India Price Inflation May 17 2008, Foreign Exchange Reserves Etc.

India's inflation accelerated to the fastest pace in more than three and a half years in the middle of May keeping up pressure on the government and the central bank to do more to tame prices calling into question in the process the rate of achievable economic growth.

Wholesale prices jumped 8.1 percent in the week ended May 17 from a year earlier, according to Finance Minister Palaniappan Chidambaram speaking in New Delhi yesterday.




Bond prices fell after the inflation figure was released. The price of the benchmark 8.24 percent note due April 2018 fell as low as 100.91 per 100 rupee face amount as of 12:28 p.m. Friday in Mumbai from 101.33 earlier.

India's economy expanded 9 percent in the year ended March 31, slower than the 9.6 percent rate recorded in 2006, as reported in this earlier post. and grew at an 8.8 percent year on year rate in the three months to March, identical with the rate in the previous quarter.




Inflation in India is being fueled by higher energy and commodities prices. Crude oil prices have doubled from a year ago and touched an all-time high of more than $135 a barrel on May 22, raising concern India's import costs will rise. India relies on crude oil from overseas to meet three-quarters of its energy needs. The fuels index, which has a 14 percent weight in the inflation basket, rose 7.79 percent from a year earlier, today's report showed. The manufactured products index gained 7.84 percent. Prices of dairy products increased 11 percent, fruits and vegetable prices rose 4.2 percent.


Indian Oil Corp., India's biggest refiner, reported its first quarterly loss in more than two years as the government forced refiners to sell fuels below cost to cushion consumers and contain inflation. The company posted a loss of 4.14 billion rupees ($97 million) in the three months ended March 31.



Foreign Exchange Reserves

Foreign exchange reserves rose $2 billion during the week ended May 23, though the central bank sold dollars during the week to meet importers demand. According to the latest figures released by the Reserve Bank of India in its weekly statistical supplement (WSS), total foreign exchange reserves including gold and special drawing rights (SDR) rose $2,090 million during the week ended May 23.

Almost the entire growth in reserves during the week was on account of the growth in foreign currency assets which went up $2,085 million. Reserves with the IMF rose $5 million, though the value of SDRs and gold in reserves remained unchanged during the week.

The central bank reportedly sold dollars during the week to meet oil importers demand. Besides, the dollar also strengthened vis-a-vis major currencies during the week. However, foreign currency assets when expressed in dollar terms also incorporate the effect of appreciation/depreciation of non-dollar currencies (such as euro, sterling, yen) held in reserves.






The Rupee

India's central bank said this week that it will provide foreign currency to oil refiners against the so-called oil bonds to help them meet the rising cost of crude oil while ensuring the stability of the financial markets. The Reserve Bank of India will buy the securities, issued to oil companies by the government as compensation for selling fuel below cost, through designated commercial banks and provide equivalent amount of foreign exchange. Such purchases will be subject to a limit of 10 billion rupees ($235 million) a day.

India's rupee broke five consecutive weeks of losses after the government eased rules for companies borrowing overseas, effectively doubling the limit on the amount of Indian debt overseas investors can hold, thus encouraging further capital inflows. The rupee climbed 0.8 percent to 42.4575 a dollar at the 5 p.m. close in Mumbai on Friday, up from 42.785 on Thursday.





The government increased the limit on overseas borrowings by infrastructure companies to as much as $100 million from $20 million. The limit for other companies was raised to $50 million from $20 million. Global funds can buy up to $5 billion of government bonds and $3 billion of corporate bonds, raising the caps from $3.6 billion and $1.5 billion respectively.

Policy makers are seeking more inflows from overseas since the rupee dropped more than 4 percent in May to a 13-month low after crude oil advanced to a record, increasing import costs for Asia's third-biggest economy. Global funds sold $3.5 billion more of local shares than they bought this year, compared with a net purchase of $17.2 billion in 2007, a record.

The benchmark stock index has dropped 19 percent this year as a slump in the global credit markets and India's inflation at 3 1/2-year high deterred investors.

India GDP Q1 2008

India's economic growth has slowed somewhat of late 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, the statistics office said in a statement in New Delhi yesterday.




These numbers are hardly indication of a dramatic slowdown, and are still above numbers that people would have been describing as "overheating" only a couple of years ago, but still India is a poor country and population growth is still rapid, so getting headline GDP growth is something of a priority, although the trick is to get it without the accomapnying inflation, especially given what is happening to global food and energy prices.

Naturally the data is producing all manner of reactions, with Finance Minister Palaniappan Chidambaram urging policy makers at the central bank to ensure they don't damp economic growth as they try to slow inflation (which of course has doubled in the past four months to over 8 percent). India's central bank has twice forced banks to set aside more reserves in 2008, after raising its key interest rate seven times in the past 2 1/2 years to 7.75 percent.

The Bank however will take there own view, and are, in my opinion, likely to continue to act to try to contain inflation - which is no easy matter - since if they do not accomplish this it will be hard to sustain the economic growth that everyone so much wants in the longer term.


India's economy expanded 9 percent in the year ended March 31, which is the slowest rate since 2005, according to yesterday's report, but again the order of magnitude in the reduction is small. Growth may slow further to about 8.5 percent in the current financial year, Chidambaram told reporters in New Delhi today.

Manufacturing growth almost halved to 5.8 percent in the three months to March 31, while farm production slowed to 2.9 percent. Growth is holding up as construction gained 12.6 percent, the fastest pace in almost two years, as the government stepped up efforts to build new airports, roads and power plants.

In an attempt to boost growth, the finance ministry this week raised the limit on overseas borrowing by companies for domestic spending. Infrastructure companies can borrow as much as $100 million overseas, up from a previous limit of $20 million, while other companies can borrow as much as $50 million, compared with an earlier cap of $20 million.

Rice Production In Kerala

In an attempt to ensure it can feed India's 600 million poor, the government banned rice exports on April 1, contributing to a shortage on world markets that drove the price of the grain to a record last month and sparked food riots from Haiti to Egypt. The curb caused local prices to lag behind the international increase, encouraging some Indian farmers to switch to more lucrative crops thus further reducing supply.

Kerala offers us one example of what has been happening in this context, since the area growing rice in Kerala has fallen to 276,000 hectares (682,000 acres) in 2006 from 801,700 hectares in 1980, according to the state's Planning Board. Production almost halved to 630,000 tons from 1.27 million during the same period.

The price of rough rice has almost tripled in the past two years, reaching a record $25.07 a 100 pounds on April 24 on the Chicago Board of Trade. It closed at $20.35 a 100 pounds on May 23. In India, rice sells for 18 rupees a kilogram (19 cents a pound) at local markets, and government-run stores distribute it to the poor for a sixth of that price.

Some farmers in Keral have switched to producing rubber since rubber prices rose to a record 123 rupees a kilo in Kerala after crude oil prices more than doubled in a year, according to the government's Rubber Board. The state accounts for more than 90 percent of the natural rubber produced in India, the world's fourth-biggest grower.



The tropical climate in Kerala is ideal for rubber, helping growers achieve an average yield of 1,879 kilograms a hectare, the highest in the world. The area producing rubber has almost doubled to 494,400 hectares during the past 25 years, according to the Planning Board. Still, government curbs on converting paddy land to cash crops do mean that farmers are holding back.

Since 2002, the local government has required paddy farmers to obtain permission to put their farmland to other uses, though construction of houses is permitted in small plots.

The order restricting land use seems not to have been very effective since it isn't widely enforced according to K. Jayakumar, Kerala's agriculture production commissioner. The state plans to introduce rules that will prevent the use of wetland for purposes other than rice.

Labour Shortage?

The prospect of spending six months of the year knee-deep in brown paddy water for scant reward is steadily encouraging rice farmers to abandon their land. About 2.5 million people, or a 10th of the state's population, now work in the Middle East, where they help build apartments, hotels and offices. The exodus has led to a tripling of wages for day laborers who stayed behind, and fueled a building boom on drained paddy fields as engineers, surveyors and construction workers send money back.

Maybe it is worth remembering here that fertility in Kerala has been below replacement level since the 1990s, and it is not clear how or why a state which isn't reproducing itself is able to export labour.

At least 60 percent of the land traditionally used for rice in the Palakkad district, about 110 kilometers northeast of Kochi, Kerala's largest city, has been lost to other crops and to the construction of homes, villas and shopping malls.

The share of agricultural land devoted to food crops, including rice, fell to 12.5 percent in the year ended March 31, 2006, from 37.5 percent in 1981.


A detailed account of how a very similar pathology is leading to very substantial problems in Vietnam can be found in this lengthy post here.