Freshly printed rupees cause unease

Freshly printed rupees cause unease

By Simon Cameron-Moore

BOMBAY (Reuters): Inflation in India, where poor voters get touchy about the price of onions, is edging toward the high end of its comfort zone.

Consumer prices for industrial workers rose 10.5 percent in the year to May, after an 8.2 percent rise in the year to April and 7.3 percent in the year to May 1997, data released on Monday showed.

The wholesale price index (WPI), the inflation measure most commonly used, showed a year-on-year rise of 6.86 percent in the week ending June 20 against 5.64 percent a year ago.

Fruit and vegetables shot up a whacking 36 percent within the WPI basket.

If inflation goes above 8 percent, warning lights start blinking for both politicians and economists.

Prime Minister Atal Behari Vajpayee's Hindu revivalist-led government has just emerged intact from a week of uncertain support from a southern ally.

If fickle coalition partners, like the Tamil Nadu based All India Anna Dravida Munnetra Kazhagham (AIADMK), eventually do unseat the minority government, Vajpayee can expect to lose votes should inflation reach 10 percent, analysts say.

"I see WPI inflation at 8.5-9.0 percent in a few months' time," Aashish Pitale, head of markets research at JP Morgan in Bombay, told Reuters.

The Reserve Bank of India's (RBI) job is to keep inflation down, but analysts are worried about the smell of freshly printed money at the central bank.

"Reserve money has been rising for the wrong reason. Over the last few months there has been higher monetization and it will stoke inflation," Pitale said.

There has been a 150 billion rupee increase in reserve money in the first three months of the fiscal year (April-June), and a 180 billion rupee rise in net RBI credit to the government.

The root cause is a 1998/99 fiscal deficit which Finance Minister Yashwant Sinha's critics say will overshoot a targeted 5.6 percent of gross domestic product.

"The RBI does not have a choice. It will have to monetize some of the deficit and that will lead to a bit of inflation," said Sanjeev Mohta, head of research at HSBC B&K brokerage.

Sinha could ease the pressure on the RBI by raising money through sales of government stakes in public sector companies. Otherwise the best bet is that the government fails to meet its expenditure targets -- which would handicap any upturn in economic growth.

Mohta forecast WPI inflation at 8-9 percent by the end of March, resulting in an average 7.5 percent for 1998/99 -- which would be politically acceptable.

But GDP growth will struggle to match government hopes of 6.5- 7.0 percent, after last year's drop to 5.0 percent from 7.5 percent the year earlier.

A favorable start to the four-month monsoon season in May should help keep food prices down.

India is also getting some relief from world oil markets. North Sea Brent ended last week at $13.55 a barrel, nearly $6 below 1987's average and just $1.50 off 10-year lows.

But a weaker rupee and increased import tariffs on petroleum prices will offset the benefits for inflation.

The RBI may be blessed by the weather and oil prices this year, but it is cursed by several years of fiscal indiscipline by successive governments.

Net government borrowing has risen by 30-35 percent annually over the last three years, while the nominal growth in revenue was around 15-17 percent and nominal GDP growth even slower.

Pitale said trouble was in store. Investors' portfolios are loaded with government paper of maturities of up to 10 years. India will be hoping that by the time it needs to seek external financing the international rating agencies will promote its sovereign debt credit rating above current junk bond status. But financing the government's borrowing domestically this year is the problem at hand.

The RBI is trying to push through a borrowing program on a low interest rate ticket that the market does not want to buy.

The market believes higher interest rates are inevitable, both because of inflation and expectations that any pick-up in industrial credit will add to upward pressure on rates in a market already struggling to digest the government's borrowing. The RBI has completed around half of 1998/99's 840 billion rupee borrowing program in the first three months of the financial year.

But a good chunk has ended up on the RBI's books, either through placements or through devolvements on the central bank after the market refused to buy.

So effectively the RBI still has to sell around 70 percent of the program to the market through auctions, sales or open market operations, or end up covering the unwanted government debt by printing banknotes.