Tags: India Raises Interest Rates | Warns of Food Inflation

India Raises Interest Rates, Warns of Food Inflation

Tuesday, 25 January 2011 07:14 AM

India's central bank raised interest rates on Tuesday by a quarter of a percentage point to clamp down on resurgent inflation and warned of persistently higher food prices unless steps are taken to boost supplies.

Even though the Reserve Bank of India (RBI) has raised its policy rates seven times since March as the economy revived from the global financial crisis, it said the balance of risks had tilted towards stronger inflation and it was ready to respond if price pressures increased.

That backed expectations the central bank will raise rates again in coming months as home-grown price pressures are fuelled by a surge in global commodity prices that are fanning inflation across emerging markets.

Indian bond yields and swap rates eased after the decision as investors were relieved the Indian central bank matched expectations with a 25 basis-point rise in rates, rather than the 50 basis-point increase some investors had expected.

"India has a serious inflation problem, something officials have been highlighting recently. I suspect the market would have been looking for a bolder move in terms of a 50 basis points move," said Jonathan Cavenagh, senior FX strategist at Westpac Institutional Bank in Singapore.

The RBI raised its repo rate, at which it lends to banks, to 6.5 percent from 6.25 percent and it lifted its reverse repo rate, at which it borrows from banks, to 5.5 percent from 5.25 percent.

Economists in a Reuters poll before the policy decision had forecast the central bank would raise rates by 75 basis points in 2011.

India's food prices have been rising at double digit pace for much of the past year and its headline inflation in December rose to 8.43 percent from 7.48 percent in November.

"As high food inflation persists, the prospect of it spilling over to the general inflation process is rapidly becoming a reality," Reserve Bank of India Governor Duvvuri Subbarao said in a policy document.

"The balance of risk has tilted towards intensification of inflation," he said as the central bank raised its inflation forecast for the end of the fiscal year in March to 7 percent from 5.5 percent.

It said demand pressures in the economy were also rising, illustrated by strong bank credit and corporate sales. In addition, wages were rising as a share of corporate costs.

Apart from a rise in food prices globally, which the United Nations food agency says are at record highs, India is dealing with domestic supply problems that are raising the price of food, including an inefficient farm sector and poor distribution network.

Talk of agriculture reforms in recent years in India has yielded little action in the face of resistance from politicians courting rural voters, and the government has instead relied on stop-gap steps to fight food inflation such as imports, export curbs, and anti-hoarding measures.

"Supply management has to be tackled, supply bottlenecks have to be removed, and on the demand side, excess liquidity is to be mopped up," Finance Minister Pranab Mukherjee told reporters.

"We shall have to deal with the supply management, and for that steps are being made," he said, without giving specifics.

Several government ministers have made clear they oppose aggressive monetary tightening, fearful that any impact on growth could erode their political support ahead of a series of state elections that, if lost, could damage the ruling coalition.

The RBI is trying to balance the need between controlling inflation threats and supporting growth of close to 9 percent.

But it suggested it could not afford to fall behind the curve, thus risking portfolio outflows that would exacerbate the current account deficit, which it projected at 3.5 percent of GDP for the current fiscal year.

It said such a big gap was unsustainable and called for a diversification of exports as well as the need for longer-term capital inflows such as foreign direct investment to help finance the gap.

The combination of inflation, a current account gap and the government's large fiscal deficit "contribute to an increase in uncertainty about economic stability," it said.

India's ruling Congress party is under pressure over rising prices, as well as its handling of corruption scandals.

Although food inflation is in double digits, some foods item have risen much more dramatically. The price of onions, the most widely used vegetable in Indian cooking, rose around 70 percent last year.

"Unless meaningful output enhancing measures are taken, the risks of food inflation becoming entrenched loom large and threaten both the sustainability of the current growth momentum and the realization of its benefits by a large number of households," Subbarao said.

Despite the inflation concerns now, the central bank said it expected price pressures to start easing in the first quarter of the next fiscal year, which starts April 1.

© 2019 Thomson/Reuters. All rights reserved.

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India's central bank raised interest rates on Tuesday by a quarter of a percentage point to clamp down on resurgent inflation and warned of persistently higher food prices unless steps are taken to boost supplies. Even though the Reserve Bank of India (RBI) has raised its...
India Raises Interest Rates,Warns of Food Inflation
Tuesday, 25 January 2011 07:14 AM
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