India Resists Bernanke#39;s Move to Calm Markets Andy Mukherjee
India Resists Bernanke;s Move to Calm Markets: Andy Mukherjee
Commentary by Andy Mukherjee
Jan. 30 (Bloomberg) — Indian central bank Governor Y.V.
Reddy showed remarkable restraint yesterday in not using interest
rates to calm the volatile stock market.
He also dared to disappoint bond traders, many of whom were
expecting at least a quarter-percentage-point reduction in the
rate at which the monetary authority lends to banks overnight.
After seven increases since October 2005, the so-called
repurchase rate currently stands at 7.75 percent.
In explaining his decision to stand pat, Reddy made as many
as five references to the elevated pace of money supply in the
economy. That makes the Indian monetary czar rather old-fashioned
in a world where central bankers are so keen to write put options
for the financial markets they have lost sight of the inflation
risk their actions are helping to create.
“We can;t afford to drop our vigil on prices,;; Reddy said
yesterday at a press conference in Mumbai. The question is: How
long will the U.S. Federal Reserve allow him to hold his guard?
Capital flows may make it hard for the Indian central bank
to keep its monetary policy autonomous of U.S. pressures.
The arbitrage opportunity has widened in favor of moving
funds into India where three-month money now earns 5 percentage
points more than dollar deposits of similar maturity at global
banks. That gap has almost doubled since the Fed began cutting
interest rates in September last year to restart credit markets
frozen by the unraveling of subprime mortgages.
And the interest-rate differential can only widen if Fed
Chairman Ben Bernanke further pares the target for the overnight
rate, as Fed Funds futures prices currently suggest.
Energy Prices
Clearly, India will at some point have to begin trimming its
own cost of borrowings so as not to be overwhelmed by overseas
inflows.
Before then, the authorities must complete the unfinished
task of putting the inflation genie firmly back in the bottle.
And that means pressing ahead with an increase in local fuel
prices, which the government has delayed because of pressure from
its political allies.
According to the calculations of Morgan Stanley energy
analyst Vinay Jaising, the average price realization of gasoline,
diesel and other oil products in the Indian market corresponds
with crude oil at $63 a barrel, a steep 30 percent discount to
the current international level.
This has kept the benchmark wholesale-price inflation in
India artificially suppressed at 3.8 percent. “In view of the
new highs to which international crude prices have recently been
lifted, the threats to domestic price stability have risen and
turned extremely volatile, representing a serious risk to
inflation expectations,;; the Reserve Bank said in its monetary
policy statement.
Slowing Demand
And what about the risks to economic growth?
Sure, Indian exports in rupee terms have slowed down in
recent months. That;s partly a result of faltering overseas
demand and partly because of the 11 percent real, or inflation-
adjusted, appreciation in the Indian currency in the past 12
months compared with India;s main trading partners.
Motorcycle demand has slackened because the interest cost on
auto loans is now as high as 24 percent a year. Mortgage demand,
too, is ebbing for the same reason. Reddy;s critics say these are
signs that India;s red-hot consumer demand is cooling.
But given that political tolerance for price gains in India
is low — and elections are due in 2009 — it makes sense for
monetary policy to tackle inflation and leave the task of
fighting the risk of economic stagnation to the government, which
can easily do so in its annual budget on Feb. 28.
Money Supply
Money-supply is expanding at an annual 22 percent pace,
higher than the Reserve Bank;s tolerance limit of 17.5 percent.
This excessive growth is partly because banks have been a tad too
active in mobilizing deposits, even raising funds at an effective
cost of 9 percent a year and more.
Trouble is there;s ample liquidity in the banking system
because of strong capital inflows and banks can, in fact, cut
both lending and deposit rates without waiting for the monetary
authority to prune its policy rate.
The Reserve Bank yesterday urged them to do just that.
“Despite comfortable liquidity conditions, banks have not
expanded credit proportionately,;; it said.
If inflation expectations start coming off, it;s quite
likely that banks will start paring their lending rates as early
as next quarter. That may give the economy that grew 8.9 percent
in the three months to September 2007 a chance to reaccelerate.
Of course, a lot will depend on the health of the world
economy and the risk appetite of global investors, on which
capital flows into India — or out of it — will depend.
Balancing Act
Pending the creation of new production capacity in the
economy, the central bank is right in wanting to delay
consumption to the extent it can. “We;ll be far more comfortable
if more demand is generated later, than now,;; Reddy said.
Those who support an immediate easing in interest rates say
that this is a risky approach: Capacity expansion may stumble if
consumers aren;t given a reprieve on mortgages and auto loans.
For now the evidence is on Reddy;s side. Controlling
inflation has to be India;s priority even if that means
sacrificing some growth.
(Andy Mukherjee is a Bloomberg News columnist. The opinions
expressed are his own.)
To contact the writer of this column:
Andy Mukherjee in Singapore at
