The Telegraph
Since 1st March, 1999
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Second offensive on inflation

Mumbai, Sept. 11: A day after the inflation rate touched a four-year high of 8.33 per cent, the government flashed its second weapon of containing price rise by deciding to suck out excess liquidity from the economy.

By raising the amount banks have to compulsorily keep with it, the Reserve Bank of India is taking out of circulation some Rs 7,000 crore, using a time-tested method of reining in inflation.

Such a measure could escalate pressures for increasing the interest rates banks charge on loans and pay on deposits but an immediate revision does not appear likely.

Expectations of an increase in interest rates have been accumulating ever since inflation started climbing on the back of rising oil prices, though the government or the RBI does not wish this to happen.

Without a revision in interest rates, saving has become meaningless because the maximum banks pay on deposits is 5.5 per cent which is far lower than the inflation rate.

Lending rates have not been raised either, except in the odd case. The Housing Development Finance Corporation, for instance, raised rates on housing loans that carry fixed, and not floating, interest rates. This was followed by the State Bank of India also making fixed-rate loans costlier.

Bankers, taken by surprise though they were by RBI's decision, do not feel this trend will gather momentum because there is still ample money swirling about in the economy.

Uco Bank chairman V.P. Shetty said: 'There is a liquidity overhang (excess cash) of Rs 50,000 crore in the system. The banks are flush with funds. Therefore, we do not see any knee-jerk reaction in the next few days. I do not see that there will be a hardening of the interest rate.'

While all this suggests that people, including companies, intending to borrow need not worry in the immediate future about an increase in the interest rate they will have to pay, for savers there will still be no incentive.

The situation could, however, change if the measures the government has taken to contain inflation do not work. First, it cut excise and customs duties to soften the impact of rising international petroleum prices and the cost of steel. Now it has followed up by impounding some money from the system.

But its success or otherwise depends to a great extent on how oil prices behave. Prices were rising even yesterday amid reports that crude oil stocks in the US had dipped and are now up around 35 per cent on the start of the year. They are, however, lower than last month's highs as supplies have increased.

The last spurt in the inflation rate has been caused not by oil but by higher prices of manufactured products and food. Some of the pressure on prices has come also from a late monsoon, though the situation has improved since July.

If the government is unable to control inflation soon, it would have to go into a series of elections, beginning with Maharashtra next month, in a position of weakness.

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