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Kalpana Kochhar, senior advisor in the Asia and Pacific department of the IMF, in an interaction with journalists during last week's annual World Bank/IMF meetings, when asked about the main concern in India currently, said, "Inflation is a big issue - it is 7.5 per cent - and this may not seem very high, but politically it is a hot issue, as you know."
"It's mainly due to food, fuel, and some due to metals," she said, adding, "The other thing is, activity has come off a very fast pace, but it is still pretty strong. So, there is a real question about dealing with inflation, even though it seems to be mostly supply driven, before it becomes entrenched in expectations, and spills over into the second-round effects David spoke about."
Earlier, David Burton, director of the Asia and Pacific department at the Fund, who also participated in the briefing, noting that growth in countries like India in the Asian region, are starting to slow and inflation is rising significantly, acknowledged that "now this increase initially reflected spikes in food and commodity prices, and those pushed up headline inflation numbers, and that is something that is likely to be bolstered by the recent increases in rice prices that we have been seeing, and prices reached 10-year highs."
"However, what we're also seeing is that second-round effects," which he argued "are starting to kick in a number of countries, reflecting the fact that domestic demand has been still pretty strong in many countries, and we are seeing that core inflation is starting to pick up, quite significantly in fact in a number of countries such as Indonesia, India, and Vietnam, and others too."
Burton said that "at the same time, we are seeing producer price inflation is now rising quite rapidly across many countries in the region, and that points to a compression of profit margins and the possibility of further inflationary pressure ahead. So, inflation is becoming quite a significant issue around the region," and when asked specifically about India's case, declared that it "deserves some attention immediately."
Kochhar agreed and said, "That really is an issue there," and added, "the stock market has come off, but there are still capital flows because there is a growth story there. And so the challenge of managing capital inflows, while doesn't seem to be as huge of an issue as it was a year ago, it still continues."
She said there was a need for exchange rate flexibility whereby the exchange rate has to be allowed "to appreciate a little, to take pressure off imported inflation, but also to help corporate capital inflows." Kochhar said such issues still remained in terms of India as well as the issue of the fiscal situation, "but probably 80 percent of GDP. Some progress made there, but much more to be done."
"So, in some sense, the issues haven't really changed that much," but she reiterated, "the immediate issue is inflation, coping with it."
Asked about the concern in the past several months over the rupee-dollar exchange rate fluctuations, and the implications of this for India both in the short and medium-term, Kochhar said, "Just to put it in perspective, there was a fairly sharp appreciation of the rupee about this time last year."
But, she pointed out that "actually, the rupee has remained stable against the dollar since then," and noted that "in our consultation report, we took issue with whether that was the right policy response to capital inflows."
Kochhar predicted that "in the medium-term, productivity differentials between India and the rest of the world would suggest that capital inflows would continue, perhaps not at the level that we saw in the middle of last year, so that would argue that there would be a tendency for the exchange rate to strengthen over time."
Burton, while agreeing with Kochhar assertions on this front, however, said that "one needs not to look at just the exchange rate vis-�-vis the dollar, one needs to look at the exchange rate in effective terms."
He said, "At a time when the dollar has been weakening quite a lot, if you just look at the dollar rate, you can get a rather misleading impression of what exchange rate policy has been."
Burton said that "it may look like a currency that has been strengthening a lot, whereas in reality, in effective terms, it has not been doing very much at all."
He said this is true when one considers the Chinese currency too where "it has moved quite fast against the dollar since late last year, but if you look at it in effective terms, it has not moved very much at all. You will find the same thing if you look at India as well."
Burton said the rupee "may have moved quite a lot against the dollar in the past year, albeit most of it in a spurt about a year ago, but in effective terms it has probably moved a lot less."
"If you worry about competitiveness of exports generally, then if you look at it in effective terms, you realize that it is less of a worry than you might think," he added.
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