The Organisation for Economic Cooperation and Development has argued that the Reserve Bank of India's process of raising policy interest rates is 'still very low by historical standards'
In a global economic outlook, released Wednesday afternoon, the Paris-based grouping warned: "With inflation remaining elevated and the recovery appearing to have taken root, there is a risk that price increases for inputs will flow through to second-round increases and that inflationary expectations will become destabilised.
To mitigate this risk, sizeable further monetary tightening will be required through 2010 and into 2011."
OECD projected the inflation rate to be 7.7 per cent in 2010 and 6.1 per cent in 2011.
It expected the consumer price index rise to be at 10.2 per cent in 2010 and still hovering at 6.3 per cent in 2011.
The trade deficit has been projected at $80 billion (imports of $405 billion) in 2010 and going up to $101 billion (imports of $478 billion up 13.1 per cent from 2010) in 2011 and real GDP growth in 2010 at 8.3 per cent and at 8.5 per cent in 2011.
OECD chief economist Pier Carlo Padoan said: "The outlook for inflation remains the main downside risk, especially if monsoonal rainfall is again deficient. In that case, food inflation would likely begin to risk anew.
"More generally, the strong state of domestic demand could lead to persistently higher inflation and an upward drift in inflationary expectations.
"The expected rebound in agricultural production is likely to bring about a continued moderation of food inflation in the short run.
However, given the relatively modest slowdown of the Indian economy during the global recession, excess capacity is limited and demand pressures are on the rise, providing firms seeking higher profit margins to raise produce.
Higher excise duties on petrol and diesel will also contribute to higher inflation at the margin. Taking these factors together, inflation is likely to remain stubbornly high."
Addressing RBI, Padoan suggested the situation 'would necessitate a strong policy response from RBI, which would weigh heavily on sentiment and activity. With the budget deficit expected to remain large over the projected period, government borrowing requirements may also exert upward pressure on companies' borrowing costs'.
Adding the context of anticipated deficit reduction being underpinned on 'expected revenue growth, asset sales and some more modest tax measures', Padoan added, 'the expected rebound in agricultural activity should help limit further increase in food prices, which have been a major contributor to high inflation.
'However, underlying inflationary pressures are likely to persist given the strong outlook for demand.
'Timely policy action to limit the scope for second-round price increases is, therefore, required. Monetary policy normalisation is also important in the light of relatively modest fiscal consolidation'.
On the overall recovery process among the 34 OECD members, OECD secretary-general Angel Gurria said: "The recovery is strengthening and GDP is growing faster than projected, albeit at different paces across countries and regions."
Gurria highlighted two consecutive quarters of growth in the US, strong activity in Japan, supported in part by vigorous external demand, and a rebound in major emerging-market economies outside of the OECD area.
The writer is with India Strategy Group, Hammurabi & Solomon Consulting
