News: Reserve Bank of India - now it's serious

(RTR 03/08/2006) Mumbai - India's economy is likely to face continued price pressures from costly oil and strong domestic demand but two rate rises in as many months have convinced analysts the central bank is serious about fighting inflation.

Although inflation has remained benign in recent weeks, thanks largely to a high base last year, the two 25-basis-point increases in interest rates show it is the priority for the central bank, even if the consequence is some slowdown in growth.

"I'm sure if inflation begins to really spiral out, they will go out there and show no mercy," said Sanjeev Sanyal, a Singapore-based economist at Deutsche Bank.

After leaving rates unchanged at its April meeting, to the concern of some analysts, the Reserve Bank of India (RBI) has now pushed its benchmark rate up to 6.0 percent.

Wholesale price inflation is running at about 4.5 percent after rising to nearly 5.5 percent in June, the top of the central bank's forecast year-end range, and the economy grew by an annual 9.3 percent in the January-March quarter.

Pressure on prices is coming from robust domestic demand and high oil and raw material costs, and analysts expect these to persist, with manufacturers passing the effects on to consumers.

Earlier this week, India's largest car maker, Maruti Udyog Ltd., a unit of Japan's Suzuki Motor Corp., and the country's top motorcycle maker, Hero Honda Motors Ltd., raised prices on some of their models, citing high input costs.

The RBI has a dual remit -- price stability and ensuring that there is adequate credit to support economic growth.

But blistering credit growth of more than 30 percent on the year, triggered by manufacturing expansion, growing consumption and a booming real estate market, is worrying the central bank, which says it wants the pace to slow to 20 percent.

"Most likely, demand-driven inflationary pressures will become more palpable, though food inflation could soften," said JP Morgan economist Rajeev Malik.

OIL A WILD CARD

India imports two-thirds of its oil and the price is a wild card the RBI can do little about.

The question is: when will the communist-backed government raise retail fuel prices again, after a long-delayed and controversial increase in June that prompted the central bank to raise rates?

June's increase, after nine months during which retail prices were left unchanged, pushed diesel up 6.5 percent and gasoline up 9 percent.

Malik said the government would be under pressure to jack prices up again if crude remained high. But other analysts say it will try to insulate consumers for as long as possible.

"Definitely, the situation is quite challenging for the government as it has to do the fine balancing act of choosing options which are palatable and still not risking inflation and growth," Shubhada Rao, chief economist with YES bank, said.

With coalition politics likely to make another increase tricky, the government would probably choose a softer option like subsidising state-run petroleum firms with oil bonds, she said. These are issued by the government to the oil companies, which can then sell them to get the cash they need to subsidise fuel.

Finance Minister Palaniappan Chidambaram says the government is open to taking fiscal steps to contain inflation if needed.

ONE EYE ON THE FED

A Reuters poll conducted after last week's increase showed nine out of 10 analysts expected another interest rate rise this fiscal year ending March 31.

However, analysts say the RBI, which has tightened by 150 basis points since October 2004, will want to gauge the impact of its most recent increases before making another move.

The initial effect of higher borrowing costs will only just have kicked in by the time it holds its next meeting in October.

In addition, the RBI has started to pay more attention to interest rate moves abroad and, with that in mind, has even shifted a policy meeting planned for Oct. 17 to the last day of that month, six days after the U.S. Federal Reserve meets.

Analysts say that, because the Fed is expected to pause in its tightening cycle soon, India could have some breathing space until the RBI's rate meeting scheduled for December.

That should ensure the economy keeps on growing, with analysts saying there is plenty of investment in the pipeline to ensure expansion of 7.5-8.0 percent this fiscal year, as forecast by the central bank.

"And most of these (investments) I do not think are so sensitive to these kind of interest rate movements," said Manju Ghodke, an economist with engineering firm Larsen & Toubro.