Rising prices are an unfortunate side effect of India's economic success story, and the country's central bank is taking action to ease the pressure on prices that are hitting its poor. But some ask if that is enough.
Indian watchdog's inflation fight
India's central bank is stepping up its effort to keep the fine balance in stoking the country's robust growth that is easing poverty, while battling a stubborn inflation threat.
For the second time in as many months, the Reserve Bank of India (RBI) raised its key interest rates, joining its peers in other developing economies such as Malaysia, China and Vietnam that have begun tightening their monetary policies to manage economic recovery. While inflationary pressures and asset prices remain subdued in developed economies, both are growing in emerging economies that are leading the way in the global recovery
"These policies should have a gentle impact in tightening money in the economy and should dampen further inflationary pressures," says Pranab Mukherjee, the Indian finance minister. "If nothing untoward happens ? my belief is that overall inflation has peaked and should be on downward trajectory from now on." The RBI last week lifted by 0.25 per cent its repurchase rate, the rate at which it lends to banks, and the reverse repurchase rate, the main borrowing rate, to 5.25 per cent and 3.75 per cent respectively.
It also raised the cash reserve ratio, which determines what proportion of their deposits banks must hold, by 0.25 per cent to 6 per cent. This is expected to soak up 125 billion rupees (Dh10.35bn) of liquidity, which means banks will have less to lend. India's inflation rate, which climbed last month to an annual 9.9 per cent, remains one of the highest in Asia. It is a major source of concern as price pressures spread rapidly from food products after disappointing harvests, to manufactured goods.
Despite these issues, India and the other BRIC countries - Brazil, Russia and China - are the recent growth stories. While many developed countries struggle to resume economic growth after the global slowdown, India is growing at nearly 8 per cent. With surging consumer demand and robust business confidence, the economy is expected to grow by 8.75 per cent this year and 8.5 per cent next year, the IMF has forecast.
"In the two worst years for the world economy, we have clocked an average of 7 per cent growth rate," says Montek Singh Ahluwalia, the deputy chairman of India's planning commission. "There is pressure on the government to get to 10 per cent. The prime minister has directed us to explore the possibilities of 10 per cent." A recent quarterly survey by India's council of applied economic research revealed 97 per cent of Indian companies are operating at full capacity, with wages growing at a number of companies that are experiencing a shortage of skilled labour.
And consumers are buying. Maruti Suzuki, India's largest car company, said its sales rose 11 per cent last month compared with March last year, its largest gain ever, as the middle class keeps spending and banks keep lending. The recent rate increases are aimed at tempering demands for loans, thus checking consumer spending. But as the growth continues, largely powered by domestic consumption, the risks of overheating grow. The outlook is daunting.
"Consumption will strengthen [in India] as the labour market improves, and investment is expected to be boosted by strong profitability, rising business confidence and favourable financing conditions," said Abdul Abaid, a senior economist in the world economic studies division of the IMF, expressing support for the RBI's tightening. The rate rises are part of the RBI's strategy to roll back the economic stimulus it introduced after the global economic meltdown in 2008.
"India is relatively more closed and has relied on stimulus to support growth," said Mr Abaid. "The main challenge will be to ensure durable fiscal consolidation, including by implementing fiscal and other structural reforms." But some analysts complain the inflationary pressures warranted a more stringent monetary regime than that announced by the RBI. "We expected a much more aggressive rate hike," said Jahangir Aziz, the chief economist at JPMorgan. "You needed a much stronger, more aggressive move initially."
But the RBI insists it is resisting the temptation to initiate a large rise in one go. The government's large borrowing programme, with an increase of about 36 per cent from the previous year in issuance of government securities, is hampering the central bank's ability to combat inflation. "But if liquidity conditions are such that there is excess liquidity in the system relative to growth of demand for funds, that is the scenario in which we will further hike the [cash reserve ratio]," said Subir Gokarn, the deputy governor of the RBI.
The country's faster inflation has been fuelled largely by rising food prices. An index of wholesale prices of staple foods such as lentils, rice and vegetables soared by an annual rate of 17.6 per cent in the week that ended on April 10, after crops were badly hit by the weakest monsoon in 37 years followed by flooding in some parts of the country. By far most Indians see inflation, particularly in food prices, as the "poor man's tax". Once conspicuous for its famines, India has experienced in recent years an economic boom that lifted millions out of poverty.
But that growth is driving up prices, highlighting the concerns and challenges of Indian policymakers to tame inflation without slowing its impressive expansion. Rising food prices remain a big concern for the government as they could harm the popularity of Manmohan Singh, the prime minister. Mr Singh, a former finance minister who is widely credited with helping to introduce the conditions for the country's recent growth, was re-elected last May on promises to alleviate poverty in a nation where 800 million of the country's 1.2 billion people live on less than US$2 (Dh7.34) a day.
Last week, the main opposition Bharatiya Janta Party rallied protesters in New Delhi demanding the government curb rising prices. The RBI is also taking its inflation fight to the people. For the first time the bank is running a TV campaign to reach out directly to Indians, calling on them for extreme diligence. Meanwhile, the central bank says it is banking on a "normal" monsoon this year to lower food prices and cut the benchmark inflation rate to 5.5 per cent by next March.