By Sumeet Chatterjee

NEW DELHI, Dec 2 (Reuters) - India's real rate of inflation rate is understated, and the central bank must do more to stem short-term capital inflows that have pushed the rupee up and fuelled liquidity, the chief economist of Standard Chartered Bank said on Sunday.

India has been taking steps to slow the inflow of foreign capital which has sent the rupee to its highest in nearly 10 years against the dollar and affected some labour-intensive merchandise exports such as textiles and handicrafts.

Gerard Lyons, Chief Economist and Group Head of Global Research at Standard Chartered Bank, told the World Economic Forum's India Summit that while India's economic growth was impressive, it was "inevitable" that the numbers would become more volatile, particularly as the U.S. economy slowed next year.

"The good is the economic outlook, the bad is the inflation prospect, and the ugly is the currency issue," Lyons said.

"Inflation is being suppressed, and it is likely to become a bigger issue in the next couple of years."

India's wholesale price inflation, the most widely watched measure, is at its lowest in five years, just above 3 percent annually in November, but analysts say the low reading masks the real picture, which is probably much higher than the official data and closer to less frequently published consumer price inflation of about 5.5 percent.

"The two sources of inflation here in India are liquidity and fuel prices. Thankfully, as yet inflation expectations and also wages have not yet risen, but this is a growing problem," Lyons said.

The government puts a ceiling on retail fuel prices and has been reluctant to raise them, even though global oil prices have neared $100 a barrel. State-run oil firms are losing $50 million a day as they have to sell petrol and diesel below market prices, which keeps inflation artificially low.

India, the world's fastest growing major economy after China, has expanded at an average 8.6 percent a year in the past four years and growth for this fiscal year is expected to come in at a similar level, despite a series of tightening measures by the central bank.

The central bank has repeatedly expressed its concern that higher oil prices are not passed through to domestic prices, which it says poses a risk to the economy.

"Thankfully, the central bank has tightened policy. It's also tried to tighten up short-term capital inflows, but it's not really doing enough, and it will need to do more," Lyons said.

The central bank has lifted interest rates five times since mid-2006 and tried to absorb extra cash coming into India from foreign investors by raising banks' reserve requirements.

The government has also limited the amount of debt that Indian companies can raise abroad and then repatriate, and the stock market watchdog recently cracked down on foreign portfolio investment through indirect investment instruments.

The rupee, which has gained about 12 percent against the dollar this year and is one of Asia's top-performing currencies, remains under upward pressure, and the central bank has been intervening to cap its gains and keep exports competitive.

Some exporters have complained to the government and it has announced relief measures, such as lower duties on textiles fibres, and offered to share more of the interest burden on loans for some sectors.

Lyons expected the rupee to appreciate further and B. Ramalinga Raju, founder and chairman of Satyam Computer Services <SATY.BO>, who was also speaking at the forum, said the speed of its appreciation was also a concern.

"The fact that the strengthening of the rupee has taken place over a very short period, it is more worrisome," Raju said.

Rahul Bajaj, chairman of Bajaj Auto <BJAT.BO>, said parts of the economy were under pressure as a result of the rupee's rise.

"Exports are suffering, seriously suffering. So are industries such as auto components and textiles. People are losing jobs," Bajaj said.

Chief executives of multinationals and senior Indian policymakers are gathering at the WEF India Summit, ahead of the WEF's main annual summit in Davos early next year, to discuss the sustainability of India's growth and its emergence on the global economic stage. The conference runs until Dec 4. (Additional reporting by Surojit Gupta, writing by Charlotte Cooper, editing by Will Waterman) (([email protected]; +91 22 6636 9257; Reuters Messaging: [email protected]))

Keywords: INDIA RUPEE/