IMF paper suggets RBI should raise rates to contain inflation

The Reserve Bank of India (RBI) should consider raising interest rates to bring down the persistently high inflation on a durable basis, an IMF working paper has suggested.

“Given elevated and persistent inflation,... the RBI may also need to raise rates to tackle inflation durably, particularly if faced with a persistent and sizable supply-side food price shock putting pressure on broad-based inflation,” said the paper, Food Inflation in India: The Role for Monetary Policy.

Food and fuel inflation in India has remained high for several years, the paper said, adding to durably reduce the current high inflation, the monetary policy stance needs to remain tight for a considerable length of time. It suggested that the government pursue structural reforms to push growth to potential levels instead of relying fully on monetary policy to promote growth.

RBI Governor Raghuram Rajan has been pursuing hawkish monetary policy stance to keep inflation under check. It has not reduced rates in four consecutive policies despite pressure from industry and the finance ministry to cut rates to boost growth. The government is in touch with RBI to set up a new structure to deal with monetary policy issues, including targeting of inflation, in line with the recommendations of the Urjit Patel committee.

Finance Minister Arun Jaitley had said in his Budget speech on July 10: “It is also essential to have a modern monetary policy framework to meet the challenge of an increasingly complex economy. Government will, in close consultation with the RBI, put in place such a framework.”

The committee had suggested RBI should target to bring down retail inflation to 8 per cent by January 2015 and 6 per cent by January 2016.

“At the current juncture, with food inflation remaining persistently high for five years, monetary policy needs to remain tight to control generalised inflation,” the paper said.

The Wholesale Price Index-based inflation dropped to a 5-year low of 3.74 per cent in August, while the retail inflation stood at 7.8 per cent.

The paper said since inflation is mostly backward looking, monetary policy has to maintain a tight stance for a prolonged period of time.