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23 Aug 2013
Monetary Challenges for the New Governor
India’s presently rising inflation and weak currency imply that the incoming governor of the Reserve Bank of India (RBI, the central bank), Raghuram Rajan, a former Chief Economist with the International Monetary Fund, will find much on his plate as he replaces the present governor, D Subbarao, who completes his five-year term on 4 September 2013.
India’s wholesale price index (WPI) grew by 5.79% year-on-year as of July 2013, while the corresponding consumer price index (CPI) grew by a whopping 9.64% during the same period – India commonly refers to the WPI for signs of overall inflation due to shortcomings in the CPI. Inflation risk is compounded by the weakening Indian Rupee, which depreciated sharply to INR/USD 61.115 at the end of July 2013 after fluctuating between INR/USD 53.000 to INR/USD 55.000 from October 2012 to April 2013. While the recent rise in the WPI is far below the 8-10% highs observed during the early 2010 to late 2011 period, this represents a stark departure from the prevailing trend as the RBI had successfully sustained disinflation in the WPI to a recent low of 4.58% as of May 2013. The success in managing WPI inflation has also been partially marred by persistently high CPI rates, hovering around 9-11% since early March 2012 and which have been attributable to rising food prices. The food component of both CPI and WPI rose by approximately 11-12% during July 2013. Unanticipated adverse rainfall has contributed to the rising food prices, with torrential rainfall damaging crops.
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The risk of rising inflation has been somewhat exacerbated by the depreciation of the Rupee. While this increases the competitiveness of Indian exporters, this advantage is mitigated by negative factors, both internal (regarding the poor infrastructures and high administrative costs in India) or external (related to the weak global economy). Indeed, the weaker Indian Rupee – along with administrative red-tape – has raised the prices of raw materials, hence increasing production costs for Indian manufacturers. At the same time, the depreciating Indian Rupee has made it increasingly difficult to quell the inflation seen in imported goods.
The rupee is also contributing to an external imbalance. India’s current account deficit totalled USD 18.08 billion as of the quarter ended March 2013 (3.56% of total Gross Domestic Product), fuelled by a merchandise (goods) trade balance deficit of USD 51.18 billion during the quarter ended June 2013]. More importantly, the depreciation of the Indian Rupee has coincided with large capital outflows from the country. During June 2013, India reported a net outflow of USD 6.53 billion in its foreign inward investments, largely due to the USD 8.73 billion outflow in foreign institutional investor portfolio holdings - the Securities and Exchange Board of India reported net outflows amounting to USD 7.54 billion and USD 3.03 billion during June and July 2013 respectively. These large outflows, if not reversed, mean that India’s current account deficit financing will become increasingly challenging.
Raghuram Rajan has indicated that the handling of these prevailing monetary concerns will involve a collaborative process between the monetary authorities and the government rather than a quick fix with monetary policy instruments. However, the incoming governor will find his experiences immediately put to the test as he manages both public expectations and the various technical challenges that arise during his term.
Contributed by Chan Yee Lui, CEIC Analyst
» Resumed Production to Reinvigorate India’s Steel Sector
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