This past week the Reserve Bank of India [RBI] increased its key rate to a six-year high of 8.5 percent, joining other central banks across Asia in raising borrowing costs as soaring fuel and commodity prices stoke inflation. Some analysts are speculating that Governor Yaga Venugopal Reddy may lift the Indian benchmark by as much as 100 additional base points before the end of the year.

The RBI raised the repurchase rate by 0.5 percentage point on 24 June and lifted the cash reserve ratio to 8.75 percent from 8.25 percent, to prevent money in the banking system from fanning inflation. The move followed a quarter-point increase in the benchmark interest rate to 8 percent on June 11.


Money supply in India's banking system grew 21.4 percent from a year earlier to 41 trillion rupees ($953.5 billion) in the week ended June 6, more than the Reserve Bank's target of 16.5 to 17 percent for the fiscal year ending March.

Soaring food prices are also stoking inflation in India, where more than half the population of 1.1 billion survive on less than $2 a day. Food product costs, including bread, salt, cooking oil and tea, jumped 14 percent in the week leading up to June 14 from a year earlier, according to Friday's report. Fuel price inflation rose 16.4 percent in the week ended June 14 from a year earlier.

India on June 4 raised retail prices of fuel for the second time this year. Higher fuel prices led to higher transportation costs, making manufactured products and food items more expensive.

The index of manufactured products, which has a 64 percent weight in the inflation basket, rose 9.7 percent.

Foreign Exchange Reserves

India’s foreign exchange reserves rose $1.8 billion during the week ended June 20 despite sustained selling by foreign portfolio investors, indicating that the Reserve Bank of India was a net buyer of forex assets in the market. The rise in reserves comes after a sharp decline of nearly $5 billion in the previous week.

According to the latest data released by RBI, forex reserves, including gold and SDR (special drawing rights), rose $1,794 million during the week ended June 20 to touch $312.5 billion. While foreign currency assets rose $1,789 million, reserves with IMF rose $5 million. The value of gold and SDR — currency with the IMF — remained unchanged during the week.


Thus, $1,794-million worth of forex assets were absorbed by the central bank during the week although these assets, even if expressed in dollar terms, include the impact of movements in the value of non-US currencies (such as euro, sterling and yen) held in the reserves. The central bank obviously intervenes to buy and sell assets denominated in a variety of currencies, and even though the currency break-down of India's reserves is not made public, the central bank does reveal the break-down of the SDR-dollar, sterling, euro, yen and non-SDR currencies.

This data suggests that over the years, the share of non-SDR currencies in the reserves - such as the Canadian dollar, yuan and the Australian dollar - has been going up.

The Rupee

India's rupee fell by the most in three weeks last week, after crude oil rose to a record and demand consequently rose from importers. India's oil imports have averaged $7.7 billion a month this year, compared with $5.4 billion in 2007.

The rupee seems to be heading for its worst quarter in a decade as accelerating inflation has prompted global funds to sell more Indian equities than they have bought so far this year. The rupee is in fact now the second-worst performer among the 10 most-traded Asian currencies excluding the yen this quarter. The rally in oil led the rupee to retreat from the three-week high it touched on Thursday, following the decision by the central bank to raise its benchmark interest rate by the most since 2000.

The rupee was down 0.5 percent to 42.88 against the dollar by the 5 p.m. close in Mumbai Friday. That is the biggest fall since June 9.