Inflation woes to hit Indian growth

Indian inflation, which hit a 13-year high last week, is an increasing threat to the subcontinent's economic revival.

Indian shoppers gesture as they buy vegetable and fruit at a Mall in Kolkata on June 27, 2008.  India's annual rate of inflation has risen to 11.42 percent on the back of rising prices of food, fuel and manufactured goods, government data released on on June 27, 2008 showed.   AFP PHOTO/Deshakalyan CHOWDHURY
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Indian inflation, which hit a 13-year high last week, is an increasing threat to the subcontinent's economic revival. India has been one of the countries hardest hit by the worldwide surge in inflation which was triggered by soaring prices of commodities such as oil and steel. Rising prices raise doubts about whether the country can maintain even its present growth rate of about eight per cent, let alone challenge the 10 per cent achieved by China.

Wholesale inflation hit 11.63 per cent in the week ended June 14 - above the 11.44 per cent consensus of leading economists and more than double the 5.5 per cent "comfort zone" set by the country's reserve bank. Economists expect the rate to top 12 per cent shortly and to continue accelerating until it peaks at about 14 per cent towards the end of the year. "We see the pain continuing on the inflation front through to the third quarter of the year: and we only see it coming off in the fourth quarter," said Shubhada Rao, the chief economist at India's Yes Bank.

At the start of June, India increased the price of fuel at the pump by about 10 per cent, ending a long delay in passing on the rising price of crude oil to consumers. R K Joshi, the lead economist at the Indian ratings agency, Crisil, said: "What India did was suppress prices for a long time, and the lid has to blow off. The more you keep a lid on prices in this manner, the more you expose the economy to higher risks in future."

But the hike in petrol and diesel prices only covered about 10 per cent of the US$57 billion (Dh205bn) gap between the price that Indian consumers pay for fuel and the international market price, meaning $30bn will be paid for by government bonds, creating the risk of further hikes when, or even before, fuel prices are reviewed in October. The rise in Friday's inflation figures came despite the efforts of India's central bank and government to keep price rises under control. The Reserve Bank of India raised key interest rates twice last month to a six-year high of 8.5 per cent, and is expected to push through another rise when it meets on July 29. Morgan Stanley said there was now little else the government could do to control prices.

"We believe the government has limited alternative options available to counter the potential further rise in second-round effects and inflation expectations," it said in a research note. As well as increasing borrowing costs, the government barred exports of key commodities. On Thursday, it added maize to a list that already includes wheat, rice, cooking oils, pulses and cement. It has also increased the proportion of funds that banks have to keep on deposit, from 8.25 per cent to 8.75 per cent by the end of this month.

"They're slamming the brakes much harder this time," Mr Joshi said. "The latest interest rate increase has been successful. Banks have actually raised their rates." The impact has already been seen in inflation-sensitive industries such as sales of cars, motorcycles and consumer durables. It has also begun to drive down property prices, opening up opportunities for the many Gulf investors waiting to enter the previously overpriced market.

Ambar Maheshwari, the director of investment advisory at DTZ property consultants in Mumbai, said he expected Indian property prices to correct downwards by 15 per cent to 20 per cent in the next six months. "We have been expecting big investments from the Gulf for some time, and any correction will be a good thing," Mr Maheshwari said. But Mr Joshi said it would take between nine and 18 months, or higher interest rates, to start to bring inflation down into single figures.

"What the central bank is doing today will not bring down the rate of inflation," he said. "But it's going to keep inflationary expectations under control - that's the immediate effect. Generally, the belief will be that growth is going to slow down." India has also been hit particularly badly by inflation in recent months because of the Reserve Bank of India's failure to keep the growth in the money supply below its target.

The rush of foreign investment into the country in the past two years forced it to buy dollars to protect the rupee's exchange rate. The rising prices of household goods will put India's troubled ruling United Progressive Alliance government under still more political pressure. Lorry drivers last week held a strike to protest against rising fuel prices.