Bloomberg News

India Raises Rates, Signals End of Monetary Tightening Cycle

October 25, 2011

(Updates bond yields, stocks in fifth paragraph.)

Oct. 25 (Bloomberg) -- India raised interest rates for a 13th time since the start of 2010 and signaled it’s nearing the end of its record cycle of increases as the economy cools. Bonds rose and the stock index climbed to near a three-month high.

“The likelihood of a rate action in the December mid- quarter review is relatively low,” the Reserve Bank of India said in a statement in Mumbai today after it boosted the repurchase rate to 8.5 percent from 8.25 percent. Eighteen of 28 economists in a Bloomberg News survey predicted the decision and the rest forecast no change.

Governor Duvvuri Subbarao is under pressure to shield India’s economy from Europe’s debt crisis and a faltering U.S. recovery, after counterparts in Brazil and Russia lowered borrowing costs in recent weeks. The Reserve Bank today cut India’s growth estimate, predicting the second-slowest expansion in nine years, and blamed the government’s “expansionary” budget for stoking inflation.

“The damage that rate increases are starting to inflict on the economy is getting larger,” said Sanjay Mathur, Singapore- based head of research and strategy for Asia excluding Japan at Royal Bank of Scotland Group Plc. “It’s now time to assess the impact of the previous rate hikes on the economy and that’s a very appropriate stance.”

Yields Drop

The yield on the 7.80 percent government note due 2021 dropped six basis points, or 0.06 percentage point, to 8.76 percent at the close of trading in Mumbai. The BSE India Sensitive Index jumped 1.9 percent, and the rupee strengthened 0.7 percent to 49.51 per dollar.

The Reserve Bank also decided to deregulate the savings bank deposit rate, granting lenders the ability to set their own interest rates on deposits with immediate effect. Still, banks will have to offer a uniform rate on deposits up to 100,000 rupees irrespective of the amount in the account, the RBI said in its monetary policy review.

The monetary policy announced today “would help in getting us back to a more comfortable inflation situation soon, while leaving scope for growth to pick up in the second half of the current fiscal year,” India’s Finance Minister Pranab Mukherjee said in a statement in New Delhi today.

Subbarao has increased the central bank’s benchmark rate by 375 basis points since mid-March 2010, the fastest round of increases since the central bank was established in 1935, Bloomberg data show.

Slowing Demand

That’s curbing consumer demand. Manufacturing in India grew in September at the slowest pace in 2 1/2 years, according to the Purchasing Managers’ Index released by HSBC Holdings Plc and Markit Economics.

India’s automakers on Oct. 10 cut their car sales growth forecast for a second time this year as companies including Honda Motor Co. and Ford Motor Co. faced lower demand.

Officials from China to South Korea have refrained from raising rates in recent weeks to gauge whether slowing economic growth will dissipate price pressures. In Brazil, the central bank opted to lower its target Selic rate this month, the second cut in less than two months.

Subbarao said Oct. 12 that inflation must cool before India’s central bank can start easing monetary policy. The Reserve Bank’s next policy review is due Dec. 16.

BRIC Inflation

India’s benchmark wholesale-price inflation was 9.72 percent in September, staying above 9 percent since the start of December. By comparison, consumer prices rose 7.3 percent in Brazil, 6.1 percent in China and 7.2 percent in Russia.

The central bank reiterated today inflation would slow to 7 percent by March 31 and cut India’s growth forecast for the current fiscal year to 7.6 percent from 8 percent.

“The rupee’s decline is making imports costlier,” and may add to price pressure, Suresh M. Hegde, Mumbai-based head of finance at Videocon Industries Ltd., an Indian maker of washing machines and air conditioners, said in an Oct. 19 interview. “We have no option but to pass on this burden to consumers.” He didn’t elaborate.

The rupee has weakened about 10 percent against the dollar this year as investors sold stocks in emerging markets because of risks to global growth, making the currency the worst performer in Asia.

Weak Rupee

The rupee’s drop is in line with other emerging-market currencies and “with falling global commodity prices partly offset by rupee depreciation, the risks to inflation projections are now balanced,” the central bank said in a report yesterday.

Inflation will start to decline from December and ease to 7 percent by March before moderating further in the first half of the new fiscal year starting April 1, the central bank said today. Beyond December, “if the inflation trajectory conforms to projections, further rate hikes may not be warranted,” the bank said.

Even so, the central bank said the government’s “large” budget deficit has been an “important source” of demand pressure. “Clearly, the impact of tightening monetary policy has been diluted by the expansionary fiscal position, which is a sub-optimal outcome,” the central bank said.

“Rate increases have not had the desired impact on inflation as fiscal policy stays loose,” Amol Agrawal, a Mumbai-based economist at STCI Primary Dealer Ltd., said before the decision. “Monetary policy alone can’t curb price gains. The government needs to cut its budget deficit too.”

India’s budget shortfall may widen to as much as 5.5 percent of gross domestic product in the year ending March 31, more than the government’s 4.6 percent target, because of higher spending on fuel and food subsidies, Agrawal said.

--With assistance from Manish Modi in New Delhi and Jeanette Rodrigues in Mumbai. Editors: Cherian Thomas, Abhay Singh

To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net


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