Large inflows of foreign capital have contributed to a significant increase in money supply, raising expectations of more frequent monetary tightening by the Reserve Bank of India to rein in inflation.
The RBI bought an estimated $10 billion of foreign currency between November 2006 and January 2007, and indications are that the scale of intervention may have intensified in February. Last week alone, the central bank mopped up roughly $2.5 billion to prevent the rupee from appreciating.
The banking sector's net foreign exchange assets went up to Rs 8,35,577 crore (Rs 8355.77 billion) on January 19, 2007, an increase of 27.4 per cent from a year earlier.
The resultant infusion of rupee liquidity prompted the RBI to raise the CRR by 50 basis points just over a month after an earlier identical hike took full effect, as liquidity in the banking system eased on the back of foreign inflows.
Foreign capital inflows - whether in real estate and equity markets, via mergers and acquisitions or the venture capital route - are expected to increase even further following Standard & Poor's recent upgrade of India's sovereign rating to investment grade, confirming some analysts' views that money supply growth is contributing to inflation as much as the rise in agricultural prices.
Bankers and analysts expect a third increase in CRR since December 2006 and an increase in the RBI overnight lending and borrowing rates in the annual review on April 24, 2007.
Describing the RBI's monetary and exchange rate interventions as a balancing act, Shuchita Mehta, Economist-South Asia at Standard Chartered Bank, said, "The RBI needs to keep liquidity tight given the continuing high credit growth and inflation at 6.6 per cent being way beyond the 'tolerance' range of 5-5.5 per cent."
Mehta also pointed to "positive surprises" on growth that will push up credit growth. Advance estimates see the economy growing at 9.2 per cent in 2006-07 after a 9 per cent expansion in 2005-06.
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