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Tuesday, July 29, 2008

India's Central Bank Raises Interest Rates Again in July

India's central bank raised interest rates for the third time in two months today and at the same time raised the cash reserve ratio that banks have to maintain in deposits with them. The Reserve Bank of India increased the benchmark repurchase rate to 9 percent from 8.5 percent, while the cash reserve ratio was increased to 9 percent from 8.75 percent. The bank has now has raised rates by 125 basis points and the cash reserve ratio by three-quarters of a percentage point since the start of June.

India's benchmark stock index fell 3 percent on the news to 13,919.01 at 12:05 p.m. in Mumbai, while the yield on the benchmark 10-year bond yield rose to 9.44 percent from 9.07 percent. The rupee gained to 42.545 against the dollar from 42.59 earlier.

India has now been joined by a growing list of Asian and Latin American central banks who are tightening monetary policy (and in the process sending Japan's export dependent economy off into recession it seems). The Philippine central bank has raised rates at its last two meetings, while the Bank Indonesia has boosted borrowing costs for three straight months. Thailand raised its benchmark for the first time in two years this month and Pakistan is expected to follow suit later today. Brazil only last week raised rates by three quarters of a percentage point to 13%.

India's inflation held near it's fastest pace in more than 13 years in the middle of July. Wholesale prices rose 11.89 percent in the week to July 12, after gaining 11.91 percent in the previous week, the commerce ministry said in New Delhi last Friday.

And things may not improve quickly since the June-September monsoon, which accounts for four-fifths of the nation's annual rainfall, was 33 percent below average in the week ended July 23, raising concerns that there is no easing of food price inflation in sight. Rains in July account for a third of the monsoon season and are crucial for the sowing of crops, including corn and soybeans.

At the same time the hike in the CRR will also be noticed, since overnight cash rates rose to a fresh six month high in the middle of last week as a result of the tightening of liquidity following the earlier increase in banks' cash reserve ratio. On Wednesday last week call rates hit a high of 9.85 per cent, which is the highest since January 18. They were however back down to the 9.50/9.60 per cent range on Thursday. Obviously the new increase will push these rates up even further.

India's economic growth has already slowed somewhat, and held at its weakest pace since 2005 in Q1 2008 as the highest interest rates in six years discouraged consumer spending and investment, while a more complex global environment reduced the possibilities for expanding India's exports. India's economy expanded at a year on year rate of 8.8 percent in the three months to March 31, matching the revised gain of the previous quarter.


aramu said...

Really nice article.

here are my doubts about india:
1. Politicians as always, and everywhere, dont care about long term benefits to the country or society, hence they are not solving infrastructure problems which is becoming a bottleneck for growth.
2. private investment in infrastructure is very risky (bangalore-mysore freeway is mired in red-tape since 7-8 years) hence i dont see infrastructure improving much.
3. in china thats is never a issue, its get done by the party, and it does appear that the party is interested in promoting china as a super power, its not the case in india (they are busy looting for themselves till they are in power).

i am not an economist hence i am clueless about the problems infrastructure presents to economic growth, please shed some light?

India has gone through a real estate boom, which maybe going bust right now. most of it was done with atleast 10-20% down payment, but if there is any pressure on jobs, we can see defaults go through the sky since most people spend almost 50% of income to service the mortgage.

i have left the same comment on seekingalpha under "Techy"

Edward Hugh said...

Hello aramu,

"Politicians as always, and everywhere"

Well exactly, so this is not an especially Indian problem. As economist we need to fator in this "studpidity" component. That is, GDP growth does not depend on exclusively on politicians, thank god. Even a country like Argentina can grow at 6% per annum.

Obviously it is desireable that politicians make thing better rather than worse, but alas this is seldom the case. I would say you are right to raise infrastructure issues, this is definitely holding back growth in India, but what is so impressive is that even with all the holding back you are still getting 8% growth.

Fiscal concerns are another issue, and there is a real danger now of credit downgrades from the rating agencies, which will make longer term money (ie not short term demand control monetary policy) more expensive, which will of course make development more expensive.

On the other hand your central bank are not doing such a bad job. They could obviously have acted sooner, but, in that comparison which everyone seems to want to make, they are streets ahead of their Chinese equivalents both in terms of economic acumen and in terms of independence from the central government. So I do think inflation will, eventually, be brought under control.

I would say India is generally streets ahead of China in the level of economic know how.

"in china thats is never a issue, its get done by the party,"

No, but be very careful about what happens next in China. They have not been able to control the growth - and reserve accumulation process on the way up - and I doubt they can do any better on the way down. So we could now see - post Olympics - a very nasty unwind. The export dependent model is completely unsustainable as all major customers - Europe, the US, Japan - border on recession, and they have followed an absolutely stupid policy of trying to control the value of their currency in a very rigid way. Read Brad Setser's blog for more on all this.

The rupee on the other hand has been floating to a far greater degree.

"India has gone through a real estate boom, which maybe going bust right now."

I wouldn't say you were in a bust, but rather in a "correction", which is different. A bust is what just happened in the US, Spain and the UK.

India's property will levelk out and then start to move on upwards. Of coures having the general CPI at 12% helps in this sense, since property only has to remain stationary for a couple of years for a substantial relative correction to work itself through. Bernanke is obviously not completely crying about the 5.6% inflation they just clocked up in the US, since while in the short term this hits consumer purchasing power, in the mid term it also sweats off debt, which is good for borrowers and bad for savers.

China also has a huge labour supply distortion coming in the pipeline following 30 years of one child per family administrative fertility policy. Basically China is not a market economy, and doesn't seem likely to me to become one at any time in the immediate future.

In this sense India, for all the failings, is much further along the road, although China has taken a lot of low fruit from the easy part of the tree.

So all in all, I am rather optimistic about India, as long as you weather the inflation and fiscal threat in the short term.