Photo Credit: The Hindu Business Line
In order to fight rising inflation, India’s central bank has raised its benchmark rate to 9 percent from 8.5 percent, which was double the estimated increase of a quarter point. The large increase shows the economic trouble that high inflation has caused, even though Governor Yaga Venugopal Reddy has done much to cut down on inflation by bumping up the reserve ratio on banks and raising the benchmark interest rate.
Money supply growing quickly
After the announcement was made that India would raise rates, Reddy also increased this year’s inflation forecast to 7 percent from a previous range of 5 to 5.5%. Money supply in India is rising at a 21 percent rate, which is much higher than the central bank’s target of 17 percent. The central bank is worried that easy lending will boost consumer demand for goods that have already appreciated in value, mostly because of the rising cost of oil.
Credit rating near junk status
The biggest threat to India’s economy isn’t its benchmark interest rate, but the threat of a credit downgrade. Currently, the nation of India maintains a credit rating of BBB- which is considered the lowest investment grade bond. Standard and Poor’s has made tough comments on India, threatening a downgrade if inflation and higher consumer spending widens the economic outlook of India.
If India’s credit standing is dropped to junk bond, it will have a very hard time financing itself. Junk bond status means many institutional investors are not allowed to hold the paper, and finding a lending is exponentially more difficult as a junk grade borrower. India’s inflation problems will be compounded if it is unable to borrow money and instead turns inflating the currency or new taxes to solve the problem. Without a good credit rating, its borrowing ability would be squashed.
Limited growth even with growing money supply
Even with money supply growing at a 21 percent rate, India’s economy is only expected to grow by 8 percent this year. This shows the disparity between the amount of money floating around and how much of it is staying in India. Controlling inflation must be a priority in India, as well as the sustained growth of the economy.