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Depreciating rupee could add to inflation: experts

Experts cautioned that a further slide in the domestic currency could add to an inflation rate that already has surged to double digits, report Arun Kumar and Gaurav Choudhury.

business Updated: Jun 22, 2008 20:55 IST

A falling rupee in the time of rising inflation could further queer the pitch for the country’s economy managers and currency administrators, who are already grappling with limited options to tame the runaway price line.

The rupee has lost 8.6 per cent to the dollar so far this year -- it closed at 42.93 against the greenback on Friday. Experts cautioned that a further slide in the domestic currency in the wake of rising demand for dollars to foot a growing oil import bill could add to an inflation rate that already has surged to double digits.

“Global uncertainties are contributing to inflationary pressures,” said D Subba Rao, finance secretary.

“Inflationary pressures will persist for the next three months. The dollar-rupee situation would also impact inflation for the next seven months.”

A stronger rupee would make imports less costly and also help in sucking out liquidity from the system and soften demand, said Keki Mistry, managing director, HDFC. “It would be difficult to predict what Reserve Bank of India (RBI) would do, but in my view central bank should intervene to strengthen the rupee.”

If RBI does not intervene, it would create fresh pressure on the rupee, said S Manikkan, managing director, Babcock & Brown, one of the largest private equity funds in the country. Importing oil at a depreciated currency levels would effectively tantamount to importing higher levels of inflation, he said.

India imports about 75 per cent of its total crude oil requirement and faces the twin challenge of containing the import bill while maintaining retail fuel prices at reasonable levels to prevent political backlash in an election year.

Oil imports during April-March 2008 were valued at $77.03 billion, up 35 per cent over last year’s $56.94 billion.

In case the central bank decides against intervening in the exchange rate market, the other option could be to use instruments of cash reserve ratio (CRR) and the repo rate to tighten liquidity in the system, analysts said.

When inflation is over 11 per cent, a further tightening of interest rates is inevitable, said KC Chakrabarty, chairman and managing director, Punjab National Bank (PNB). “The deposit rate is likely to increase, which in turn would push the lending rates. We would take a decision by the end of this month.”