India’s central bank said it will react “swiftly” and use all policy tools to stem inflation that is threatening to derail record economic growth.
“The firming up of inflation bothers us,” Reserve Bank of India Deputy Governor Rakesh Mohan said in a speech in Mumbai today. “It is a key concern for us in overall macroeconomic management.”
Inflation in India accelerated to 6.58 %, the fastest pace in more than two years, in the week ended Jan. 27 as prices of milk and oilseeds rose, the government said on 9 February . That was more than a percentage point higher than the upper end of the 5 % to 5.5 % range targeted by the central bank for the fiscal year through March.
The Reserve Bank of India on 31 January raised the benchmark overnight lending rate for the fifth time in a year to curb inflation that accelerated to a two-year high last month. The rate increase followed its decision in December to ask banks to set aside more cash to cover deposits.
Prices are rising at a quicker pace as the nation’s $854 billion economy grows at the second-fastest rate among major economies, lifting prices of agricultural and manufactured products. The federal government has forecast the economy, Asia’s fourth largest, will expand as much as 9.2 % in the fiscal year through 31 March .
India hasn’t adopted the policy method known as inflation targeting, Mohan said. Central banks that have adopted inflation targeting usually attempt to keep inflation steady near a chosen level or in a range.
Some factors continue to put pressure on global core inflation, he said, without elaborating. Core inflation typically indicates the increase in prices after excluding more volatile components of a price index.
“Compression of Spreads”
Short-term interest rates have risen more than long-term ones globally, causing the spreads between interest rates for various maturities to narrow, Mohan said. He didn’t elaborate.
“Changes in the short-term rates have not transmitted to the longer end of the yield curve,” Mohan said. “There’s a great compression of spreads and the yield curve has flattened.”
The U.S. Federal Reserve increased its benchmark overnight rate target 4.25 percentage points since June 2004. The key 10- year U.S. Treasury yield has risen 1.27 percentage points in the same period, according to data compiled by Bloomberg. The Indian central bank increased its overnight borrowing rate 1.5 percentage points since October 2004, while the nation’s benchmark 10-year bond yield has risen 104 basis points.
India may be moving toward faster growth, which will pose policy challenges for the central bank, Mohan said. The quality of bank credit may be affected by the accelerated expansion in loans stoked by economic growth. The bank is concerned about an increase in credit given to the real estate sector, he said.
Indian bank loans have grown at the fastest pace in three decades in the past three years. Credit grew 30 % in the 12 months through Jan. 26, faster than a 23 % increase in bank deposits during the same period, central bank data show.
The expansion in credit has reduced the supply of funds in the nation’s banking system, Mohan said. Borrowing costs between banks in the local money market averaged 7.7 % in the three months through today, compared with 6.4 % in the previous similar period, according to Bloomberg data.