Bloomberg News

India Holds Key Rate, Skirting Global Easing on Inflation

July 31, 2012

India Holds Key Rate, Skirting Global Easing to Damp Inflation

The Reserve Bank of India governor Duvvuri Subbarao raised his inflation forecast to 7 percent as a drop in the rupee, infrastructure bottlenecks and higher food costs stoke price pressures, a trend that may be exacerbated by the impact of a scanty monsoon on crops. Photographer: Dhiraj Singh/Bloomberg

India refrained from joining peers in lowering interest rates, focusing instead on curbing inflation as a power-grid shutdown exposed infrastructure deficiencies that keep prices elevated and limit policy options.

The Reserve Bank of India kept the repurchase rate at 8 percent while cutting the amount of deposits banks must hold in government bonds, it said in Mumbai today. Governor Duvvuri Subbarao said after the decision the benchmark gauge of prices, which climbed 7.25 percent in June, has stayed “sticky.”

Hours after the release, north India’s electricity network shut down for the second time this week, illustrating the added costs businesses face operating in a nation with the highest inflation rate among BRIC members. Along with a falling currency and poor monsoon rains, the combination leaves the RBI little scope to address India’s weakest growth in nine years.

“Challenges emerging from inadequate infrastructure as reflected in power failures, an investment slowdown and substantial drop in growth potential mean inflation lingering on for a long time,” said Jahangir Aziz, an economist at JPMorgan Chase & Co. based in Washington who worked at the International Monetary Fund. The government needs to deliver on reforms and fiscal consolidation to create space for rate cuts, he said.

The rupee gained 0.1 percent to 55.53 per dollar as of 3:56 p.m. in Mumbai. It has tumbled about 20 percent against the dollar in the past year due to India’s trade deficit and a debt crisis in Europe that sapped demand for emerging-market assets.

SLR Cut

The BSE India Sensitive Index, down about 5 percent in the past year, rose 0.5 percent. The yield on the 8.15 percent bond due June 2022 rose to 8.24 percent from 8.15 percent yesterday.

Today’s decision was predicted by 31 of 34 economists in a Bloomberg News survey. Three expected a cut to 7.75 percent. Subbarao reduced the statutory liquidity ratio to 23 percent from 24 percent, effective Aug. 11, the first cut since 2010.

He raised his inflation forecast to 7 percent as a drop in the rupee, infrastructure bottlenecks and higher food costs stoke price pressures, a trend that may be exacerbated by the impact of a scanty monsoon on crops. The risks limited India’s scope to join Asian neighbors such as China and South Korea in cutting rates this month.

’Primary Focus’

“The primary focus of monetary policy remains inflation control in order to secure a sustainable growth path over the medium term,” the RBI said today. “Lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth. As the multiple constraints to growth are addressed, the Reserve Bank will stand ready to act appropriately.”

The central bank forecast a 6.5 percent economic expansion in the 12 months through March 2013, down from an earlier prediction of 7.3 percent. It estimated inflation of 7 percent by the end of the period, compared with a previous projection of 6.5 percent.

The deficient and uneven monsoon, a slowdown in global trade and impending fiscal retrenchment in the U.S. are among the threats to India’s expansion, the monetary authority said. The weak rupee, energy prices and the impact of the below- average rains on crops pose inflationary risks, it said.

Prime Minister Manmohan Singh is grappling with a budget deficit and discord in the ruling coalition that has set back efforts to turn around a slowdown in investment. Monsoon rains, key for India’s more than 235 million farmers, are 20 percent below normal, threatening slower growth and higher food prices.

Growth Slowdown

Singh, who took on the finance portfolio in June, has vowed to revive investor confidence after Standard & Poor’s and Fitch Ratings warned they may strip Asia’s third-largest economy of its investment-grade credit rating.

Subbarao said at a press briefing in Mumbai after the decision today that he sees scope for a rate cut, adding he can’t say when it might happen and that a reduction will depend on inflation and other risks. He was responding to a question on whether he may lower borrowing costs again this year.

Gross domestic product rose 5.3 percent in the first quarter, the least since 2003. Gaps in infrastructure from roads to power plants are holding back the economy, underscored by India’s worst power-grid failure in a decade yesterday.

The country’s northern and eastern regions, including the capital New Delhi, had a second grid collapse today, affecting a population about that of North America. India has missed every annual target to add electricity-production capacity since 1951.

Benchmark wholesale-price inflation was 7.25 percent last month, and consumer prices rose 10.02 percent, the fastest among the BRIC nations of Brazil, Russia, India and China. Wholesale- price gains have eased from more than 9 percent in most of 2011.

Above Comfort

The Reserve Bank said that inflation remains “well above” its comfort zone. India’s “large twin deficits” in the current account and the budget pose “significant risks to macroeconomic stability,” it also said.

Subbarao lowered the repurchase rate by 0.5 percentage point in April, the first reduction since 2009. The central bank has said that move “frontloaded” a cut on the assumption the government will restrain the budget deficit. Today, the Reserve Bank said the government’s target of reducing subsidies requires “immediate action” on fuel and fertilizer prices.

The central bank has also reduced the amount of deposits lenders must set aside as reserves twice this year to ease a cash squeeze. Subbarao raised the repurchase rate by a record 3.75 percentage points from March 2010 to October last year.

Some companies are feeling the impact of higher borrowing costs. Sales at Bajaj Auto Ltd., India’s second-largest motorcycle maker, slid 5.9 percent in June.

‘Sub-par’ Growth

“Growth in India is likely to remain sub-par and inflation uncomfortably high,” said Arun Singh, Mumbai-based senior economist at Dun & Bradstreet Information Services India Pvt. “What you urgently need are measures on the policy front, including reforms and reducing the budget deficit.”

India has foregone foreign investment in industries from retail to pensions and insurance in recent months as a factious ruling coalition obstructs Singh’s efforts to open up the economy and ease bottlenecks that are pushing up prices.

The government is also struggling to narrow its budget gap amid pressure to keep subsidies for fertilizer and diesel to help the 824 million Indians living on under $2 a day.

The administration projects record borrowing of 5.69 trillion rupees ($102 billion) in 2012-2013 to fund its targeted fiscal shortfall of 5.1 percent of GDP, down from 5.8 percent last year. The government is at risk of missing the goal, the Reserve Bank said in a quarterly review of the economy yesterday.

India’s potential rate of growth may have fallen to 7.5 percent a year from 8.5 percent before the onset of the global financial crisis, Subbarao said July 17.

Economies from China to the U.S. have slowed as the euro area pursues austerity to escape its debt crisis.

“India’s decision to keep rates on hold shows inflation remains a priority over growth,” said Tirthankar Patnaik, a Mumbai-based strategist at Religare Capital Markets Ltd. “It also makes sense for the central bank to keep its powder dry in case the euro-area debt crisis deepens further.”

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

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


Hollywood Goes YouTube
LIMITED-TIME OFFER SUBSCRIBE NOW

(enter your email)
(enter up to 5 email addresses, separated by commas)

Max 250 characters

 
blog comments powered by Disqus