To exit or not to exit

Tue, 19 Jan Pre-Open

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With inflation in India charting an upward path, the RBI is toying with the idea of withdrawing the economic stimulus. But the task is indeed challenging. In fact, the RBI governor Dr. Subburao has said that timing the removal of stimulus is a challenge. He said, "The challenge for the RBI is to support the recovery process without compromising on price stability."

India had introduced stimulus measures as the global recession intensified. As reported on Bloomberg, this amounted to more than 12% of GDP between September 2008 and April 2009. This was largely instrumental in helping the economy grow 7.9% in the September 2009 quarter, the fastest pace in more than a year. Not just that, despite a lower growth in GDP in FY10, India was still touted to be one of the fastest growing economies in the world. This obviously increased its attractiveness as an investment destination to foreign investors. These investors poured large sums of money into the India stockmarkets. As a result, the indices surged at a time when inflation was already rearing its ugly head.

Thus, all fingers now point to an imminent hiking of interest rates. After all, while food prices have shot up, the inflation index has revealed a rise in prices of non-food items as well. What is more, just recently China's central bank raised the reserve requirements. This was to check price gains and asset bubbles giving the impression that India is also likely to follow suit. Even if the RBI chooses not to tamper with the rates now, it will not have much choice in this regard in the subsequent quarters. Especially, if food prices refuse to cool down!

IMF wary of exiting stimulus
Speaking of exiting stimulus measures, the IMF chief Dominique Strauss-Kahn is of the opinion that some countries may suffer double-dip recession. This will be especially so if they exit strategies taken to deal with the global financial crisis too early. What the governments need to take into account is the recovery in private demand and the rate of unemployment. Only if these turn out to be favourable then the decision to withdraw stimulus measures carries weight.

This has certainly not been the case at least in the advanced economies of US and Europe. These are grappling at present with an unemployment rate as high as 10%. This has obviously had an impact on demand conditions as well. According to the IMF chief an early exit from stimulus measures could backfire. Why? Because countries may not be able to find new tools to deal with a renewed downturn. This is especially after using both fiscal and monetary stimulus measures to tackle the crisis. But predicting the right timing for the exit is very tricky. And even if that dilemma gets resolved favourably, governments will then have to focus their attention on the next equally important problem - reducing the fiscal deficit. Indeed, there are some tough decisions that central bankers and governments around the world will have to take to guide the global economy on its path to recovery.