India's Central Bank Reverses Stimulus

By Anjana Pasricha

January 29, 2010

India's Central bank has made its first significant move to reverse stimulus measures taken in the wake of the global financial crisis by asking banks to set aside larger cash reserves. The step is aimed at tackling rising inflation. The Central Bank has also raised its growth forecasts for Asia's third largest economy.

In a statement Friday, the Central Bank said economic growth could reach 7.5 percent for the financial year that ends in March. That is far higher than earlier forecasts of six percent.

But as economic recovery takes root, the Central Bank has moved to check rising inflation, which it estimates could hit 8.5 percent by March.

It has raised by three quarters of a percentage point the cash deposits that banks have to set aside as reserves. This will drain excess cash from the banking system.

It is the first major step by the Central Bank to reverse stimulus measures taken to stabilize the economy after it was rocked by the global financial crisis. Like others governments around the world, India infused its economy with billions of dollars, and slashed interest rates.

The emergency measures helped India emerge faster than expected from the global recession, but it has also fueled high inflation, prompting calls for a tighter monetary policy.

However, the Central Bank has not raised interest rates, for the time being.

India's finance secretary Ashok Chawla says the Central Bank, or Reserve Bank, is moving in a gradual, calibrated manner to handle the economic recovery.

"The Reserve bank has taken a very balanced view of the situation, and rightly acknowledged that managing the recovery is as important as managing the crisis was," he said. "Overall the scenario seems that the growth process is very much on track, it is being handled appropriately, adequately by the Reserve bank, and this should be a good signal for trade, industry and business."

The government's greatest concern is to ensure that the nascent economic recovery is not hurt, while at the same time cooling inflation.

Officials admit that what is most worrisome is food prices, which have increased by over 15 percent, and is hurting middle class and poor people in the country.

India's move to tighten monetary policy comes as several Asian countries also contemplate similar measures. Several Asian economies have begun registering good growth, but are also grappling with inflation.

Economists have warned that stimulus measures will have to be withdrawn gradually to ensure that the slow economic recovery being witnessed in many countries is not damaged.