India Raises Interest Rates, Reserves on Inflation
April 20 (Bloomberg) -- India's central bank raised interest rates for the second time in a month and ordered lenders to set aside more cash as reserves to contain the fastest inflation among the Group of 20 nations.
The Reserve Bank of India increased the reverse repurchase rate to 3.75 percent from 3.5 percent, the repurchase rate to 5.25 percent from 5 percent and the cash reserve ratio to 6 percent from 5.75 percent, the central bank said in a statement in Mumbai today. The announcement was in line with the median forecast of 30 economists in a Bloomberg News Survey.
Governor Duvvuri Subbarao described India's inflation as ``worrisome'' and is aiming to slow it by restraining consumer demand until companies including Maruti Suzuki India Ltd. and ACC Ltd. can expand capacity. Pressures may still come from power and road shortages that drive up prices -- unlike China, where infrastructure spending is double that of India.
``It will take 12 to 15 months more before the new investment adds to productive capacity,'' Jahangir Aziz, chief economist at JPMorgan Chase & Co. in India, said before the report. ``Both food and non-food inflation could enter an extended phase where structural shortages in the economy could keep them stick and elevated.''
Subbarao estimated India's $1.2 trillion economy, Asia's largest after Japan and China, will expand 8 percent ``with an upward bias'' in the year ending March 31, according to today's statement. Inflation may slow to 5.5 percent by March 2011 from 9.9 percent last month, he said, adding the forecast is ``contingent'' upon normal monsoon rains this year and a fall in food prices.
``With growth expected to accelerate further in the next year, capacity constraints will re-emerge, which are expected to exert further pressure on prices,'' Subbarao said. ``There is, therefore, a need to ensure that demand side inflation does not become entrenched.''
Yields on benchmark 10-year Indian government notes have climbed 45 basis points this year on the inflation outlook. The central bank has allowed the rupee to appreciate to aid its inflation fight, with the currency gaining about 4 percent this year against the U.S. dollar.
Today's action comes after consumer prices paid by industrial workers in India rose 14.9 percent in February from a year earlier. Consumer prices in China rose 2.4 percent in March, less than economists had forecast, even amid evidence of accelerating economic growth.
India's inflation is in part the result of strained infrastructure. The nation produces about 10 percent less electricity than it needs, while roads, which account for 65 percent of the nation's cargo, are plagued by single lanes and irregular surfaces, boosting companies' costs, according to government estimates.
ACC, India's biggest cement maker, plans to raise capacity to 30.5 million metric tons in 2010 from 26 million tons, Chairman N. S. Sekhsaria said April 8. Maruti, the nation's biggest carmaker, is spending 17 billion rupees ($381 million) to increase capacity by 250,000 cars.
Infrastructure spending accounts for just 4 percent of India's gross domestic product compared with 9 percent of GDP in China, according to CLSA Asia-Pacific Markets. The Planning Commission of India estimated last month the country needs to more than double spending on infrastructure to $1 trillion in the five years to March 2017.
Subbarao cited rising cost of oil, which India imports to meet three-quarters of its needs, as one of the three risks that may exacerbate inflation. The other two being monsoon rains and ``evidence of demand side pressures building up.'' Crude oil prices have surged 78 percent in the past year.
The June-September monsoon rains is the main source of irrigation for India's agriculture. Food-price inflation in the country has stayed above 15 percent since November as last year's rains were the weakest since 1972, creating shortages in rice and wheat.
Prime Minister Manmohan Singh, under attack from opposition parties for failing to check rising prices, has vowed to bring inflation under control soon. Inflation is a sensitive issue in India, where the World Bank estimates three-fourths of the 1.2 billion people live on less than $2 a day.
The nation's bottlenecks may also reduce the effectiveness of the central bank's steps, some analysts say.
``Tighter monetary policy will have limited impact upon inflation in the current environment,'' Nikhilesh Bhattacharyya, an economist at Moody's Economy.com in Sydney, said before the report. ``Inflation depends on supply-side factors that are beyond the RBI's control.''
At the same time, signs of increasing liquidity in the Indian economy indicate a need for higher borrowing costs to rein in inflation.
A surge in banks' subscriptions to the central bank's money- market auctions is one sign of the increase in cash in the financial system. Lenders' bids at the Reserve Bank's reverse repurchase auctions averaged 776 billion rupees a day in the past six months, more than double the amount from a year earlier.
O.P. Bhatt, chairman of State Bank of India, the nation's biggest lender, said April 16 that there is a ``fair amount of liquidity'' in banks and that he doesn't expect commercial-bank lending rates to rise in the next two to three months.
The higher cash reserve ratio announcement made today, will be effective April 24 and drain 125 billion rupees from lenders, Subbarao said. The interest rate decision takes immediate effect, he said.
The governor said he faces a ``dilemma'' in absorbing more cash from the economy because the central bank has to support the government's borrowing program. The government's new bond sales in the year starting April 1 is 36.3 percent higher than the previous year.
``While monetary policy considerations demand that surplus liquidity should be absorbed, debt management considerations warrant supportive liquidity conditions,'' Subbarao said. ``The Reserve Bank, therefore, has to do a fine balancing act and ensure that while absorbing excess liquidity, the government borrowing program is not hampered.''
The central bank is next scheduled to meet on July 27 to announce its monetary policy statement.
Foreign retailers may offer India one way of restraining prices. Wal-Mart Stores Inc., the world's largest retailer, said last week India's inflation would slow by at least two percentage points if the government permitted them to invest in the country. The company is betting their supply chain network and sourcing ability will allow them to remove middle men and sell products directly to consumers at lower prices.
India's rate increases are part of a regional battle to restrain price pressures as growth in emerging markets outpaces that in the developed world.
Besides India, Australia and Malaysia have already raised borrowing costs, while Singapore last week announced it will allow its currency -- the city-state's principal monetary tool -- to strengthen, as Asia Pacific economies recovered from the worst recession since World War II.
To contact the reporter on this story: Cherian Thomas in Mumbai at Cthomas1@bloomberg.net