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Friday, July 04, 2008

Accelerating Indian Inflation Continues to Pressure The Central Bank

Inflation accelerated again in India in the week ending June21, reaching its fastest pace in more than 13 years, and strengthening the case for the central bank to increase borrowing costs again this month. Wholesale prices rose 11.63 percent in the week to June 21, after gaining 11.42 percent in the previous week, according to the latest government report issued in Delhi last Friday.

The Reserve Bank of India, which next meets to review rates on July 29, last month raised its benchmark interest rate twice to a six-year high of 8.5 percent and lifted its cash reserve ratio to 8.75 percent, in an ongoing battle to contain growth in the money supply and rein-in inflation. According to the latest RBI data the money supply rose 20.7 per cent year-on-year basis as of June 20, as against the 21.4 per cent increase recorded for the fortnight ended June 6. The pace of money supply growth is thus still well above the RBI's indicative projection of 16.5-17 per cent set for 2008-09.

As a further inflation control measure the Indian government last week also banned exports of corn. This follows earlier restrictions placed on the overseas sales of other food items including wheat, rice, cooking oils and pulses. India has also banned cement exports and imposed a tax on outgoing shipments of steel products.

Evidently this whole situation presents policy with great difficulties since the driving force behind the lions share of the inflation is now not domestic demand as such but global commodity prices (although of course it is the case that rapid economic growth in the BRICs and other emerging economies lies behind the rapid rise in these prices). Crude oil prices touched an all-time high of $145.85 a barrel on July 3, raising concern India's import costs will once more surge as the country relies on overseas crude to meet three-quarters of its needs.

Rising energy costs have fanned inflation in India by making transport, manufactured products and food more expensive. Fuel, power and electricity prices rose 16.2 percent in the week ended June 21 from a year earlier, while food costs, including bread, salt, cooking oil and tea were up 14.6 percent.

Foreign Exchange Reserves

India's foreign exchange reserves fell to $311.790 billion as on June 27, down from $312.481 billion a week earlier, according to the RBI weekly statistical supplement released on Friday. Reserves rose to a record $316.171 billion in late May and have since declined, mainly due to dollar sales by the Reserve Bank of India (RBI), which has been intervening in the currency market to prop up the rupee and provide foreign exchange to the oil companies who need to use them for their import payments. Foreign currency assets, expressed in dollar terms, include the effect of appreciation or depreciation of other currencies held in its reserves such as the euro, pound sterling and yen.

Foreign institutional investors (FIIs) have also been pulling out a part of their investment from the now volatile Indian stock markets, adding to the downward pressure on foreign exchange reserves. FIIs have sold $6.7 billion more Indian shares than they have bought so far in 2008, following a record $17.2 billion in net purchases last year, according to data from the Securities and Exchange Board of India.

The Rupee

The Rupee fell to a 15-month low this week as data showed the India's trade and current-account deficits are widening after oil prices in New York more than doubled in the past 12 months. The rupee also dropped as losses in local equities spurred speculation overseas funds will pull their money out of the country. The currency declined 0.6 percent to 43.15 a dollar this week as of the 5 p.m. close of trading in Mumbai.

Current Account

India has paid an average $7.7 billion a month for oil imports so far this year, compared with $5.4 billion in 2007, government data show. That widened the trade deficit to a record $10.8 billion in May.

India's current-account deficit narrowed in the last quarter as exports and remittances increased faster than oil imports, the central bank said. The deficit was $1.04 billion in the three months ended March 31 from $5.1 billion in the previous quarter, the Reserve Bank of India said during the week. India last had a current account surplus of $4.3 billion in the quarter ended March 2007.

The rising trend in crude oil costs suggest India's current account deficit may widen this quarter, extending the rupee's losses. The average cost of India's crude oil import basket, a mix of Dubai and Brent, almost doubled to $93.9 a barrel in the quarter ended March 31. The international price of oil has surged 41 percent since then.

India's merchandise exports rose 20 percent to $42.8 billion in the quarter ended March 31 from a year earlier, while imports gained 37 percent to $66.6 billion. Invisibles, an item which includes both software exports and remittances from Indians working abroad, increased 26 percent to $22.8 billion.