International | May 04 2011
By Greg Peel
They don't call it Chinese water torture for nothing, as the painstakingly slow pace of Chinese monetary policy tightening and currency revaluation over the past decade has left many a global observer screaming with frustration. Only recently has Beijing started a more emphatic policy of interest rate hikes but further renminbi revaluation is still missing in action.
Still, the People's Bank of China's tightening tool of choice has been increases in the bank reserve ratio requirement which, after constant upgrades, now sits at 25%. Actual interest rate hikes have been few despite Chinese GDP growth remaining at a stubborn 9.7% when 8.0% is the government's target, and inflation running over 5%. Chinese banks may no longer be lending as much, but Chinese property developers have simply resorted to issuing paper offering double-digit yields to global investors and in so doing they are keeping the property bubble fire well fuelled.
The Reserve Bank of Australia was praised across the globe when it was one of the first central banks of note to raise its cash rate in late 2009, following previous GFC slashing. But right along side the RBA was the Reserve Bank of India, which wasted no time in pulling the reins on its booming GDP growth. Indeed, while the RBA has now made six 25 basis point increases to its cash rate, India has made eight, at least until yesterday, when the ninth was announced.
And it wasn't 25bps but 50bps, to 7.25%, catching most in the market off guard. India's Sensex stock index reacted with a 2.4% plunge, taking losses in a week to 5.4%. When the US Federal Reserve cut its cash rate by 50bps in late 2007 it was seen as “shock and awe”. A 50bps hike is equally as shocking, and indicates a level of desperation. After eight rate rises, India's headline inflation reading for March came in at 9%.
India's reliance on imported oil is even more extensive than most emerging economies, so it's not hard to see where a lot of that inflation may have come from. Except for one thing: The Indian government caps fuel prices. China has run into such problems before, as has Indonesia, in that a policy of fuel price capping as a form of stimulus has backfired when oil prices do nothing but rise. India has not passed on any of the recent MENA-inspired price surge.
Were the government now to suddenly spike the fuel price cap, the effect could be crippling, so if that's not an option then commentators can see why the “shock and awe” rate hike. Capping fuel prices does not constrain headline inflation much anyway, as price rises make their way back through the system via an increasing fiscal deficit.
India posted 8.6% GDP growth last year and the government is targeting 8.0% this year. The problem is, as the Financial Times notes, that after a decade of rapid growth the economy is now running into capacity constraints left, right and centre, on everything from roads to airports and even skilled labour in a population of over a billion. Rises in commodity prices are simply adding fuel to the inflation fire.
Indian companies are already facing their own earnings constraints from the same input cost rises, and now the cost of credit will weigh even further. Shares in the State Bank of India fell 4% yesterday and dominant automaker Tata suffered a drop of over 5%. Bank stocks were doubly hit from both the cash rate hike and an increase in interest payments on deposits to the RBI to 4.0% from 3.5%.
And the 50bps hike was by no means a final hurrah, or the double-move that might finally nip inflation in the bud. “Current elevated rates of inflation pose significant risks to future growth,” said the RBI governor in the bank's annual monetary policy statement, “Bringing them down, therefore, even at the cost of some growth in the short run, should take precedence”. Commentators point out that a 7.25% cash rate is still well shy of the 9.0% rate imposed in 2007-8.
It will come down to just whether inflation can be held to 9% and whether GDP growth can indeed be trimmed. The RBI is expecting 8.0% growth in FY12 with downside risk. Standard Chartered Bank, for one, sees further rate hikes as inevitable.
India is still very much China's little brother amongst the emerging market economies, but not alone insubstantial, particularly to Australian interests. The world is terrified of overly aggressive tightening in China but so far India has largely been ignored.
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