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Inflation poses the biggest threat for India

Business Materials 17 August 2008 03:42 (UTC +04:00)

There will be more headwinds for Indian shares this week after inflation spiked to 12.4 per cent, the highest since early 1995, putting the focus on interest rates that are already at nine-year peaks, GN reported.

With prices of food and other essential items showing no sign of easing despite oil tumbling more than a fifth from a record high of over $147 a barrel in mid-July, money managers are turning circumspect about the outlook.

After buying shares worth half a billion dollars over eight days, foreign funds dumped $255.5 million in two days last week and the outflows are likely to gather momentum with inflation set to climb further.

"Inflation is the most watched indicator at the moment," said equity trader Rasesh Shah. "The rising trend means we'll have to brace for another round of interest rate increases."

Annual inflation in the week ended August 2 hit 12.44 per cent, sharply up from 12.01 per cent a week earlier, and could actually top 13 per cent when the provisional data is updated.

The Reserve Bank of India (RBI) had raised its key lending rate by half a percentage point to nine per cent on July 29, after a 75 basis points hike in June, and raised the deposits that commercial banks must set aside as reserve to rein in inflation.

The central bank revised its inflation target to seven per cent by the end of March from an earlier goal of five per cent, but economists and other policy planners said the RBI was being ambitious and inflation was likely to hover closer to nine per cent.

"With inflation remaining well above the RBI's target range, we continue to expect one more round of rate increases of 25 basis points on the repo rate and 25 basis points on the cash reserve ratio by end-October," economists at Goldman Sachs wrote in a note.

Government-run State Bank of India, the country's biggest commercial lender, last week raised its prime lending rate by 100 basis points to 13.75 per cent, taking cues from the RBI's rate hike in July. Rising rates have dented demand for automobiles and car sales in July fell for the first time in more than two and a half years, dropping 1.7 per cent to 87,724 units from 89,250 a year earlier, the Society of Indian Automobile Manufacturers said last week.

It was the first monthly decline since November 2005. "High fuel costs, interest rates and rising raw material input costs are challenges," said Dilip Chenoy, director general of the society.

The Sensex fell 2.9 per cent last week to 14,724.18, snapping gains for five weeks in a row that was its best run in 2008. The index is, however, down over 27 per cent so far this year, with foreign funds pulling out about $6.7 billion during the period.

Equity strategist V Venugopal said rising inflation and higher interest rates were twin risks for the stock market in the coming months, and they would take a heavy toll on economic growth and corporate earnings.

The prime minister's economic advisory panel last week forecast economic growth to slow down to 7.7 per cent this year, lower than the RBI's prediction of eight per cent and below nine per cent last year.

"Maintaining a tight monetary policy stance and active fiscal and other methods are necessary to bring down inflation rates," the panel said in a report last week.

Probably concerned about the impact of rising rates on growth, Prime Minister Manmohan Singh drove this point in his Independence Day address on Friday.

"The RBI is taking steps to control the rate of money supply so that prices are controlled," he said. "But in taking these steps we need to keep in mind that we do not do anything which hurts the growth rate."

A pay rise for about five million government employees poses a big upside risk to inflation. The wage rise would cost the public exchequer about $5.2 billion in 2008-09, and result in blowing a hole in the fiscal deficit - something that could trigger a downgrade in sovereign ratings.

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