Indian Central Bank Tries to Curb Inflation; Perhaps Not the Best Method

Top Quote Corolla Financial Report: The Reserve Bank of India has hiked interest rates again in its attempts to curb inflation. With high food prices, and higher fuel prices looming, this move will likely turn out to be fruitless. End Quote
  • (1888PressRelease) July 02, 2011 - The Reserve Bank of India raised the cost of borrowing from 7.25% to 7.5%, the 10th rise since March 2010, continuing to fight rising prices in the country. Wholesale prices in India rose by a faster-than-expected 9.06% in May, as rising food and fuel costs kept up the pressure on inflation. Prime Minister Manmohan Singh has called inflation a "serious threat" to the country's growth. As a result, the central bank has been raising the cost of borrowing in the country in an attempt to slow down demand and keep prices under control. The Reserve Bank of India said in a statement that inflation had reached "uncomfortable levels" and increased the repo rate at which it lends to commercial banks by 25 basis points to 7.5%. Analysts say that as it becomes more expensive to borrow money, growth is likely to be hit. However, the bank said that fighting rising prices was its top priority and it recognised that growth could be hit in the short term.

    The central bank's previous rate hikes have made little difference in the cost of living in India. With a cumulative 2.75 point increase in its lending rate and little to show from it, the RBI may need to rethink its strategy to tackle inflation. The wholesale price index in May rose 9.06% from a year earlier, despite the fact that fuel prices in India are subsidized and don't reflect the global uptrend. More aggressive rate increases can only partly help assuage India's inflation, which is driven by infrastructure bottlenecks and food shortages. The rapid rebound in the economy and the spillover of food inflation into other items is threatening to lead to a wage-price spiral.

    Asia's third largest economy, India now has the highest inflation rate of any large Asian economy, growing 7.8 percent from January to March, the slowest pace in five quarters. Analysts say the slower growth is making it harder for the second-fastest-growing major economy in the world to pull hundreds of millions of people out of poverty. The RBI has said: "In the current circumstances, some short-run deceleration in growth may be unavoidable in bringing inflation under control."

    India's annual food inflation rate dropped to 8.96% for the week ended June 4 from the previous week's rise, on the back of cheaper cereals, fruits, rice, wheat and onion, remaining in the single digits for the twelfth consecutive week. Despite this, food prices are also set to rise in the next few weeks following a possible hike in prices of diesel and LPG that will pinch household budgets even more, already pummelled by bout of relentless rise in prices of most goods. Indications are that oil companies will raise diesel prices in the next few weeks. High transport fuel prices will push up the cost of ferrying products across locations and knock up prices of most goods. In its mid-quarter review, the RBI warned that in the short-term, there will be a spell of high inflation.

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