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RBI to hold rates if rupee fall has muted inflation impact

RBI to hold rates if rupee fall has muted inflation impact
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First Published: Thu, Nov 24 2011. 03 09 PM IST

A file photo of the Reserve Bank of India building in Mumbai(AFP)
A file photo of the Reserve Bank of India building in Mumbai(AFP)
Updated: Thu, Nov 24 2011. 03 09 PM IST
New Delhi: The sharp slide in the Indian rupee, Asia’s worst performing currency, will add slightly to inflation by raising the cost of imported goods, but that may not be enough to prompt the Indian central bank to raise interest rates at its December policy review.
The rupee has slid more than 14% this year against the US dollar, with most of the losses coming in the last three months, as investors cut exposure to riskier assets amid Europe’s raging debt crisis, fears of a global recession and signs of a domestic economic slowdown.
Strains on India’s current account balance and the fiscal deficit have heaped further pressure on the rupee, with a Reuters poll this week showing investors have turned the most pessimistic on the currency in more than three years.
A file photo of the Reserve Bank of India building in Mumbai(AFP)
Much of the inflationary pressure from a falling rupee comes from crude oil, which makes up a third of India’s total import bill.
But the resulting impact may only add between 20 and 50 base points to headline inflation, economists say.
That would be something that policymakers could live with, given worries that 13 rate hikes since March 2010 are now hurting growth even as global demand sputters.
“As far as the current cycle of tightening is concerned, I think we are done for now,” said Shubhda Rao, chief economist with Yes Bank.
Yes Bank says headline inflation will fall from December to about 7% by end-March, in line with forecasts from the Reserve Bank of India.
Inflation in October was stronger than expected, remaining above 9% for the 11th straight month.
“I do not completely rule out inflation breaching the double-digit mark in November but I think the base effect will come into play in December and we would expect inflation to trend down after that,” Rao said.
A senior finance ministry source told Reuters on Wednesday that the rupee could stay in the region of 50 to a dollar for three months, indicating that inflation from commodity exports could continue to add pressure to prices.
Others say that with the Indian economy showing definite signs of fatigue, the risks to growth for Asia’s third-largest economy will be the key criterion that will shape RBI’s policy response.
“I expect RBI to pause in December because in deciding its monetary stance it would be more guided by risks to growth and other macro factors”, said N.Bhanumurthy, economist with National Institute of Public Finance and Policy, a Delhi-based policy think tank.
While more than a dozen rate hikes have failed to cool price pressures, largely because of domestic constraints such as poor infrastructure and an addiction to subsidies, economic growth has definitely started to suffer as credit conditions tightened.
Many policymakers now project it could slip to as low as 7% this fiscal year, the lowest since the depths of the 2008/09 global financial crisis.
Energy prices add pressure on inflation
Though diesel prices are state set, the higher cost of crude oil imports gets passed on through higher prices of deregulated fuels such as gasoline and aviation turbine fuel, stoking inflation.
North Sea Brent crude, used as the benchmark in budgeting by New Delhi, is currently above $107 a barrel, pushing India’s import bill to around $10 billion a month.
“We have had a 15% depreciation of the rupee over the last few months and the effect of that could be 50-60 basis points on headline inflation,” said Yes Bank’s Rao.
India relies heavily on coal to fuel its power plants and the slide in the rupee has also hit generating companies like National Thermal Power Corporation.
A UBS research note said that it expects a drop in demand in the December and March quarters, which should compress import demand and help stabilise the trade gap from a three-month average of $15 billion to $10 billion.
“Also inflation should slow in response to weaker PPI pressures and fuel base effects (we think 7% by March 2012),” the note said.
Some of the products in the capital goods sector, which contracted almost 7% in September, such as heavy machinery and other heavy engineering products are sourced from various euro zone countries, including Germany.
Slowing export prices in this region along with greatly reduced demand for these goods in India have ensured that price pressures from imported capital goods are held in check.
“When you are talking about imported inflation, I do not see more than a 20 basis point impact on headline inflation in India”, said Bhanumurthy.
India’s imports in October grew nearly 22% from a year earlier, roughly double the growth in exports. But trade secretary Rahul Khullar said earlier this month that imports would slow down, indicating there could be reduced price pressures coming from imported commodities in the coming months.
Critics say that higher costs of crude needed by domestic refiners to produce price-regulated products like diesel have to be absorbed by the government through higher subsidies, further straining government finances. The budgeted 4.6% fiscal deficit target already looks in danger.
In India, diesel accounts for 40% of all fuel demand in the country.
One adviser in the finance ministry, who did not wish to be identified, said the impact of a rise in gasoline prices on inflation will be minimal as gasolene accounts for just 10% of fuel demand and has around 1% weighting in the inflation index.
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First Published: Thu, Nov 24 2011. 03 09 PM IST
More Topics: RBI | Inflation | Rupee | Economy | Shubhda Rao |