India's July inflation eases; rate hike still seen

NEW DELHI: Indian inflation eased in July although still-high headline number and persistent price pressures in manufactured goods raised the odds that policy will have to stay tight in the economy despite the rising risks to growth.

The high inflation print still has most economists betting that India's central bank will have to extend what has been an aggressive 18-month policy tightening spree.

But a slew of weak data on consumer spending and bank credit coupled with the heightened possibility of a slump in the developed world could upset those odds.

The Reserve Bank of India (RBI) has raised rates 11 times since March 2010 to combat high inflation, which is seen as dragging down growth from the government's projection of 8.5 percent for the current fiscal that ends in March 2012.

The RBI Governor Duvvuri Subbarao acknowledged those risks last Friday, but said it was crucial that inflation and inflationary expectations be brought down in Asia's third-largest economy -- a clear indication that the central bank may continue to raise rates at its policy review next month.

"With inflation over 9 percent and growth above 8 percent, the current situation indicates that the central bank will most likely hike rates by 25 basis points on Sept. 16," said Sujan Hajra, chief economist at Anand Rathi Securities in Mumbai.

"Any turn in monetary policy after that will be decided based on actual trajectory of growth and inflation," Rathi said.

The benchmark 7.80 percent 2021 bond yield fell 1 basis point after the data to 8.32 percent, while the 30-share main share index remained unchanged.

The 5-year overnight indexed swap rates was steady at 6.91 percent and the 1-year was also unchanged at 7.80 percent, dealers said.

The wholesale price index, India's main inflation gauge rose 9.22 percent in July, almost in line with the median forecast for a 9.20 percent rise in a Reuters poll.

Manufacturing inflation quickened to 7.49 percent in July from 7.43 percent in the previous month, adding to fears that inflation is deeply entrenched in the economy as manufacturers still retain some pricing power.

WILL CBANK HAVE TO PRIORITISE GROWTH?

A better-than-expected growth in industrial output in June and an uptick in food inflation may bolster the case for a rate increase next month, despite indications of slowing growth.

Production of consumer goods grew less than 2 percent in June, a pointer to waning consumer demand.

Exports grew more than 80 percent in July, but the trade secretary warned that there could be tough days ahead for the sector on continuing economic uncertainty in the United States and the euro zone, India's largest export markets.

Car sales in India fell 15.8 percent in July, the first drop in two-and-half years, and higher interest rates and rising vehicle costs are expected to keep demand subdued for the next few months.

The RBI has raised policy rates by 325 basis points since March 2010 and that is now hampering private investment and corporate expansion plans. As a result, the credit-deposit ratio now stands at 74 percent, an indication that tight lending conditions persist in the world's second-fastest growing major economy.

The fact that the government has little room for a renewed fiscal push to the economy has only added to the problem. The promise of reforms in infrastructure and ushering in foreign direct investments (FDI) in multi-brand retail are still hanging fire.

Though the focus of the RBI is on fighting inflation, yet it may soon have to shift gears to protect growth from faltering. The bank, has, as of now, retained its end-March growth projection for India at 8 percent.

However, Subbarao said that the RBI will take into account all uncertainties while formulating its mid-quarter policy.

Other central banks in South Korea and Indonesia have held rates steady at reviews this month, but they appear to have less of a fight against price pressures on their hands.

Copyright Reuters, 2010