Bloomberg News

India Spending Plans May Spur More Rate Rises, Gokarn Says

July 27, 2011

(Updates with Gokarn’s comment on yields in seventh paragraph.)

July 27 (Bloomberg) -- Reserve Bank of India Deputy Governor Subir Gokarn signaled that a move by the government to boost spending on health care and food risks adding to inflation pressures without steps to pay for it, forcing the central bank to respond with higher interest rates.

“If it comes in a way in which government commitments increase without their ability to finance them, then it is a problem,” Gokarn said in an interview in his office today in Mumbai after the RBI raised its benchmark rate a half point yesterday. “Inflation pressures mount and in which case the response of the central bank is to use the only instrument that it effectively has, which is the interest rate.”

Prime Minister Manmohan Singh plans to expand a health- insurance program for the poor and introduce legislation next month to guarantee wheat and rice supplies at subsidized prices to 70 percent of India’s 1.2 billion people, without specifying a financing source. The steps may add to demand already fueled by “very dramatic trends in wage growth,” according to Gokarn.

“Essentially we have a rebalancing of expenditure towards government spending and away from investment, which is the classic textbook crowding out and that’s clearly a problem,” Gokarn said. “And if you’re squeezing investment that is also impairing long-term growth potential.”

Rate Action

The RBI yesterday surprised all 22 economists surveyed by Bloomberg News with a half-point boost in the repurchase rate to 8 percent. The bank said in a statement that stronger action was needed in the absence of government steps to damp demand or efforts to address the nation’s supply bottlenecks.

The Bombay Stock Exchange Sensitive Index slid 0.5 percent as of 3:26 p.m. in Mumbai, adding to its biggest loss in five weeks yesterday after the rate announcement. The rupee advanced 0.4 percent to 44.01 per dollar. The yield on the 7.8 percent government bond due April 2021 gained 2 basis points, or 0.02 percentage point, to 8.46 percent. It reached 8.48 percent earlier, the highest level since September 2008.

Gokarn said the central bank doesn’t aim to “control and influence” bond yields and that they’re an outcome of the actions taken to tame inflation. Bond yields are “unnecessarily high” R. Gopalan, secretary of economic affairs at India’s finance ministry, said in a July 20 interview. Gokarn said the government may be expressing its “discomfort” at the rate at which it has to borrow.

Rupee Gains

On the strengthening rupee as a tool to fight inflation, Gokarn said the value of the currency is “market determined” and the link between monetary policy and the rupee may not be that strong in an economy like India’s where there are capital controls.

Governor Duvvuri Subbarao was forced to escalate what was already the steepest increase in borrowing costs among major Asian economies, after household expectations for inflation exceeded 12 percent, above the 9.44 percent current pace. The bank will add another half point to the benchmark rate by the end of 2011, according to the median estimate of 11 economists surveyed yesterday by Bloomberg.

The government’s food subsidy costs may climb 67 percent to 1 trillion rupees ($23 billion) once the law comes into force, Food & Consumer Affairs Minister K.V. Thomas said last month.

Health Coverage

India plans to extend the government’s health insurance coverage to workers in industries such as asbestos, dolomite and mica, Finance Minister Pranab Mukherjee said in February.

Subbarao, 61, acted yesterday as the central bank elevated its inflation forecast for the year through March by 1 percentage point, to 7 percent.

Commenting on the debate in the country on whether the current pace of price gains are the “new normal,” Gokarn said that there is “a level of inflation above which things could spiral out of control and our endeavor as a monetary authority is to make sure that inflation remains below that level.”

While keeping its growth forecast for the fiscal year through March at 8 percent, the RBI yesterday said that “in the absence of appropriate actions for addressing supply bottlenecks, especially in food and infrastructure, questions about the ability of the economy to sustain the current growth rate without significant inflationary pressures come to the fore.”

While growth has shown signs of moderation, “there is no evidence of a sharp or broad-based slowdown as yet,” the central bank said in its policy statement yesterday.

Demand Driver

Maruti Suzuki India Ltd., maker of almost half the cars sold in India, yesterday reported first-quarter profit increase of 18 percent that beat analyst estimates because of higher sales and a jump in unspecified other income.

“Policy makers now have accepted that demand is the underlying driver of inflation and needs to be brought down to cool inflation and avoid a hard landing,” said Jahangir Aziz, an economist at JPMorgan Chase & Co., who previously worked at India’s finance ministry and the International Monetary Fund. “Capacity constraints are much tighter and demand pressures much higher than they had thought.”

After what could be Subbarao’s final rate decision, the central bank blamed the government for contributing to inflation, with its “large fiscal deficit” stoking price pressures. The RBI July 25 also cited a high share of production capacity in use, risk of a “wage-price spiral” and “stickiness” in food costs fanning price gains.

Salaries in the world’s second-most populous nation may grow this year by an average of 13 percent, the fastest in Asia, according to a March survey by Aon Hewitt LLC.

Subbarao’s Term

Subbarao’s term concludes before the next scheduled rate announcement on Sept. 16. A former top bureaucrat in the Ministry of Finance, Subbarao took office in September 2008. Prime Minister Manmohan Singh’s government hasn’t publicly indicated whether it intends to reappoint him.

“The challenge for the government and the RBI is to ensure demand is constrained in the short term,” Subbarao said at a press conference yesterday. He said “fiscal consolidation” is critical to managing inflation.

“The governor of the RBI has correctly pointed out that to address the issue of inflation and ensure higher growth, the monetary and fiscal policies should move in tandem,” Mukherjee said in New Delhi today. “Therefore appropriate measures will be taken.”

The minister said he doesn’t think the central bank is near the end of its rate-increase cycle. Mukherjee aims to trim the budget gap to a four-year low of 4.6 percent of gross domestic product in the year ending March 31.

Sovereign Wealth Fund

On building a sovereign wealth fund, Gokarn said since India has a capital-account deficit, it should be concerned about the fact that “the money that you are using is not your own.” He said “small” amounts of foreign-exchange reserves can be used for investment, citing the money that was extended to the India Infrastructure Finance Co. Ltd.

“But as a strategy and anything approaching the scale at which other countries have sovereign wealth fund, it really doesn’t have much traction,” Gokarn said.

Montek Singh Ahluwalia, deputy chairman of India’s Planning Commission, said in a July 19 interview that India is considering a plan to set aside $10 billion from its foreign- exchange reserves and create a sovereign fund to secure energy assets overseas.

--With assistance from Manish Modi in New Delhi and Shamim Adam in Singapore. Editors: Cherian Thomas, Chris Anstey

To contact the reporter on this story: Kartik Goyal in New Delhi at

To contact the editor responsible for this story: Stephanie Phang at

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