Surprisingly strong Indian growth and a jump in inflation above 8 percent put an interest rate rise back on the agenda on Friday, although many analysts thought the Reserve Bank of India would remain focused on cash management.
The finance minister said there was no sign of inflation declining and more steps would be taken if needed after wholesale price inflation rose 8.1 percent in the 12 months to May 17, its highest in more than 3-½ years.
Annual growth of 8.8 percent in the Jan-March quarter outstripped forecasts for 8.2 percent, showing momentum remained strong in Asia’s third-largest economy in the fiscal second half despite policy tightenings, although economists expected it would lose height in 2008/09.
The strong data comes as the government is debating whether to raise state-set retail fuel prices to tackle mounting losses at state oil firms forced to sell fuel at discounted rates, a move which would also put pressure on prices.
"Monetary policy will continue to remain tight and it seems the Reserve Bank of India’s first priority is to target liquidity," said A. Prasanna, economist at ICICI Primary Dealership in Mumbai."But with inflation continuously surprising on the upside and a fuel price increase in the offing, a repo rate hike cannot be ruled out."
The RBI has left its key lending rate, the repo rate, unchanged at 7.75 percent for over a year. But it has been tightening cash conditions over the past 18 months, most recently in April and May when it raised the cash reserve ratio, the amount of funds banks must deposit with it, by 75 basis points to a seven-year high of 8.25 percent.
The rupee took both sets of data largely in its stride, edging up to 42.52 per dollar, while the benchmark 10-year bond yield rose to 8.11 percent from 8.08 percent shortly before the price data came through.
INFLATION
The WPI is India’s most widely watched price measure and the mid-May reading outstripped forecasts for an annual rise of 7.96 percent and the previous week’s 7.82 percent.
Finance Minister Palaniappan Chidambaram said on Friday price pressures stemmed largely from abroad, particularly oil, and there were no easy solutions. The government has already curbed some exports and lowered duty on some imports to keep domestic supplies up and import prices down.
"We will take more measures if needed," he said. "We will take corrective measures to control inflation."
He expected the economy would grow 8.5 percent in 2008/09 after data on Friday showed 2007/08 growth at 9.0 percent, higher than a first estimate of 8.7 percent.
"The current financial year appears even more difficult than the year that has come to an end, but I am confident we will maintain growth," he said.
Growth for the December quarter was revised up to 8.8 percent and the full-year reading gave India its third successive fiscal year of expansion at 9 percent or above, to be the world’s fastest-growing major economy after China.
"Even though the industrial sector has been hurt by past interest rate hikes, the services sector continues to grow at a fast pace," said Sonal Varma, economist at Lehman Brothers.Varma expected high oil prices, financial market turbulence and slowing world demand would provide headwinds to the economy in the fiscal year to the end of March 2009.
"The question is whether the services sector can sustain this pace, despite industry slowing down. We have our doubts," she said.
Manufacturing grew an annual 5.8 percent in the quarter, slowing from 9.6 percent in the December quarter, while services grew 11.2 percent in the quarter.Farm output grew an annual 2.9 percent in the March quarter compared with 6 percent in the prior three months.
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