Expensive oil could fuel inflation: FM

By agencies   |   Tuesday, 24 May 2005, 07:00 Hrs
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MUMBAI: Finance Minister Palaniappan Chidambaram said on Tuesday there was a need to keep inflation low and interest rates benign to promote growth but added that oil prices could put upward pressure on inflation.

He said he saw pressure on inflation from money supply which could also push interest rates higher, comments which rattled bond traders who said the central bank could tighten liquidity by raising banks' cash reserve ratio (CRR) to fight inflation.

The yield on the actively traded 12-year 8.07 percent bond rose to 7.0651 percent after the comments, from an intraday low of 7.0554 percent, the lowest since early April.

The Reserve Bank of India raised banks' CRR-the ratio of cash to deposits that banks must keep with the central bank-by 50 basis points last September, a move that sucked nearly 8000 crore from the banking system. The rise came after inflation hit a 3-1/2-year high of 8.74 percent in August.

"It is the government's intention that inflation is kept under control, that interest rates are benign to promote investment," Chidambaram told a gathering of industrialists in the financial capital, Bombay.

"There is a huge inflow of foreign exchange contributing to money supply. Add to that oil prices, and add to that the temptation of the manufacturing sector to raise prices."

RBI month raised the key short-term interest rate by 25 basis points to 5.0 percent to contain price pressures in a robustly expanding economy.

It was the central bank's second straight interest rate increase. It raised the rate by a quarter point in its mid-year review of monetary policy last October.

Inflation eased to around 5 percent in early February but it crept up to 5.61 percent in the first week of May as demand for manufactured goods increased.

India has also refrained from raising fuel prices since November despite rising international prices of crude oil, India's biggest import.

Chidambaram said the government's huge borrowing program of 1.4 trillion rupees ($32 billion) for the year to March 2006 was a concern, but that it might borrow less than the targeted amount.

Analysts say the borrowing plan could eventually put upward pressure on interest rates, crowd out private investment and dampen growth, which is expected to be at 7 percent this year.

"I concede that the government borrowing is a problem ... I am confident that this year also we will borrow less than what was projected," Chidambaram said.

"Demand for (bank) credit will be as good as last year. The key again is investment."

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