Inflation to cause economic slowdown

28 Jul, 2008, 0014 hrs IST, REUTERS

NEW YORK: Latin America is likely to see a mild slowdown in economic growth this week on the
back of erosion of real wages and higher inflation, including higher food prices. This could put a
damper on investor sentiment and pressure sovereign debt prices. However, emerging market paper will
likely be entwined with the US market.

"There are ongoing concerns about credit and the overall stability of financial institutions in the United
States, and that tends to continue to affect sentiment," said Enrique Alvarez, head of Latin America debt
strategy at IDEAglobal. In addition, Latin American debt in general is starting to see rises in interest
rates, which is pulling growth back somewhat. This is due to faltering domestic demand, analysts said.

"Tighter monetary policy in almost all countries, coupled with the negative income effect of higher food
and energy prices, explains a large portion of the slowdown seen in domestic demand this year,"
analysts at Bulltick Capital Markets in Miami wrote in a research note.

The latest country to raise rates was Colombia On Friday, its central bank increased its key interest rate
by 25 basis points to 10 percent, its highest level since September 2001. The bank also lowered its
forecast for gross domestic product growth in 2008 to between 3.3 percent and 5.3 percent from the
previous 4 percent to 6 percent.

The economy grew 7.5 percent in 2007. Colombia's yield spreads, an important gauge of investors'
aversion to risk, tightened nine basis points on Friday to 199 basis points over comparable US
Treasuries, according to JP Morgan's Emerging Markets Bond Index Plus.

Higher interest rates in Latin America are favorable to investors who can borrow short-term money at
low rates and then invest it in higher-yielding securities such as emerging market debt to profit from the
difference in rates, a practice know as a "carry trade."

"Despite the already impressive run seen in the foreign exchange markets, the very high positive carry
has continued to allow investors to resist higher stop-loss targets. In our view, only very sharp volatility
will be able to force investors to flee places such as Brazil, Chile, or Mexico," Bulltick said in their
report. So far this year, emerging sovereign debt investors have gained a mere 0.325 percent of their
original investment, according to the EMBI+.

On their Brazilian bonds investors have gained 2.75 percent, while on their Mexican paper they have
received just below 1 percent. But analysts said sometimes it's good to be mediocre. "Emerging market
bonds have delivered mediocre total returns year-to-date. However, those returns are significantly better
than those offered by its investment grade and high yield siblings," Guillermo Mondino, an analyst for
Lehman Brothers, said in a research note.

"The outperformance of the emerging market bond asset class is not just recent; it has outperformed
since the start of the capital market turbulence." Investors are likely to keep an eye on Monday on
Brazil's current account balance for June; on Tuesday for Mexico's IGAE economic activity for May;
and on Wednesday for Mexico's central bank quarterly inflation report, Brazil's July wholesale inflation
and June budget surplus.
On Thursday, they will watch the minutes from Copom, Brazil's monetary-policy committee, Chile's
June unemployment and June industrial production; and on Friday, Mexico's central bank monthly poll
on inflation expectations and Brazil's industrial output.

Double-digit inflation influenced by global factors: PM

15 Jul, 2008, 2003 hrs IST, IANS

NEW DELHI: Global factors are behind India's current bout of inflation, Prime Minister Manmohan
Singh said on Tuesday, a week before his government seeks a vote of trust in parliament.

In an interaction with a group of editors at his 7 Race Course Road residence, Singh admitted curbing
inflation and maintaining growth momentum were major challenges for his government.

"It's not a typical inflation, it's influenced by global factors," Singh was reported by television channels
as having said during his interaction, which was largely focussed on the India-US nuclear deal.

Indian equity markets ended at a 15-month low Tuesday following a 654-point drop in the Sensex, the
benchmark index of the Bombay Stock Exchange. Banking, capital goods, metal and power stocks were
the worst hit.
The markets started on a weak note and kept going down through the day. All the sectoral indices ended
the day in the red.

An official press communiqué from the prime minister's office said that at the interaction with the
editors, Manmohan Singh "outlined the steps taken by the government to sustain the growth momentum
and curb inflation, in the face of external pressures on account of rising crude oil prices."

"He also referred to various initiatives taken by the government to make the growth process socially
inclusive, including measures taken to insulate the poor to the extent possible from inflation," the
statement said.

Some of important measures taken by the government to rein in inflationary trends include the ban on
export of non-basmati rice, upward revision of cash reserve ratio (CRR) and repo rate by the central
Reserve Bank of India (RBI).

RBI June 24 had hiked the repo rate or the rate at which the apex bank lends money to banking
institutions to 8.50 per cent from 8 per cent, and the CRR by 50 basis points to 8.75 per cent from 8.25
per cent.

The Prime Minister June 2 had expressed his government's inability to allow the "subsidy bill to rise"
and "fully insulate" the people from the impact of the world commodity price situation.

His statement at the annual session of Associated Chambers of Commerce and Industry (Assocham), a
leading industry lobby, had been followed by an increase of diesel and petrol prices by Rs 3 and Rs 5
per litre respectively, while that of a cooking gas cylinder went up by Rs 50.

"We cannot allow the subsidy bill to rise any further. Nor do we have the margin to fully insulate the
consumer from the impact of world commodity price and oil price inflation," the prime minister had
said in his speech.

India's headline inflation during the week ended June 28 touched a 13-year high of 11.89 per cent,
while the growth rate of industrial production decelerated to a six-year low of 3.8 per cent in May this
year.

In view of soaring inflation, economists have expressed doubts if India would be able to log even an
eight per cent growth this fiscal as compared to 9 per cent in 2007-08.

Tips to beat the soaring inflation

Inflation reduces your purchasing power, erodes your net worth and adversely affects your lifestyle in
the long run.

Sadly, however, there seems to be no respite from this soaring inflation in sight, at least in the near
future. Economists have already warned that inflation is bound to cross a 13-year high of 9 per cent from
the current level of around 8 per cent, as a fallout of Wednesday's sharp hike in petrol and diesel prices.

Still you need to look out for some ways to keep your household budget intact. Here are some tips to
shield you from this devil..

Insulate Your Long-Term Goals Against Inflation

Do not let inflation affect your long-term mandatory goals like house purchase, education and marriage
of your children and regular income for the retirement years.

"With the help of a qualified financial planner, incorporate the inflation factor in your long-term goals
and invest the required amount regularly towards meeting those goals," says Dalal.

For example, if you want to make provision of Rs 10 lakh for your 6-year-old daughter's higher
education when she is 18, incorporating an inflation figure of 6 per cent p.a. will give you a figure of Rs
20 lakh at that point of time.

Therefore, you should start an investment plan from now, which will help you accumulate Rs 20 lakh
after 12 years.

Review Your Financial Goals and Portfolio

In the current scenario of staggering prices, there is a need to review your financial plans and
investments as the expenses and corpus required to achieve financial goals may increase.

So, you need to balance your portfolio so that it can generate better inflation-adjusted returns.
In the times of rising prices, you need to spend your monthly household budget smartly. To maintain
your lifestyle, you should limit the household expenses to 70 per cent of your monthly take-home
income. "If it is exceeding the limit, you need to judiciously cut down on the unnecessary expense
items," says Ramesh Dalal, V-P, Bajaj Capital Financial Planning Group.
For example, you should buy the seasonal fruits and vegetables and avoid the non-seasonal ones, as they
are expensive. Control the use of electricity and telephone and try to reduce the expenses on wardrobe,
partying, gifts etc. by a certain percentage.

You may also think of enhancing your earning capacity by changing to a better-paying job or doing
some part-time work.

Diversify Your Portfolio

Inflation impacts different sectors in different ways. "Due to current inflationary trends, one needs to
have a well thought-out sector spread in his investment portfolio. While investing in companies, one
should look at how they are being impacted by the rising input and borrowing costs," informs Ashish
Kapur, CEO, Invest Shoppe India Ltd.

For example, manufacturing companies or heavy industries, though their stocks, will be available at
tempting valuations. However, chances are high that they will further fall in short term, owing to
negative sentiment.

Hence, investments should be made in large cap companies having economies of scale and their ability
to handle input and borrowing costs.

Stay Invested in Equities

For long-term investment goals like child education, retirement etc, equity can generate handsome
inflation-adjusted returns.

Therefore, In spite of the current volatile situation in the equity market, it is advisable to stay invested as
this is a cyclical event and in the long run the markets are bound to rise.

Hence, to achieve such goals one should be able to take a calculated risk.

"Consider this bearish trend as a good entry point in garnering blue chip stocks," says Kapur.

Don't Let Your Money Lie Idle, Invest It Wisely

Don't keep on accumulating your money in the savings bank A/c.

Keep only 2-3 times of your monthly household expenses in the liquid form and invest the balance
amount regularly in a well-diversified portfolio of equity, short-term debt, real estate, commodities and
gold.

It will increase your cash inflows and help you reduce the burden of rising prices.

Check The Real Return On Investment Portfolio

Inflation eats into your net worth by reducing the real return on your investment portfolio. Real returns
are inflation adjusted returns.

For example, if you have a bank FD, which earns returns at 8 per cent p.a., and inflation is 8 per cent,
then the real return on this investment is zero.

Therefore, you should review your existing portfolio as well as make fresh investments to check whether
your absolute returns are beating the rate of inflation by a good margin or not. Equity, commodities,
gold and real estate are good investment options to generate a positive real rate of return.

For short-term requirements, you can consider investing in the short-term funds or floater funds. It is
generally seen that a high inflationary trend is followed by an upward revision in the interest rates. Hike
in the interest rates will adversely affect your long-term debt portfolio. Therefore, during inflationary
periods, it is wise to invest in short-term funds and wait to reap high returns
Add the Shimmer of Gold to Your Portfolio
Historically gold has proved to be the perfect hedge against inflation. After adding gold in your
portfolio, the risk remaining the same, the overall inflation-adjusted returns of portfolio can be
enhanced.

High inflation, in fact, puts an upward pressure on the interest rates, which in turn create uncertainty in
the capital markets.

During such times of crisis, gold as an investment avenue is a good bet. Investment in gold can be made
in the form of bullion, coins, jewellery and Gold Funds Exchange Traded Gold Funds, among others.
Avoid Investments In Illiquid Assets
Illiquid assets with low returns restrict the performance of a portfolio.

So, try to exit from such investments and redeploy the amount in asset classes that generate better
inflation-adjusted returns.

For example, bank fixed deposits, post office recurring deposits, etc.

Where to invest in times of inflation?

In a period of high inflation the big question is: Where could you park your funds, which are both safe
and offer productive returns? With the two popular avenues of investment usually used to beat inflation -
equity and realty - not doing well, it's no wonder then if the retail investor is at a loss as to where to park
his/her funds.

While the Indian stock markets are plummeting, there is a lull in the real estate market too. Obviously,
anyone with a little market sense would advice against real estate at the moment. Moreover, it also calls
for huge sums. So, where should you invest?
Experts also aver that the stock markets also may not give positive returns in the next 12-15 months
owing to two factors. One, the current political situation and two, the high oil prices.

"As long as the oil price does not stabilise, the markets cannot give much positive returns," points out
Kancheti Surendra, director, SK Wealth Creators Pvt Ltd, a wealth management advisory.

"Don’t put all your assets in any one basket, as none is the best in these times. Spread your assets," is the
advice most experts gave.
Investing in systematic investment plans (SIPs) of mutual funds, whereby you invest a certain quantum
every month, is a good idea, according to many investment counsellors. "The SIP products help you
average your investment against the vagaries of the market conditions and inflation," says C
Parthasarathy, chairman of Karvy Stock broking Ltd.
If you have Rs 100 to invest, put in Rs 70 in balance fund schemes of mutual funds, which balance
investments in equity and debt, through the SIP route. The rest, divide Rs 15 each in gold and realty, he
advises. Concurs Surendra. "Actually, SIPs of mutual funds are diversified largecap funds and according
to me this is the best instrument in an uncertain market," he adds.

Gold still glitters

"Buy Gold" or gold funds is the advice most investment counsellors are giving their clients, to protect
the value of their hard-earned money, though one has been witnessing some dip in gold prices recently
after an earlier rise.

According to Quantum Asset Management Company Private Limited, gold has historically been a good
hedge against both falling stock markets and rising inflation and continues to give that “double hedge
advantage” even today.
Are you in a lifestyle trap?

TGIF (Thank God It's Friday) is a phrase that rings hollow these days. The reason? Well, Fridays bring
the dreaded news of growing inflation, analysis of how it will pinch your pocket and also, how you can
prepare yourself for dealing with the same.

However, the analyses and suggestions highlight only headline inflation and not lifestyle inflation,
which needs to be provided for.

Lifestyle inflation indicates the rise in your lifestyle expenses, which you need to consider even if the
headline inflation is not soaring.
What is lifestyle inflation?
"As your disposable income increases, you tend to acquire certain expensive tastes and desires. This is
also a function of the growth in availability of a number of options," explains RK Shukla, senior fellow,
NCAER. He feels that it is an urban phenomenon, where the youth who aspire to follow western
lifestyles, play a major role.

For example, you would have been content to watch movies in an ordinary movie hall a few years ago.
However, with the hefty pay hikes you've received over the years, you would now have upgraded to
multiplexes.

In simple terms, it means your ticket cost has jumped from Rs 100 to Rs 250. Now, the wholesale price
index, from where the headline inflation is derived, does not include these costs. This is what you spend
on maintaining a lifestyle that you desire; hence it is termed lifestyle inflation.
A growing concern
This problem is unique to the new generation. The concept of lifestyle inflation was not prevalent earlier
as the income growth was usually 5% over and above the inflation. The scenario has changed now.

An individual's income growth is pegged at a minimum of 10% in excess of the inflation. So, the
affordability is much higher, resulting in people giving in to aspirational and peer pressures.

"This bug bites individuals in the range of 30-40 years. This is the age where individuals stretch
themselves to buy the latest car or an LCD TV, even if that siphons off a considerable portion of their
bank balance," says PARK Financial Advisors' director Swapnil Pawar.

If an individual is over 40 years of age, he/she is likely to exhibit more maturity. Also, the pace of
growth of an individual's income tends to slow down, and he/she doesn't see the steep increase that used
to happen when he/she was in his/her thirties, the experts say.
10 nations with abnormally high inflation
1) Zimbabwe – Over 1 million per cent

Weary Zimbabweans are facing a new wave of price increases that will put many basic goods even
further out of their reach: A loaf of bread now costs what 12 new cars did a decade ago.

According to an AP report, independent finance houses said in an assessment recently that annual
inflation rose in May 2008 to 1,063,572 per cent based on prices of a basket of basic foodstuffs.
Economic analysts say unless the rate of inflation is slowed, annual inflation will likely reach about 5
million per cent by October.

A small pack of locally-produced coffee beans now cost just short of 1 billion Zimbabwe dollars. A
decade ago, that sum would have bought 60 new cars.
10 nations with abnormally high inflation
2) Burma – 40%

Burma comes in second behind Zimbabwe with its inflation rate hovering around 40 per cent. It has
been termed a ‘least developed country’ and continues to struggle as one of the poorest countries in
Asia.

According to 2007 estimates, 32.7 per cent of the Burmese people live in poverty. Per capita GDP in
Burma is $1,900 compared with $8,000 in neighboring Thailand, $26,400 in South Korea, and $33,800
in Japan

3) Iran – 25.3%

Iran’s annual inflation rate rose to 25.3 per cent in May compared with the previous month, when it
reached 24.2 per cent, the central bank said. The statistics highlight the economic problems facing
President Mahmoud Ahmadinejad’s government, under pressure from many lawmakers, media and the
public over its failure to rein in the strength of inflation in the world’s fourth-largest oil producer. The
central bank said that prices rose by 1.7 per cent in the Iranian month to May 20, pushing up the year-
on-year rate to more than 25 per cent, according to a Reuters report.

Monthly prices increased 3.1 per cent the previous month, to April 19, when the year-on-year rate was
24.2 per cent. The year-on-year rate was 22.5 per cent in March, showing a steadily climbing trend.
Iran’s inflation rate was about 12 per cent in mid-2005, when the conservative president came to power
pledging to share Iran’s oil wealth more fairly.
4) Vietnam – 25.2%

Vietnam’s ruling Communist Party is facing one of its biggest challenges with yearly inflation in
double-digits for seven consecutive months, hitting 25.2 per cent in May.

Despite authorities’ efforts to control inflation, including interest rate hikes, consumer prices were 4
percentage points higher than last month, according to the Government Statistics Office, news agency
AP reported.

Vietnam’s inflation rate is among the highest in Asia, and higher food prices in particular are hurting the
country’s poor. Soaring imports have tripled the trade deficit this year to $14.4 billion, while the
Vietnamese stock market has lost 60 per cent, making it the world’s worst-performing market.

•
Egypt – 21%

The Egyptian government has reported that inflation rates in the country rose to over 21 per cent in May,
as a direct result of rising prices that have worsened the North African nation’s food crisis.

The official news agency, MENA, quoted an Egyptian government official as saying that inflation in
rural areas had "increased even higher to 22.9 per cent" for the month, raising concerns over widespread
discontent.

“The May figures are in stark contrast to the already high inflation rate reported in March of around 14
percent. This does not bode well for approximately 20 percent of the nations almost 80 million people,
who live below the poverty line of US$2 per day,” the official was quoted as saying. )

Pakistan – 19.27%

Inflation in Pakistan reached all-time high of 19.27 per cent in May, mainly because of growing prices
of food items.

Analysts however predict the average inflation will be closing at 12 per cent or slightly above that in the
fiscal year, which will end June 30, 2008.

Data released by the Federal Bureau of Statistics showed that food inflation, measured through the
Consumer Price Index (CPI), swelled to record 28.48 per cent in May, highest in over three decades.

Latvia – 17.9%

Latvian inflation accelerated again in May, with the annual inflation rate rising to 17.9 per cent, the
highest in the 27-nation EU.

Despite the fact that activity is slowing – Latvia’s economy expanded a revised 3.3 per cent in the first
quarter, compared with 8 per cent in the previous three-month period.

Food prices, the biggest item in the consumer basket, rose an annual 21.6 per cent, but other areas like
education (20.5%) and hotels and catering (23.2%) are going up at a rapid clip, and there is no short
term sign of all this abating.

Iraq – 16%

Higher food and energy costs lifted Iraq’s inflation rate to 16 per cent in April this year, still well below
the rate recorded in 2007.

According to media reports, despite the record price of oil which was trading at 133 dollars a barrel
recently, the oil-rich nation has not benefited from recent price rises because of corruption and security
concerns.

Iraq’s Central Bank governor Sinan al-Shibibi said the bank would absorb the inflation rate by
appreciating the Iraqi dinar against the US dollar and maintaining high interest rates which currently
stand at 17 per cent.

The figures are still considerably lower than in 2007, when the inflation rate reached almost 32 per cent.
In 2006 the rate stood at almost 70 per cent.

Bulgaria - 15%

The annual inflation in Bulgaria reached 15 per cent in May 2008, compared to the comparative period
last vear, a reading that in the last 10 years trails only the 18.8 per cent clocked in May 1998, the
National Statistical Institute reported.

The inflation for the period January-May 2008 compared to the same period in 2007 stood at 13.9 per
cent. The overall increase in prices compared to April 2008 is reported to be 0.5 per cent.

Qatar – 14.75%

Annual inflation in Gulf oil producer Qatar rose for a third quarter running in March to a near record of
14.75 per cent, the country’s state Planning Council said on June 2, 2008, amid a surge in food and
commodity prices, and rents.

The Consumer Price Index reached 166.87 points on March 31, the council said on its website, without
giving year-earlier data. The index was at 145.42 points on March 31 last year, according to earlier
Planning Council figures.

Inflation at the end of December was 13.74 per cent. The last time it was higher was on March 31 last
year when it was 14.81 per cent.

Inflation stabilised on week-on-week basis: FinMin

17 Jul, 2008, 2014 hrs IST, PTI

NEW DELHI: Relieved that inflation during the week-ended July 5 rose by only 0.02 per cent, the
Finance Ministry on Thursday said the rate of price rise has stabilised on week-on-week basis, with
prices of many essential items either declining or remaining static.

"The rate of inflation for the week ending July 5, 2008 stands at 11.91 per cent, very marginally higher
than the rate of 11.89 per cent reported last week... Inflation, on a week- on-week basis, has stabilised,"
the Finance Ministry said in a statement released along with official figure on inflation.

The statement said annual inflation rate for the group of 30 essential commodities has declined to 5.74
per cent during the week ending July 5 from 5.98 per cent reported last week.
Prices of essential commodities which include foodgrain, pulses, edible oils, vegetables, dairy products
and some other commodities including kerosene, soap and safety matches have more or less stabilised.

The annual inflation has declined to 9.92 per cent in the primary articles group during the week
compared to 10.84 per cent reported last week.

Out of a total of 98 articles, 13 have shown a decline in prices, compared to June 28, 2008. These
include rice, jowar, onion, brinjal, black pepper, okra, barley, groundnut seed, gram and banana.

Another 57 items have shown no rise in prices, it said. In the case of manufactured products, of a total
320 commodities, a large number of 281 have shown no increase in prices over the last week, while in
the case of 12 commodities there is a decline in prices, the ministry said.

These commodities include salt, sugar, other iron and steel, lead ingots, zinc ingots, groundnut oil,
deoiled cake, bran, liquid, liquid chlorine and caustic soda.

Effects and a ready reckoner on basic terms and facts

Whenever we talk about inflation, everything seems to be a repeat of the past. The script has all the
obvious elements: price shocks, excess money supply, declining output, monetary tightening, fiscal
measures, et al. Grown-ups have seen many such phases of ups and downs. But kids born in the last 10
years are seeing double-digit inflation for the first time in their lives. So let’s put together some of the
basic terms associated with inflation that will serve as a ready reference for all time.
Jinny: Wherever I go these days, I see inflation-hit faces. What to say of kids, even some of our older
folks are looking utterly confused. Many of them seem to have blissfully forgotten the old lessons.
Johnny: I think, Jinny, it’s the right time to repeat the old lessons. Tell me the most basic thing first:
What do we mean by inflation?
Jinny: Inflation is defined as an increase in the general level of prices of goods and services from one
period to another (generally one year). It is measured in terms of per cent change in the value of a price
index consisting of a basket of goods and services. An inflation rate of 10% means that the general level
of prices of goods and services has increased by 10% over the period. In other words, it means that for
purchasing the same amount of goods and services, you have to pay 10% more money.
(Illustration: Jayachandran /Mint)
But, you may ask, why do prices increase year after year? Can’t we have constant prices over a period?
Or better still, can’t we make prices actually fall from one period to another? Well, the prices of goods
and services in a free market are determined by the forces of demand and supply. So you can’t have
constant prices unless your demand and supply remain constant. Generally, it is observed that demand
increases faster than the supply of goods and services, leading to increases in prices of goods and
services over a period.
However, in unusual times, when demand is slacking, you may actually observe a fall in the general
level of prices, which in technical terms is called deflation. This is the opposite of inflation.
Is that good for the economy? No. Both high inflation and deflation adversely affect the economy. It is
believed that moderate inflation over a period of time is good for the economy because it encourages
producers to increase output.
However, an unexpectedly high increase or fall in prices has the opposite effect. High inflation reduces
the purchasing power of the money in the hands of people, leading to a decline in aggregate demand in
the economy, which compels producers to decrease output.
Falling prices, on the other hand, make production of additional goods non-lucrative and so encourage
producers to voluntarily cut their output.
Johnny: So, the problem of inflation is actually a problem of unexpectedly high increases in prices.
Now tell me, how is cost-push inflation different from demand-pull inflation?
Jinny: Demand-pull inflation is caused by excess money leading to an increase in aggregate demand in
the economy. It is a case of “too much money chasing too few goods”. Aggregate demand includes both
consumption and investment.
This kind of inflation is best controlled by monetary measures such as high interest rates and asking
banks to maintain high cash reserves, which act as brakes on money supply.
Cost-push inflation, on the other hand, is caused by supply-side constraints. The high cost of labour or
raw materials may force producers to increase the prices of their goods and services. High crude oil and
food prices are examples of supply shocks leading to unexpected increases in prices of other goods and
services. This kind of inflation requires more careful use of monetary and fiscal measures.
Johnny: Economists talk about core and headline inflation. Now what are these?
Jinny: Headline inflation is most commonly represented by a price index consisting of a basket of
different goods and services. Core inflation is what we get after removing volatile elements such as oil
and food from this basket of goods and services. So, headline inflation is often higher than core
inflation.
Johnny: I often hear that inflation hurts the old and the poor the most. How does inflation affect our
lives?
Jinny: Well, how inflation is going to affect you depends on where you are placed. People living on
fixed incomes, such as retirees, feel the pinch more. Inflation eats away the value of their fixed income
day by day.
A person living on borrowed money is probably better off because inflation decreases the real value of
the debt if the inflation rate is higher than the interest rate. Today, you can have breakfast and lunch with
the borrowed money.
But tomorrow, when you pay back the money, your lender realizes that he can only buy breakfast with
the same amount of money. Uncertainty about the future always hurts economic growth.
Johnny: That’s true, Jinny. We need to save our kids from the uncertainty of inflation.
What: Inflation is defined as an increase in the general level of prices of goods and services from one
period to another.
How: Demand-pull inflation is caused by increase in aggregate demand in the economy whereas cost-
push inflation is caused by supply-side constraints.
Why: High inflation reduces the purchasing power of money, leading to a decrease in aggregate
demand, which slows economic growth.

Industrial growth dips, inflation soars

New Delhi: India’s attention swung from one number—the support of the 272 Lok Sabha members the
government needs to stay in power—to other, more economy-related numbers on Friday and these
showed that its macro-economic outlook had taken a turn for the worse and could result in the
downgrading of India’s sovereign credit rating and increasing the cost of its foreign loans.
Inflation, as measured by an increase in the wholesale price index, rose to 11.89% in the week ended 28
June, compared with 4.42% for the same period in 2007. And, the country’s industrial growth in May
dipped to 3.84%, the lowest in six years. It was 10.59% last May.
India’s benchmark index, the Bombay Stock Exchange’s 30-stock Sensex, fell 456.39 points, or 3.3%, to
13,469.85.
Inflation will continue to stay in the double digits till December and soaring prices will hurt the
country’s economic growth slightly, according to Shubhashis Gangopadhyay, adviser to finance minister
P. Chidambaram.
“We are trying to cope with the impact of high oil prices and inflation,” he said.
The country’s central bank, the Reserve Bank of India, or RBI, has tried to tighten monetary conditions
by raising the cost of credit and other measures but inflation continues to march on. N.R. Bhanumurthy,
associate professor at the Institute of Economic Growth, said an-other round of monetary tightening
might aggravate the slowdown.
“The impact of high food prices, both international and domestic, has gone down. The more serious
issue is the adverse impact of inflation on manufacturing. The deceleration in manufacturing is primarily
due to the increase in fuel prices and the interest rate hike by RBI in January.” He said that any move
that “constrains growth is ill-directed”.
LITTLE COMFORT (Graphic)
A report by credit rating agency Standard and Poor’s warned of a likely economic deceleration,
“especially if high inflation leads to higher real interest rates and weakening investment demand and
consumer borrowing”. Rising inflation and worsening fiscal deficit and current account on the balance
of payments may lead to cut India’s sovereign credit rating to “speculative grade” said Takahira Ogawa,
a credit analyst with the firm.
According to it, measures such as the farm loan waiver, higher oil and fertilizer subsidies and pay hike
for government employees are likely to push up the consolidated fiscal deficit in 2008-09 to 9% of the
gross domestic product from 6.5% estimated earlier.
Reuters contributed to this story
No ceasefire on inflation, rates should go up

Will Reserve Bank of India, or RBI, governor Yaga Venugopal Reddy call a truce in his war on inflation
when he unveils the quarterly monetary policy review on 29 July, and leave interest rates unchanged?
Or, will he continue to tighten policy by raising interest rates and soaking up liquidity through an
increase in commercial banks’ cash reserve ratio, or CRR, in the belief that the beast of inflation is yet to
be caged?
The market is divided on the stance of the July review, the last in the Reddy regime. Those bankers and
bond dealers who strongly feel that the time is ripe to rein in Reddy’s aggression in raising rates, cite
three developments to build their argument. First, the drop in the wholesale price-based inflation from
11.91% to 11.89% for the week ended 12 July, the first such drop in two months. Second, a decline in
industrial production. The year-on-year growth rate in industrial production in May fell to 3.8%, its
lowest in six years. Finally, they point to a drop in crude oil prices.
Since the beginning of the current fiscal, Reddy has raised the policy rate by 75 basis points to 8.5% and
CRR by 125 basis points to 8.75%. One basis point is one-hundredth of a percentage point. These
bankers and bond dealers feel any policy action at this juncture is not necessary and RBI should wait and
watch the trajectory of inflation as well as the monsoon before taking a call on further rate hikes.
But there are others who equally strongly feel that it’s too early to wave the white flag and RBI should
continue what it has been doing—making money dearer by raising policy rates. I would go with this
group. Inflation is a bigger enemy than the slowdown and there is no room for complacency. At 11.89%,
inflation is still more than double of what the central bank is comfortable with. More importantly, a drop
of 2 basis points does not mean that inflation has reached its peak, particularly when the base effects will
continue to remain unfavourable for the next few months. It had fallen from 4.7% to 3.1% between July
and October last year and, because of the lower base, inflation will continue to remain in double digits
for quite sometime and may not come down before the year-end. An uneven monsoon can queer the
pitch further as it will impact food prices. So far, 14 out of 36 meteorological sub-divisions across India
have received either deficient or scanty rainfall, the worst distribution of rain in four years.
Indeed, supply constraints are contributing to the rising inflation. But there are demand pressures too.
There is no drop in investment demand as well as demand for consumer durables. Besides, non-oil
imports are rising at a considerable pace.
The year-on-year growth in money supply has marginally come down to 20.5%, from 21.8% last year,
but it is still well above the RBI projection of 16.5-17% for 2009. Similarly, aggregate deposits in the
banking system have grown by 21.7% this year against RBI projection of 17% and credit growth has
been 25.7%, substantially higher than RBI’s target of 20%. All these indicate growth impulses and
monetary policy, the proverbial first line of defence against inflation, should come to the fore by raising
the policy rate by 25 basis points or so.
There may not be any need to raise CRR at this point, as liquidity is already tight. Banks, on an average,
borrowed around Rs45,000 crore daily from RBI last week and the rates in the overnight call money
market, from where banks borrow to tide over their temporary asset-liability mismatches, have been
hovering around 9%, above RBI’s policy rate.
Death of bank rate?

Is the bank rate, RBI’s most potent signalling device, dead? The last time this rate was tinkered with was
in April 2003, when it was brought down by 25 basis points to a three-decade low of 6%. Since then,
there has been no change in the rate even though the reverse repo rate has gone up from 4.5% to 6%, and
the repo rate from 6% to 8.5%. The reverse repo rate is the rate at which banks park their short-term
excess liquidity with RBI and the central bank pumps in short-term liquidity into the system at the repo
rate.
Earlier, the bank rate was the refinance rate at which banks used to draw down liquidity support from
RBI. But this has now been delinked from the refinance rate. The bank rate is a statement of RBI’s
views on interest rates in the medium term, while repo rate is a short-term signalling device. But how
“medium” is the medium-term view?
One can always argue that there are too many policy rates and why add another, especially one that has
not been changed in a long time. But then, the bank rate is a signal of where medium-term interest rates
should be and, by implication, where medium-term inflation is likely to settle. In an environment where
managing inflationary expectations is the central bank’s most important job, wouldn’t it be wise to
increase the bank rate?
The real policy rate is now at -339 basis points (inflation at 11.89% and repo rate 8.5). Since double-
digit inflation is here to stay for at least a few more months, isn’t it better to give a medium-term signal
to the market and be perceived as being ahead of the curve? In spite of the 125 basis points increase in
CRR and 75 basis points rise in the repo rate, the corresponding hikes in banks’ lending rates are far
lower. An increase in the bank rate will encourage banks to raise their lending rates and make money
costlier.

Inflation: a short history

India is deeply intolerant of high inflation. It’s either because we have been blessed with very
conservative policymakers or because the political elite knows that the electorate explodes in anger
whenever inflation crosses the middle teens. That’s perhaps a comforting thought as the inflation rate
moves towards double digits. History suggests that the chances of inflation running completely amok are
quite low; but then history can be misleading.
The actual track record tells a more complicated story. India has never had to face the terror of
hyperinflation. Look at Zimbabwe. The most recent estimate is that prices in that unfortunate African
nation are rising at an annual rate of 66,000%. Prices change every day, and sometimes every hour. Its
central bank introduced a 500-million-dollar note last month. It can be used to buy two loaves of bread, 
Reuters had said in a 15 May report from Harare. Every citizen is a billionaire, but in terms of a
currency that is worthless.
India never had hyperinflation. The highest inflation we have seen is 53.8%, in the famine year of
1943

India has never had to face such insanity since 1801. The highest inflation that India has ever seen in the
past two centuries is 53.8%, in the famine year of 1943. Amartya Sen has often written about the havoc
wreaked by that inflation in his part of the country. Satyajit Ray captured the suffering in Ashani Sanket,
a film he made in 1973. Those were terrible times, but nothing like what Germany faced in the early
1920s or what Zimbabwe has to deal with today.
Many other Asian countries have done far worse than India over the years. (The less said about
hyperinflation-prone Latin America, the better.) Inflation in China reached 1,579% in 1947, when there
was a civil war raging there. Japanese inflation peaked at 568% in 1945, the year of defeat and economic
collapse. South Korea saw inflation shoot up to 210% in 1951, when it was at war with the communist
North.
These episodes of runaway inflation are linked to political dislocations and war. So peace, political
stability and credible governments do matter when it comes to keeping a lid on prices. But even if the
extreme cases of inflation that have their roots in war are kept aside, India has a middling record in
fighting the genie of rising prices. It has a far better long-term record than most other regional peers.
India has spent about one out of every eight years with inflation about 20%. The likes of China,
Indonesia, Korea, Myanmar and even Japan have done worse. But Asian economies such as Hong Kong,
Malaysia and Singapore spent far less time struggling with 20%-plus inflation.
The ability to keep inflation under some sort of control is one part of India’s good economic record. The
other part is the ability to stay clear of foreign defaults though, lest we forget, India has had three trysts
with semi-defaults since it became an independent country. The government rescheduled foreign debt in
1958, 1969 and 1972.
The data used here is taken from a recent paper, by economists Carmen M. Reinhart and Kenneth
Rogoff, on financial crises over the past eight centuries. They show that financial crises are a given in
the world economy since the Middle Ages. “Serial default is a universal rite of passage through history
for nearly all countries as they pass through the emerging market state of development,” they write. And
add: “Episodes of high inflation and currency debasement are just as much a universal rite of passage as
serial default.”
So, on the one hand, we have India’s reasonably good record in avoiding financial crises and
hyperinflation. On the other hand, we have the iron law that high-growth economies tend to fall into
trouble every now and then.
Which way will we go? A lot will depend on the policy response. Manmohan Singh is no stranger to
episodes of high inflation. He was chief economic adviser to the Indira Gandhi government in the mid-
1970s, when two years of 20%-plus inflation was attacked with the then-fashionable option of price
controls. Then he was finance minister during the inflation spike in the mid- 1990s, when he and
Reserve Bank of India governor C. Rangarajan pushed up interest rates to dizzying heights to bring
inflation under control.
Now Singh is Prime Minister, and inflation is once again headed for double digits. His government has
tried a mild version of the 1970s medicine — trade restrictions and moral suasion to hold the price line
in commodities such as steel. But it is a matter of time before the 1990s medicine will have to be taken
in a larger dose — higher interest rates.
There are several reasons why we should worry about the spike in the inflation rate. Inflation is a tax on
the poor and long-term lenders. Also, as Reinhart and Rogoff show, “inflation crises and exchange rate
crises travel hand-in-hand”. Inflation is already too high, though it is definitely not at economy-wrecking
levels. But it’s best to be serious about the threat it poses.

The inflation scare

Just five months ago, the International Monetary Fund (IMF) in its annual country report on India
assessed that inflation in India had been contained, and that the medium-term prospects for the economy
were good. Now, headline inflation has doubled and the Reserve Bank of India (RBI) governor has
suggested that true inflation may be even higher — even without factoring in the suppressed inflation
due to price controls on petroleum products. TheEconomist, in a cover story, has suggested that failing
to deal with inflation in emerging economies will put future growth at risk, with the experience of the
developed world in the 1970s “great inflation” as a lesson in what to avoid. What should RBI do?
The obvious answer is to raise interest rates and choke off demand for credit. It is always possible that
new inflation shocks will force RBI to do so and, indeed, it may act before this article is published. But I
would argue for holding off on further monetary tightening.
The Reserve Bank of India should hold off raising interest rates till the US Federal Reserve does
so

The reasons are as follows: In addition to interest rate hikes, RBI has aggressively raised the cash
reserve ratio for banks, with the latest increase just taking effect. Credit growth has already slowed quite
a bit: Though it is still slightly above target, my guess is that it will come down further. Foreign capital
inflows seem to have cooled off as well. Growth in industrial production has already come down
dramatically. Finally, the factors leading to the recent upsurge in inflation, namely, jumps in the prices
of oil, metals and food, have probably reached their short-term limits. They may still work through the
economy, but, given the tightening that has already taken place, my guess is that increases in raw
material costs will further dampen industrial growth.
Essentially, a dampening of expectations with respect to real rates of return on investment will trump
inflation expectations. Signals of those expectations are mildly pessimistic, but do not indicate panic.
RBI has not released the results of its inflation expectations survey at the time of writing, but 10-year
government bond yields have crept up only marginally in recent weeks.
Support for a “do-nothing” position comes from an unlikely quarter. Joshua Felman, IMF resident
representative in India, by examining recent weekly data, suggests that inflation may have peaked,
though the year-on-year figure may climb for a while longer.
If we put this information together with what we know about lags in the impact of monetary policy and
the likely stabilization of commodity prices, then a wait-and-see attitude makes sense. I would also draw
a lesson from the 1990s episode of RBI tightening, which led to a greater slowdown than might have
been optimal. Lost growth is costly, and provided inflation does not get out of control, India may be at a
point where keeping investment and growth high may be worth a little bit of extra inflation in the short
run.
This is heresy for inflation targeters, and seemingly at odds with the concerns expressed in
TheEconomist. The problem with the latter is that it mixes up all kinds of stories and experiences in the
emerging economies pot. The Bric (Brazil, Russia, India and China) grouping is catchy, but hardly
useful for policymaking in the individual economies. Russia certainly seems to have problems with its
money supply growth, and all the macroeconomic management challenges that come with being an oil
exporter. In its more nuanced analysis of the Bric countries, the IMF country study pointed out that
Brazil and India have already put more emphasis on containing inflation than Russia and China. Finally,
the analogy with the 1970s industrial countries may be misleading because of the different structures of
cost pass-through, including powerful labour unions.
One place The Economist is right is in assessing the consequences of US Fed policy. The US Fed has cut
interest rates dramatically. In doing so, it was motivated by the need to avoid a crisis in the financial
system. But that was best handled by specific liquidity enhancing measures, which were also used. The
US macroeconomic slowdown is certainly a cause for concern, but my sense is that the Fed has cut rates
too much, in its desire to protect domestic growth.
It would be ironic if this policy, by exporting liquidity, were to force emerging economies to sacrifice
their own growth.
Two other general prescriptions are also right for India. One is fiscal tightening, and the other is
allowing greater exchange rate flexibility. Both of these measures would allow RBI greater room to
manage monetary policy in a way that does not kill growth.
And the main policy prescription, which has nothing to do with monetary management, should never be
lost. Removing rigidities and unnecessary controls in India’s internal and external markets, and making
it easier to do business and make productive investments are the only sure-fire methods for making
people’s lives better in the long run.
The government could use the current inflation scare to reform in a positive direction, rather than
regressing with added controls.
Inflationary pressures may force RBI to raise policy rates
28 Jul, 2008, 1920 hrs IST, PTI
MUMBAI: A further rate hike seems imminent with RBI saying on Monday, a day ahead of its
quarterly monetary review, that inflationary pressures are likely to continue for some time.

The central bank fears the situation may worsen in case of a hike in global oil prices which as such have
not been fully passed on to consumers in India.

Expecting that global crude prices would remain high due to tight supply conditions, RBI said in first
quarterly review of Macro Economic and Monetary Developments that "the pass-through in case of
administered petroleum products is still incomplete".

The Government on June 5 hiked the prices of petrol, diesel and cooking gas which had catapulted
inflation to double-digit mark. The increase however did not fully cover the rising prices in global
markets, RBI said.

The central bank also said inflationary pressures are likely to be there for some time.

"As the potential inflationary pressures from international food and energy prices appear to have
amplified and, by current indications, are likely to remain so for some time," it said.

In Tokyo, Finance Secretary D Subbarao also said inflation may accelerate from a 13-year high and a
further interest rate increase is an "obvious solution".

Global investment banker Goldman Sachs expected RBI to increase short-term lending rate (repo) and
mandatory deposit rates of banks with the central bank (CRR) by 25 basis points each tomorrow as
inflation is much above the RBI's comfort zone.

However, chambers and bankers called for maintaining a status quo in monetary policy of the RBI since
it would harm the growth prospects.

Inflation reflects oil prices, demand: RBI

28 Jul, 2008, 1853 hrs IST, REUTERS

MUMBAI: The Reserve Bank of India said on Monday a rise in inflation to nearly 12 per cent in mid-
July reflected some increase in fuel and raw material prices as well as strong demand.

But an increase in state-set petroleum product prices had not kept pace with the rapid rise in global
crude prices. It also said supply side pressures on global food prices did not appear to be abating.

The central bank holds its quarterly review on Tuesday and a Reuters poll of 11 economists showed
seven of them expected it to raise its key lending rate, the repo rate, by 25-50 basis points from 8.5
percent.

In its first quarter review of macro and monetary developments, the central bank said the Indian basket
of crude rose by 122 percent in rupee terms between February 2007 and June 2008. The mineral oils
index rose just 27 percent in the same period, although freely priced items in the mineral oil group rose
15-104 percent.

"This suggests that pass-through in case of administered petroleum products is still incomplete," it said.
Annual inflation was 11.89 in mid-July and has more than doubled since late February to its highest
since the index was made available in 1995 after the government raised state-set fuel prices in June.

The central bank raised the lending rate by 75 basis points in June in two unscheduled moves to clamp
down on inflation. It also raised the cash reserve ratio, the proportion of deposits that banks have to
keep with it, by 50 basis points to 8.75 percent to absorb inflation-stoking surplus cash. The central
bank said the finances of the federal government could be pressured by higher government salaries, a
cut in petroleum product duties, higher oil and fertiliser subsidies and compensating banks for waiving
debts of small farmers.

The cabinet has yet to approve an increase in salaries of government employees but the move is widely
expected ahead of parliamentary elections due by May 2009. The report said a survey of professional
forecasters by the central bank in June predicted the economy would expand 7.9 percent in 2008/09,
lower than the previous prediction of 8.1 percent. Asia's third largest economy has grown at 9 percent
or more over the past three years.

RBI expects it to expand 8.0-8.5 percent in the current fiscal year ending in March, which is higher than
forecasts by many private sector economists.
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