Monday 4 February 2008

India's Capital Inflows Complicating Monetary Policy, IMF Says

India will attract ``large capital inflows'' as the economy expands, complicating efforts by the central bank to curb the rupee's accelerated gains, the International Monetary Fund said.

The inflows are helping to boost investment in Asia's third- largest economy, which may expand 8.7 percent this fiscal year, the Washington-based lender said in a report released today. The growth may slow to 8.3 percent the next fiscal period, IMF said.

``Given India's vibrant growth outlook and sizeable capital demands, inflows will likely remain strong,'' the IMF said. ``Large capital inflows are complicating the conduct of monetary policy, creating excess liquidity and pressuring the rupee.''

India expanded at more than 9 percent since April 2005 as Ford Motor Co., Tata Steel Ltd. and other companies increase output at the quickest pace in a decade to meet soaring demand from a growing middle class. Rising prices prompted the Reserve Bank of India to keep its benchmark interest rate unchanged near a six-year high last week.

Wholesale prices unexpectedly accelerated to a five-month high in the week ended Jan. 19 from a year earlier, vindicating the central bank's decision to refrain from cutting rates.

``Inflation risks are to the upside due to rising international food and fuel prices, ample domestic liquidity, tight capacity utilizations, and rising skill premia,'' the IMF said. Wholesale prices are projected to rise between 3.5 percent and 4 percent in the ``near term,'' the report said.

Fuel Subsidy

India needs to prioritize spending, the IMF said, pointing to the government's fuel subsidy bill that is growing as oil prices rise.

There is a need ``to adapt to higher international oil prices through a phased reduction in subsidies for most fuel products, while ensuring that adequate and well-targeted safety nets are in place to protect the poor,'' the report said. ``A tighter fiscal stance could help offset the liquidity impact of buoyant capital flows and thus relieve appreciation pressures.''

The Indian rupee gained 12.3 percent against the U.S. dollar last year.

The ``rupee appreciation reflected strong fundamentals and increasing productivity, and the policy of a managed float'' remains appropriate, the IMF said. Still, there is some concern ``that rupee appreciation has adversely affected India's external competitiveness in certain labor-intensive sectors.''

Rising imports will probably lead to a widening of the country's trade deficit and boost the current account deficit to 1.5 percent of gross domestic product this fiscal year, the report said.

``Nevertheless, with low levels of external debt, ample reserves and limits on the amount and end-use of foreign debt financing, India's external position is sustainable and robust to significant shocks,'' the lender said.