India's Central Bank Raises Interest Rates Again - Will It Help?

Includes: INP, PIN
by: Edward Hugh

India's central bank raised interest rates for the third time in two months and at the same time raised the cash reserve ratio that banks have to maintain in deposits with them. The Reserve Bank of India increased the benchmark repurchase rate to 9 percent from 8.5 percent, while the cash reserve ratio was increased to 9 percent from 8.75 percent. The bank has now has raised rates by 125 basis points and the cash reserve ratio by three-quarters of a percentage point since the start of June.

India's benchmark stock index fell 3 percent on the news to 13,919.01 in Mumbai, while the yield on the benchmark 10-year bond yield rose to 9.44 percent from 9.07 percent. The rupee gained to 42.545 against the dollar from 42.59 earlier.

India has now been joined by a growing list of Asian and Latin American central banks who are tightening monetary policy (and in the process sending Japan's export dependent economy off into recession it seems). The Philippine central bank has raised rates at its last two meetings, while the Bank Indonesia has boosted borrowing costs for three straight months. Thailand raised its benchmark for the first time in two years this month and Pakistan is expected to follow suit. Brazil only last week raised rates by three quarters of a percentage point to 13%.

India's inflation held near its fastest pace in more than 13 years in the middle of July. Wholesale prices rose 11.89 percent in the week to July 12, after gaining 11.91 percent in the previous week, the commerce ministry said in New Delhi last Friday.

And things may not improve quickly since the June-September monsoon, which accounts for four-fifths of the nation's annual rainfall, was 33 percent below average in the week ended July 23, raising concerns that there is no easing of food price inflation in sight. Rains in July account for a third of the monsoon season and are crucial for the sowing of crops, including corn and soybeans.

At the same time, the hike in the CRR will also be noticed, since overnight cash rates rose to a fresh six month high in the middle of last week as a result of the tightening of liquidity following the earlier increase in banks' cash reserve ratio. On Wednesday last week call rates hit a high of 9.85 per cent, which is the highest since January 18. They were however back down to the 9.50/9.60 per cent range on Thursday. Obviously the new increase will push these rates up even further.

India's economic growth has already slowed somewhat, and held at its weakest pace since 2005 in Q1 2008 as the highest interest rates in six years discouraged consumer spending and investment, while a more complex global environment reduced the possibilities for expanding India's exports. India's economy expanded at a year on year rate of 8.8 percent in the three months to March 31, matching the revised gain of the previous quarter.