India continues aggressive tightening

By James Lamont in New Delhi

Published: March 17 2011 07:35 | Last updated: March 17 2011 07:35

India has shrugged off fears about the effects of the earthquake in Japan and turmoil in the Middle East by continuing its aggressive campaign of raising interest rates.

The Reserve Bank of India on Thursday responded to doggedly high inflation and quickening economic growth by raising its policy rate by 25 basis points, following a similar increase in January.

The move takes the repo rate, the rate at which the central bank lends to commercial banks, to 6.75 per cent, its highest since early 2008. The reverse repo, the rate at which the central bank absorbs money from the system, was raised 25 basis points to 5.75.

The move was the eighth interest rate rise in a year, making India the most active tightener of monetary policy among the Group of 20 leading nations, as it fights the highest inflation of any major Asian economy.

Most economists had predicted the magnitude of the rate rise in the face of volatile food prices, rising energy costs and alarmingly high headline inflation of 8.3 per cent in February .

"Things are not as clear as they were a month ago," said Sonal Varma, economist at Nomura, the Japanese banking group, in Mumbai. "The RBI has to be a bit more cautious. The balancing act [between inflation and growth] is getting tougher."

Brian Jackson, chief emerging markets strategist at the Royal Bank of Canada, said other Asian countries would likely follow India’s lead and make policy moves against inflation in the coming weeks. “So far it looks like the Japanese disaster will not have a significant impact on growth in other Asian countries, nor do we expect it to have a significant disinflationary influence on the region,” he said.

The country’s leading industrialists, however, have expressed anxiety about sluggish industrial production growth. They lobbied the central bank to stay its hand in light of rising crude prices, and the effect on the global economy from the recent earthquake in Japan.

They have complained about the rising cost of capital – with prime lending rates upwards of 12.75 per cent - choking off economic growth. Rajiv Kumar, the director of the Federation of Indian Chambers of Commerce and Industry, said there was growing uncertainty in the investment environment.

“The growth of manufacturing sector is moderating. The rising cost of capital may be responsible for a slowdown in investments,” he said.

However, their calls come as economists are forecasting GDP growth to rise to as much as 9.25 per cent in the coming fiscal year, which begins next month, from 8.6 per cent this year.

India is pursuing a high growth strategy and braving the pains of high inflation. Manmohan Singh, the prime minister, said this year that more could have been done to curb inflation but warned that such measures would have jeopardised India’s quest to reach double digit economic growth.

Other policymakers, such as C. Rangarajan, chairman of the prime minister’s economic advisory panel, has insisted that India must not lose sight of its goal to bring inflation back to nearer 3.5 per cent in a country where rising consumer prices hurt a population of 1.2bn people, many of whom survive on meagre incomes.

Inflation has not fallen in recent months as quickly as expected in the world’s fastest growing large economy after China. The government had taken emergency measures to alleviate price rises in agricultural commodities – such as onions – but recent data show that price pressures are now building among non-food manufactured products.

“Inflation rose to 8.3 per cent in February and the concern is really with the increase in prices of manufactured products, which have increased by 4.94 per cent in February from 3.75 per cent in January,” said Madan Sabnavis, chief economist at Mumbai-based Care Ratings.

Economists increasingly identify a structural change in prices – particularly in agriculture – in India. They expect another two rate rises in India this year, the first as early as May.

This is because, in spite of ambitious fiscal consolidation targets laid out by the finance ministry, they still regard monetary policy as the main tool to control rising prices against a backdrop of swelling public spending.

However, with global markets in turmoil since the Japan earthquake, some economists now say widespread rate increases across Asia are now no longer a certainty.

“Over the next couple of months, we had expected China, India, Indonesia, Korea, the Philippines, Singapore, Sri Lanka, Taiwan and Thailand to tighten monetary policy further,” said Frederic Neumann, co-head of economic research in Asia at HSBC, the banking group.

“Financial market volatility could delay these moves well into the second half, if not further,” he said.

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