Inflation, volatility pose risks, says Reddy

Reserve Bank of India Governor Yaga Venugopal Reddy said that increasing inflationary pressures and volatility in the global financial system pose risks to the South Asian economy.

"Risks from global developments continue to persist, especially in the form of inflationary pressures, re-pricing of risks by financial markets and the possibility of a downturn in some of the asset classes,'' Reddy said in a speech in Washington DC yesterday. "Large changes in liquidity are obscuring the assessment of risks.''

India cannot remain immune to the "flux'' in global financial markets and monetary policy conditions, he said. The text of the speech was posted on the Reserve Bank of India's web site today.

The nation's policy makers are struggling to cope with a record influx of overseas capital that has driven the rupee to a 9 1/2-year high and may stoke inflation.

The stock market regulator said that it plans to slow capital inflows by putting curbs on global investors buying offshore derivatives linked to local shares.

Economic growth is also spurring an expansion in credit and money supply. India's consumer price index rose 7.3 per cent in August from a year earlier, after a 6.5 per cent gain in the earlier month. The weekly figures, at the wholesale level, moderated to the slowest pace of gains in two years last month.

"The consumer price index (CPI) is slightly hardening,'' Reddy said in his remarks yesterday to the Peterson Institute for International Economics, a Washington-based research group.

"The recent upward trend in the global prices of major food items have significant implications for the domestic agricultural sector and overall macroeconomic and financial stability.''

Reddy declined to comment directly on the outlook for the central bank's policy. He also avoided judgment on the government's proposed curbs on foreign purchases of the country's stocks, which caused a sell-off in equities yesterday.

"We have obviously some pressure in terms of growth in the monetary indicators,'' he said. "We will have to review'' the data when central bank officials meet later this month.

Early this year, the central bank increased the share of deposits that banks must hold with it, so as to slow the growth of loans and restrain inflation. The central bank has raised the borrowing costs nine times since 2004 to curb price gains.

"There are some elements that create comfort,'' Reddy said. "Excessive demand pressures have moderated'' after the central bank's monetary policy actions of the past two years. The Reserve Bank meets to set monetary policy on October 30.

Policy preference
"The policy preference for the period ahead is strongly in favour of price stability and well-anchored inflation expectations,'' Reddy said.

The wholesale prices, the main inflation parameter, rose 3.36 per cent in the first week of October, compared with 3.23 per cent in September.

Still, S&P's said yesterday RBI's goal of 5 per cent inflation for the fiscal year is endangered by a surge of cash in the financial system. India, the fastest- growing major economy after China, has lured $17.7 billion in net foreign investment into its stock market this year.