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Inflation races higher, more steps to come PDF Print E-mail
Sunday, 22 June 2008

REUTERS, NEW DELHI - Inflation shot above 11 percent in early June to a 13-year high following a rise in state-set fuel prices, rattling markets and prompting the finance minister to warn of stronger anti-inflation measures ahead.

Government bond yields jumped to their highest in nearly seven years after Friday's data and the finance minister's warning, while shares fell to their lowest in 2008 on concern that interest rates will move up.

Traders said the central bank, which raised its main lending rate to 8.0 percent last week, stepped in to support the weakening rupee after the release of the wholesale price index (WPI), the country's most widely watched inflation measure.

The index showed annual inflation jumped to 11.05 percent in the 12 months to June 7, its hottest pace since May 1995 and much higher than forecasts for 9.82 percent. It also marked a big jump from 8.75 percent in the week-earlier data.

"The number is quite intimidating and it will require some response from the fiscal authorities and the Reserve Bank of India," said Abheek Barua, chief economist at HDFC Bank.

"So I wouldn't be surprised if there is another monetary measure on its way in the next fortnight or so, and this is likely to be a repo rate hike of about 25 basis points."

Stoked by a fuel price hike of about 10 percent early this month when India cut subsidies, the double-digit inflation rate will also heap political pressure on the government ahead of state and national elections in coming months.

WHERE TO NEXT?

The benchmark 10-year government bond yield jumped 21 basis points on the day to 8.68 percent after the data and the finance minister's comments, while the benchmark stock index ended 3.4 percent down.

India's inflation rate was last this high in the week of May 6, 1995, when it stood at 11.11 percent. In the latest figures, inflation for the week of April 12 was revised up to 7.95 percent from 7.33 percent.

Energy costs account for 14.2 percent of the WPI index and Friday's data showed the index for fuel, power, light and lubricants rose 7.8 percent in the week of the price rise.

Finance Minister Palaniappan Chidambaram promised action.

"This is indeed a very difficult time and we will have to take stronger measures both on the demand side and monetary side," he told reporters.

Food prices have been a source of concern for the Congress party-led coalition as these impact the poor the hardest, but the food articles index fell 1.1 percent in the June 7 data.

Nonetheless, Indranil Pan, chief economist at Kotak Mahindra Bank, said inflation could go towards 12 percent. "The next 3 to 5 months are going to be very crucial."

The central bank surprised markets last week with a 25 basis point increase in its key lending rate to 8.0 percent, its first increase in more than a year.

Robert Prior-Wandesforde, economist at HSBC in Singapore, saw both the repo rate and the cash reserve ratio (CRR), used by the central bank to drain surplus cash from the money market, rising by 50 and 75 basis points respectively by year-end.

"I think the central bank will have to think much more seriously about what it does with the exchange rate, try to intervene to push that higher as well," he said.

The CRR stands at 8.25 percent, its highest in seven years.

POLITICAL FALLOUT

By raising fuel prices, India joined other Asian countries no longer able to afford big fuel subsidies in the face of costlier oil, sparking street protests and calls for industrial strikes.

Political worries have already rattled markets this week, fuelling losses on Wednesday and Thursday, while surging food bills have contributed to a string of defeats for the Congress party at state elections over the past few months.

Now the coalition's communist allies have renewed threats to withdraw support for the government over the nuclear deal. The government has just a week or so to decide if it wants to risk early polls -- at which rising prices will be a key battleground -- by going ahead with the agreement.

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