Mumbai: Inflation continues to be the main concern for the Reserve Bank of India (RBI), which “cannot be idle to the threat even if it is driven by supply-side factors”, deputy governor Subir Gokarn told a meeting of businessmen on Tuesday in what is seen as a signal that interest rate increases may continue.
“The purpose of raising interest rates is to manage inflationary expectations. At the end of the day, projects may become less attractive,” Gokarn said in Mumbai. “But the alternative to that is a meltdown with inflation spiralling the risk around us and weakening investment activity. We cannot afford to take that risk.”
The five-year overnight indexed swap rate rose 10 basis points to 8.02% following Gokarn’s comments because dealers read them as an indication of further rate increases.
“A little bit of pain now, a little bit of medicine now, with the prospect of less suffering in the future, is the way to look at it,” Gokarn said, replying to a question on rates.
RBI has already hiked its repo rate eight times by a total of 200 basis points since March 2010 to rein in inflation. One basis point is one-hundredth of a percentage point.
Wholesale price inflation at 8.31% in February is still beyond RBI’s target of 8% and rates are expected to be raised by at least another 50 basis points in the current fiscal. RBI’s next monetary policy announcement is scheduled for the first week of May.
Industry has been complaining that higher interest rates may hurt growth by raising the cost of funds.
One businessman at the meeting said inflation has accelerated mainly because of higher food prices and “RBI raising rates is not going to make people eat less eggs or fish”.
But Gokarn said the challenge for RBI was to ensure that these supply-side factors did not “spill (over) into more generalized inflation”.
“We cannot afford to be slack on inflation just because it comes from certain forces. If we don’t rein it in now, you can see what has happened to countries that have gone into a spiral due to inflation bringing investment activity to a standstill,” he said.
Food inflation has been stubbornly above 9% week on week for the last few months. The latest numbers for the week ended 19 March showed that food prices rose by 9.5%.
Bankers at the same meeting were convinced that the key inflationary threat emanates from overseas, particularly oil prices.
Higher oil prices will be transmitted either through a wider fiscal deficit, or higher fuel prices, said Uday Kotak, executive vice-chairman and managing director of private sector Kotak Mahindra Bank Ltd. “Every $1 rise in oil prices costs India $100 billion a year. Inflation is a big issue and that will transmit into higher interest rates. But we have no choice as oil is high,” he said.
Oil prices have risen in the last few months because of the political unrest in the Middle East and higher demand.
Brent crude for May futures rose to its highest level since August 2008 to $121 per barrel on Monday.
Interest rate increases will have to be balanced with the need to push economic growth, said Naina Lal Kidwai, group general manager and country head at HSBC India.