Inflation forces India into fresh rate rise

By James Lamont in New Delhi

Published: June 16 2011 09:20 | Last updated: June 16 2011 18:06

Stubbornly high inflation has forced India to raise benchmark lending rates for the 10th time in 18 months as its central bank struggles to curb curb rising prices in the absence of tough fiscal action.

India has the highest inflation of any major emerging market, and has battled to bring it under control over the past two years by leaning heavily on monetary policy.

Originally triggered by high food prices, inflation has in recent months become more generalised across the economy. In May, inflation was 9.1 per cent, almost double the level in neighbouring China.

The Reserve Bank of India on Thursday said it had tightened monetary policy in response to “uncomfortable levels” of inflation. It raised the repo rate – the rate at which the central bank lends to commercial banks – to 7.5 per cent, while the reverse repo was increased to 6.5 per cent.

The central bank dispelled fears that the rate hikes had prompted “any sharp or broad-based slowdown” in the world’s fastest growing large economy after China.

The RBI also warned of a worsening global environment, airing its concern about the collapse of a recovery in the US as its ultra-loose monetary policy nears an end and highlighting the threat of high commodity prices to emerging markets.

Rajiv Kumar, director-general of the Federation of Indian Chambers of Commerce and Industry, said the RBI had to act in the face of high inflation but urged the government to take steps to restore investor confidence in the economy.

“The RBI has hardly an option but to raise its rates,” he said. “But it needs to be careful not to administer medicine that pushes the patient into a downward spiral.”

He said the Congress party-led government and the RBI had to “synchronise efforts” better to fight inflation.

The government has faced criticism that it has left the RBI to shoulder the burden of fighting inflation, while continuing to stimulate an economy that grew at 8.5 per cent last year.

There are concerns that New Delhi will fail to cut spending sufficiently to meet its fiscal deficit targets this year, having previously overstimulated the economy in response to the global economic downturn.

There is also frustration that parliamentary paralysis caused by a bitter standoff between the government and the Hindu nationalist opposition is blocking reforms that would otherwise revive business confidence and help trigger investment in expanding industrial capacity.

Many economists expect another rate rise another rate rise within the next six weeks.

Robert Prior-Wandesforde, an economist at Credit Suisse, said he expected the RBI to raise the repo rate another 50bp to 8 per cent by mid-September.

“The obvious danger involved with a sizeable interest rate tightening is that it will discourage the investment spending necessary to help ease the country’s capacity constraints,” he added.

“But at this stage the RBI’s number one priority must be to break the wage-price spiral, which itself is extremely harmful to the country’s investment prospects.”

Other analysts warned that should energy prices not cool and the government fail to push ahead with reforms, the RBI could be forced to raise the repo rate beyond its 9 per cent peak before the global financial crisis.

Copyright The Financial Times Limited 2011. Print a single copy of this article for personal use. Contact us if you wish to print more to distribute to others.

"FT" and "Financial Times" are trademarks of the Financial Times. Privacy policy | Terms
© Copyright The Financial Times Ltd 2011.