Indian monetary policy still loose: Economist

Indian monetary policy is still very accommodative and interest rates
need to rise more to prevent global supply-side shocks from seeping
into the broader economy, a former IMF chief economist said on
Thursday.

Raghuram Rajan said the Reserve Bank of India's (RBI) recent
tightening measures were steps in the right direction, a day after the
central bank raised its key lending rate by 25 basis points to 5-1/2-
year high of 8 percent.

"On most counts real interest rates in India are negative, which means
that monetary policy is still accommodative and it has to be tightened
much more," he told Reuters in an interview on the sidelines of a
banking conference.

The RBI said its move late on Wednesday was to contain inflation
expectations.

Economists have said annual inflation could hit double-digits by mid-
June, which would be its highest in more than 13 years, as last week's
increase in state-set fuel prices cascade through the economy.

Wholesale price inflation, the most widely watched measure in India,
touched 8.24 percent in mid-May, far above the central bank's comfort
zone of 5.5 percent for 2008/09.

The central bank held off outright rate increases for a year, opting
instead to keep cash availability tight, as prices pressures largely
came from supply constraints and record commodity prices rather than
demand.

Rajan said if the supply shocks remained for long it would lead to a
rippling effect and create demand-side pressures.
They (RBI) must accept that it is a supply side issue and focus on
that not spreading out to the other sectors of the economy, something
that happened to the industrialised economies in the 1970s after the
oil shock," Rajan, who was IMF chief economist from September 2003 to
January 2007, said.

Rajan chairs a panel on financial sector reforms in India whose draft
report has said the central bank should have the single objective of
controlling inflation, rather than focus sometimes on the exchange
rate and sometimes on inflation.

The 229-page draft said the RBI should set a target range for
inflation and move to a single instrument such as short-term rates to
achieve that goal. The final report is due in June.

The twin objectives of monetary policy in India have evolved as
maintaining price stability and ensuring adequate flow of credit to
facilitate the growth process.

"The risk of having so many objectives is that you flip-flop between
them and people are not sure what are you focused on," said Rajan, now
a professor of finance at the Graduate School of Business at the
University of Chicago.