India signalled it will soon boost lending rates as solid economic growth has raised the spectre of a new threat: inflation.
The country's central bank left its key lending rate unchanged yesterday, but laid the groundwork for future interest rate hikes as it warned inflation will rise faster than previously forecast.
The Reserve Bank of India (RBI) predicted wholesale price inflation will reach 6.5 per cent by the end of March, 2010, a significant increase from the previous forecast of 5 per cent and well above its target inflation rate of 3 per cent.
India also began unwinding a series of emergency economic stimulus measures implemented during the financial crisis.
"The attention around the world, as also in India, has shifted from managing the crisis to managing the recovery ... most of these countries do not face an immediate risk of inflation, whereas India is actively confronted with an upturn in inflation," RBI Governor Duvvuri Subbarao said in a statement.
The threat of inflation is more dire in India, in part because of its antiquated infrastructure system, which slows the transportation of goods and makes buyers more susceptible to price increases when supply falls and demand rises.
Inflation is now rising in India because of buoyant commodity prices such as copper and oil coupled with drought hurting India's crop production and raising food costs amid the weakest monsoon season in 37 years.
Some analysts forecast India's inflation rate will hit 8 per cent by the end of March.
"Nobody wants high inflation. It's much easier to manage your economy without high inflation and I'm sure this is the kind of issue that will be keeping the central bankers up at night," said Paul Beamish, professor of international business and director of the Asian Management Institute at the Richard Ivey School of Business.
To begin countering rising inflation and the risk of asset bubbles in real estate and financial markets, India's central bank yesterday removed emergency liquidity support measures that were imposed following the global economic collapse last year. The RBI raised the statutory liquidity ratio - the percentage of holdings banks must keep in cash, bonds or gold - and increased provisioning requirements for commercial real estate loans.
Mr. Beamish said India's large population, diverse economy and the fact that the RBI is reducing liquidity and "saying the right things, suggests to me that this is not going to be a long-term problem."
The unwinding of the special liquidity support measures is a likely harbinger of interest rate increases at or before the RBI's next policy meeting in January. Goldman Sachs expects the central bank to hike rates by 300 basis points in 2010.
"In our view, the policy statement suggests a hawkish stance and signals that rate hikes are imminent," Goldman economist Tushar Poddar told clients in a report.
The RBI's response to the financial crisis has been swift and dramatic. It has infused more than 5.85 trillion rupees or $125.5-billion (U.S.) of liquidity into Asia's third largest economy since September of 2008. It reduced the benchmark repurchase rate - the rate at which the central bank makes short-term loans to commercial banks - by more than 400 basis points to 4.75 per cent from 9 per cent. It cut the reverse purchase rate - the level at which it borrows from commercial banks - to 3.25 per cent from 6 per cent.
Those key lending rates in India's trillion-dollar economy were left unchanged yesterday. The RBI left its prediction of 6-per-cent economic growth, with an upward bias, unchanged.
India's economy enjoyed economic growth of more than 9 per cent for three consecutive years until GDP growth fell to 6.7 per cent last year.
So far, Australia is the only G20 nation that has increased lending rates to quell inflation since the global economic collapse last year. South Korea, another Asia Pacific country that has weathered the downturn relatively well, is also expected to increase rates soon.
