News: India takes breather from inflation fight

(Forbes 27/04/2007) Mumbai - India’s central bank on Tuesday left key lending rates untouched and introduced measures to counter a surge in foreign funds that is fuelling the rise of the rupee against the dollar.

In an annual report on monetary policy, the Reserve Bank of India predicted that economic growth would slow to 8.5% for the year ending in March 2008, down from 9.2% in the last fiscal year.

Governor Y.V. Reddy left the central bank’s repurchase rate, an overnight lending rate, at 7.75%. It has been raised five times in under a year to suck liquidity out of the system.

He also increased the overseas investment limit for Indian companies to 300% of their net worth, raised the ceiling on mutual fund investments abroad from $3 billion to $4 billion and doubled the current and capital account transaction limits for individuals to $100,000.

The central bank expects inflation to moderate from its current levels of 6% to 5% in this fiscal year. “In the event of demand pressures building up, increases in interest rates may be advocated to preserve and sustain growth in a non-inflationary manner,” the bank said.

The markets responded well to news that the government was taking a breather from aggressively fighting inflation. The Bombay Stock Exchange’s Sensex rose 1.5% Tuesday to 14,136.72. However, the rupee appreciated as well, touching a new high of 41.04 against the dollar.

“The RBI appears comfortable with the slight decline in inflation, but if it moves up they will be ready to raise rates again,” said Bidisha Ganguly, an economist with the brokerage Brics Securities. “This was a good policy and the targets set for growth are very realistic.”

The strategy is to liberalise capital outflows in the hope that net inflows will drop, she said. Foreign investors are pouring billions of dollars into India’s booming stock markets and to expand operations in the country, encouraged by a strong growth rate and lower costs here. Foreign exchange reserves in India touched a new high of $200 billion this month.

“Foreign exchange inflows can potentially reduce the efficacy of monetary policy tightening by expanding liquidity,” the central bank said in a statement. It wants to reduce the growth of money supply to 17%-17.5% in this fiscal year, below the present rate of around 20%.

Business groups reacted positively to the policy, calling it an acknowledgement of the fact that growth cannot be sacrificed in the fight against inflation.

“The various measures announced in the policy, which also indicate certain degree of liberal approach to outward flow of foreign currency, are most welcome… since they would definitely have a sobering effect on the rapidly appreciating rupee,” R. Seshasayee, president of Confederation of Indian Industry, said in a statement.