked to FIIs taking away money from the equity markets.

"While some intervention to smooth current market volatility may be appropriate in countries with adequate reserves, it should not forestall underlying external adjustment for those economies where external deficits exceed levels warranted by fundamentals and desired policies," it said.

The rupee has depreciated over 23% against the dollar till yesterday in the current financial year. It fell over 15% since May 22, when talks of tapering of quantitative easing by Federal Reserve Chairman Ben Bernanke spooked markets worldwide. However, it has recovered 2% in the morning trade today to stand at 65.54/dollar.