India Wholesale Price Inflation March 1 2008

India's inflation unexpectedly accelerated to a nine-month high at the begining of March, making it more difficult for the central bank to reduce interest rates in an attempt to respond to slowing economic growth. Wholesale prices rose 5.11 percent in the week ended March 1 from a year earlier, faster than the previous week's 5.02 percent, according to the Ministry of Commerce and Industry in New Delhi on Friday.

Crude oil jumped to an all-time high of $111 this week, putting pressure on India's government to continue increasing prices following February's initial increase in the cost of retail gasoline and diesel. Central bank Governor Yaga Venugopal Reddy last week said rising food and energy prices pose ``acute policy dilemmas.'' Reddy also indicated that benchmark interest rates, currently at a six-year high, won’t be coming down in a hurry, due to the current inflation and the current uncertainty in the global financial markets.

Reddy recently stressed that tackling inflation was a higher priority for the RBI than boosting economic growth.

"The large segments of the poor tend to reap the benefits of high growth with a time lag while the rise in prices affects them instantly.....Considerable weight is currently accorded by the Reserve Bank of India to price and financial stability while recognizing its twin objectives of growth and stability."

Speaking following the latest inflation announcement he did hint, however, that the Reserve bank of India (RBI) might offer some relief to banks by widening the liquidity adjustment facility (LAF) corridor. He stressed that this action would be taken as a response to the difficulties being presented by the current global uncertainty. The LAF corridor is the difference between the repo (rate at which the RBI lends overnight money to banks) and reverse repo (rate at which banks park their surplus cash with the RBI). Reddy said that the current 175 basis point difference between the RBI’s repo and reverse repo rates was a direct reflection of the level of uncertainty in financial markets. The repo rate is at 7.75%, while the reverse repo rate is 6.0%. The margin can be widened by either raising the repo rate or cutting the reverse repo rate.

Reddy has also indicated that the current wide gap between the policy rates is the result of monetary operations and not the consequence of a specific predetermined policy decision.

One of the key questions lying in the background here is the functioning of the market stabilisation scheme (MSS). The MSS is essentially a liquidity absorption mechanism which has been adopted by the RBI and involves the issuance of treasury bills and bonds to suck out excess liquidity as foreign capital inflows continue. The need to service the coupons on these bills has increased the government’s fiscal burden and as a result affected the fiscal deficit target mandated by the Fiscal Responsibility and Budget Management (FRBM) Act.


The scheme has become an embarrassment for policy makers as the MSS target of Rs 250,000 crore exceeded government borrowings of around Rs 111,196 crore. As a result the government’s liquidity management function has gone well beyond mere borrowing to meeting current expenditure needs. The government is absorbing funds to manage liquidity and compensating by making coupon payments on treasury bills and bonds issued under MSS rather than borrowing for planned expenditure. The result is that in order to address the twin requirements of meeting the FRBM target of reducing the fiscal deficit to 3 per cent of GDP by the end of the next financial year and of maintaining inflation within the RBI target range, the government may have to sacrifice public welfare expenditure if inflows continue at the current rates.


Bank Lending and Financial Inflows


Meannwhile bank lending continues to rise, being up 21.88% year-on-year in the two weeks to February 29, 2008, as compared with a 21.84% growth logged in the fortnight ended February 15, according to Reserve Bank of India data released on Friday. Outstanding loans rose by Rs 41,481 crore to Rs 22.51 lakh crore in the two weeks to February 29. Non-food credit rose by Rs 39,988 crore to Rs 22.07 lakh crore over the two weeks, while food credit rose by Rs 1,493 crore to Rs 44,311 crore in the same period. Deposits were up 23.7% in the two weeks to February 29 from a year earlier. Banks' deposits rose by Rs 43,539 lakh crore to Rs 30.81 lakh crore.

At the same time the country's foreign-exchange reserves continued their upward march and increased by $2.2 billion in the week ended March 7 to $303.5 billion, the central bank said.




The Weakening Rupee


One of the greatest incognitas on the India macro economic horizon at the present time is the future path of the rupee. The rupee has been weakening steadily over the last couple of months, and has fallen more than two per cent against the dollar so far this year (at the same time, it will be remembered that the dollar is also falling quite substantially). Conventional explanation of this movement are the pressure produced on the currency by equity outflows and a severe shortage of spot dollars in the market. India Sensex, which has been Asia's worst-performing major benchmark index so far this year, fell 1.4 percent again last week, declining for a second week in a row after industrial production growth slowed in January, a reflection the higher interest rates are having on demand for consumer durables. Rising credit defaults in global stock markets have also had an impact on Indian stocks.

Curbs on foreign borrowing imposed by the government last year and the global credit woes caused by the US subprime crisis have also reduced the appetite for Indian equities.

After gaining more than 12 per cent in 2007, the rupee has fallen steadily in 2008, and is now around 40.5 per dollar, its weakest level since mid-September and well off the near 10-year high of 39.16 reached in November.



The rupee really started to drop significantly in February following the withdrawal by the Indian unit of Emaar Properties of its $1.8 billion initial public offer (IPO) due to the volatile situation in the Indian stock market. Foreign investment in IPOs had constituted a major support for the rupee in January, when Reliance Power raised $3 billion within a minute of opening for sale. India's trade deficit, which has suffered on the back of the rise in the rupee - and which swelled to $9.4 billion in January, more than three times larger than in the same month a year earlier - clearly hasn't help undrepin expectations for a continuing rise in the currency. In February, US investment bank JP Morgan - feflecting widespread sentiment in the banking and investment sectors - lowered its forecast for the rupee to 40 by March 31 from its earlier projection of 38.5.



Foreign funds have pulled more than $3 billion out of Indian shares so far this year, and the outlook remains full of uncertainty. Slowing economic growth, the government's reluctance to push ahead with reforms in the run up to national elections and the benchmark Sensex share index's 25 per cent tumble from its high in January have all served to spook investors. External pruchasers seem to have moved large quantities of cash into Indian shares to take advantage of arbitrage opportunities between the cash and futures markets, rather than as the result of any strong convictions about underlying fundamentals.

Not everyone, however, is convinced by the standard explanations, and some analysts are arguing that the weakening in the rupee has been engineered by the Reserve Bank of India, which bought dollars heavily through 2007 to slow the currency's appreciation as it began to squeeze the margins of export-focused companies in sectors like software and textiles.

Ila Patnaik, a senior fellow at the National Institute of Public Finance and Policy, points out the apparent inconsistency in the fact that the rupee's decline in February came even as India's foreign exchange reserves jumped by $11.7 billion on the month to reach a record of $301.2 billion.

"This suggests that the depreciation of the rupee was engineered," she wrote in The Indian Express last Wednesday, arguing the rise in reserves could not have come from the revaluation of other currencies or gold against the dollar.

Patnaik suggested that the hefty US interest rate cuts were drawing cash into higher-yielding Indian assets. India's benchmark lending rate at 7.75 per cent against the Federal Reserve's three per cent offered a 4.75 percentage arbitrage opportunity for foreign investors.

"Interest rates in India are higher and if the rupee was also going to get stronger, dollar returns would be even higher," Patnaik wrote. "In this situation, the RBI may have tried to break the one-way bet by pushing the rupee to depreciate."

Will the rupee's decline be an enduring phenomenon, or will the market turn? Perhaps in the short term the rupee may well not strengthen significantly, but the long-term outlook for the rupee has to be bullish simply because India's $1 trillion economy, which is Asia's third-largest after Japan and China's, is set maintain robust growth of eight per cent plus in 2008, and could this pace could even accelerate further over the next couple of years.

The Slowdown in India Bank Lending

Joe Leahy has an article on this interesting topic in the Financial Times this moprning. He suggest India is beginning to experience its own version of a credit crunch as banks tighten lending procedures to curb rising delinquencies, particularly in small unsecured personal loans. He argues that India’s financial system has so far been spared much of the pain of the global subprime crisis because of the relatively small size of its banks and their conservative investment focus overseas.

But persistent inflationary pressure has forced the Reserve Bank of India, the central bank, to keep interest rates high, which in turn has hit retail credit, from home loans to car and personal unsecured loans.

Overall loan growth in India, which has been on a downward trend since peaking at nearly 40 per cent in early 2006, has slumped to about 20 per cent this year due to real lending rates that are among the highest in Asia at about 7 per cent, according to Credit Suisse.

The slowdown has been felt most acutely in what was formerly one of the sector’s fastest growing segments – personal unsecured loans – which includes credit cards and micro “small ticket” loans. The small ticket loans form what analysts have loosely dubbed India’s “subprime” segment, although unlike in the US, these borrowers are low-income earners – blue collar workers and self-employed traders – and not people with a poor credit history.


However, while the growth in defaults in small ticket loans has only had a marginal impact on overall credit quality, it has scared Indian banks into becoming more conservative about their lending. This has led to a tightening in consumer loans across the board and taken some of the gloss off India's economic outlook on the basis of reduced expectations for economic growth.

I had previously taken the view that India’s gross domestic product growth might well exceed 10 per cent in the near future, and I still hold to that view, but over the coming 12 to 18 months figure of 8-9 per cent is now looking more realistic. Should we call this a "mini recession" or simply a growth slowdown?

ICICI, India’s largest private bank, withdrew altogether from small ticket lending six months ago and now only provides credit to the “prime personal loan” segment, or facilities above about Rs100,000 ($2,500, €1,600, £1,200).

India Industrial Output January 2008

India's industrial production growth slowed in January as interest rates near a six-year high curbed demand for cars and other consumer goods. Production at factories, utilities and mines rose 5.3 percent from January 2007 after gaining a revised 7.7 percent in December, according to data from the statistics office in New Delhi.




Today's report also showed that industrial production grew 8.7 percent in the ten months ended Jan. 31, slower than 11.2 percent in the same period twelve months earlier.

Finance Minister Palaniappan Chidambaram in his Feb. 29 budget cut duties and reduced the tax burden on individuals to spur consumption after nine rate increases by the Reserve Bank of India in the last three years curbed demand. The central bank last week said it faces policy ``dilemmas'' as economic growth slows and inflation accelerates.

Bank governor Reddy has raised the central bank's benchmark rate nine times since October 2004 and ordered commercial lenders to set aside more money five times since December 2006 to prevent excess cash in the economy from stoking inflation, currently at a nine-month high of 5.02 percent. He also reiterated last week that tackling inflation is a higher priority than boosting growth.

Higher rates have forced ICICI Bank - India's biggest by market value - and its peers to raise their lending rates, reducing demand for motor vehicles, homes and washing machines.

Passenger vehicle sales rose 13 percent to 1.26 million units between April and January, slower than the 21 percent pace for the year ended March 31. Production of two-wheeled bikes at Bajaj and TVS declined 3.6 percent in January.



Chidambaram in his budget cut the excise on small cars, buses, motorcycles and scooters to 12 percent from 16 percent and raised the income tax exemption limit to 150,000 rupees ($3,700) from 110,000 rupees to spur consumption.

Manufacturing, which accounts for about 80 percent of India's industrial production, gained 5.9 percent in January from a year ago, according to today's report. Consumer-goods output jumped 7 percent, mining grew 1.8 percent and electricity increased 3.3 percent.

Consumer durables production, including washing machines and television sets, fell 3.1 percent in January after increasing 5.3 percent a year earlier. Output of capital goods rose 2.1 percent compared with 16.3 percent a year ago.

The slowdown in capital goods output growth, a lead indicator of investor activity, is worrying since investment has been the main driver of strong economic growth in recent years.

Higher interest rates have also curbed loans growth. Lending rose 21.8 percent in the 12 months to Feb. 15, less than the 29.6 percent expansion a year earlier.


Chidambaram last week said there is a need to reduce loan rates for homes and consumer durables as they are the key drivers of the economy, and he has been urging commercial banks to lower lending rates to revive slowing loan growth and help boost investment as consumer goods sales begin to decline.

India needs faster industrial production to lift economic growth, which is expected to be 8.7 percent in the year to March 31, the slowest in the last three years. Still, growth will have averaged 9.2 percent since 2005, the quickest pace since India's independence in 1947 and behind only China among the world's major economies.