Tight cash in India fails to rein in inflation
Inflation in India remains elevated despite tight cash conditions, suggesting the Reserve Bank should be more aggressive in raising interest rates as inflation spreads beyond food and primary articles.
January 24, 2011 / 17:25 IST
Inflation in India remains elevated despite tight cash conditions, suggesting the Reserve Bank should be more aggressive in raising interest rates as inflation spreads beyond food and primary articles.
Costlier food items have played a key role in pushing up headline inflation, and the Reserve Bank of India's projection for inflation to ease to 5.5% at the end of the fiscal year in March appears optimistic.The Reserve Bank of India is widely expected to raise its two key interest rates by 25 basis points each for the seventh time in less than a year at its monetary policy review on Tuesday.Some data suggests price pressures in Asia's third largest economy are still building, while monetary conditions remain relatively loose, leaving room for further tightening.Banks' net cash balance with RBI in deficit, inflation highTight cash conditions have done little to help contain inflation. The daily liquidity deficit in the banking system of more than Rs 1 lakh crore (USD 22 billion) is twice what the central bank has said it is comfortable with.The wholesale price index (WPI) , India's main inflation gauge, rose an annual 8.43% in December compared with an expected 8.35% rise in a Reuters poll and above 7.48% in November.Reserve money growth threatens to drive inflationReserve money has continued to rise rapidly in recent months. Before the financial crisis, reserve money consistently led broad money growth, the central bank's key monetary gauge.Between 2000-2007 the annual change in reserve money had a 0.6 correlation with the year-on-year change in M3. That dropped to 0.4 for the 2000-2010 period because of massive liquidity injections during the global financial crisis.However, with robust economic activity that correlation is likely to get tighter. A pickup in money supply growth will further add to inflationary pressures.Credit-deposit ratio widensBank credit is growing at an annual pace of around 24.4%, above the central bank's 20% projection, while deposits are growing at a 16.5% clip.The credit-deposit ratio widened to around 75.7 at the end of December compared to around 70% at the start of 2010, climbing above the monthly average of the past five years of 69%.The rising credit growth reflects investment intent in the economy and also rising demand side pressures on inflation. Raising policy rates would make credit more expensive and help curb demand side pressures.Real effective exchange rate of rupee set to riseIndia's real effective exchange rate has been sliding in recent weeks as high inflation erodes the nominal value of the rupee.However, with persistent inflationary pressues, many analysts expect the rupee to appreciate on REER terms in 2011. Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
