India Bond-Purchase Plan May Ease Path to January Rate Increase

The Reserve Bank of India’s plan to address the biggest cash crunch in a decade with bond purchases may revive liquidity enough for the central bank to resume raising interest rates next month, say economists at JPMorgan Chase & Co. and Credit Suisse AG.

The RBI yesterday left its benchmark repurchase rate unchanged at 6.25 percent after six increases in 2010 and unveiled plans to buy back 480 billion rupees ($10.6 billion) of government bonds to ease a cash squeeze caused by a record 1.1 trillion rupees of share sales this year.

Governor Duvvuri Subbarao is trying to contain price expectations that have risen in the wake of a jump in costs of fuel and manufactured goods. With the benchmark rate below the 7.48 percent inflation rate, household savings and purchasing power are being eroded, risking a deeper impoverishment of the 828 million people who live on less than $2 a day.

“The bond buyback will certainly bring relief to the extreme tight liquidity conditions,” said Jahangir Aziz, the Mumbai-based chief economist at JPMorgan Chase. “Given the hawkish tone on inflation, the RBI will almost surely come back to raise rates in January.”

The yield on the benchmark 10-year government bond fell 12 basis points to 7.95 percent, the lowest in six weeks, in Mumbai yesterday. The Bombay Stock Exchange’s Sensitive Index gained 1.1 percent, while the rupee rose 0.1 percent to 45.35 against the dollar. India’s financial markets are shut today for a local holiday.

‘Continued Vigilance’

“Inflation pressures persist both from domestic demand and higher global commodity prices,” the RBI said in yesterday’s statement. “There is, therefore, a need for continued vigilance on the inflation front against the buildup of demand-side pressures.” It added that the risk to its inflation forecast of 5.5 percent by March 31 is “on the upside.”

While a report this week showed India’s wholesale-price inflation slowed to an 11-month low in November from 8.58 percent in October, the rate is still higher than the 5.1 percent in China and 5.6 percent in Brazil.

Subbarao, who has boosted the repurchase rate by 1.5 percentage points since mid-March, said yesterday that inflation remains “significantly above the comfort level.” He said last week the RBI aims to slow inflation to between 4 percent and 4.5 percent.

Credit Suisse economist Robert Prior-Wandesforde said yesterday he expects Subbarao to raise borrowing costs as early as January, advancing an earlier prediction of an increase between February and March.

State Elections

Prime Minister Manmohan Singh wants to gain control over inflation before nine states hold elections in the next 18 months.

“A major challenge for the Reserve Bank in the recent period has been liquidity management,” according to the statement. “It is the Reserve Bank’s endeavor to alleviate the liquidity pressure in a manner consistent with the monetary stance of containing inflation.”

The RBI will offer to buy bonds worth 120 billion rupees via open-market auctions in each of the next four weeks, the statement showed. It also cut the statutory liquidity ratio, or the proportion of deposits lenders need to invest in government bonds, to 24 percent from 25 percent starting Dec. 18.

Overnight loan rates between banks averaged 6.6 percent this month, compared with 3.3 percent a year ago. Lenders borrowed an average 816.4 billion rupees a day this quarter using the Reserve Bank’s repurchase auction window, compared with 239 billion rupees in the previous three months, according to data compiled by Bloomberg, indicating a shortage of money.

Bond Buyback

“The bond buyback is a direct injection of funds and will prove more helpful in easing the domestic liquidity crunch,” Credit Suisse’s Prior-Wandesforde said. “The message that I get from the RBI’s statement is that they are clearly worried about inflation risks and are setting us up for a January hike.”

An RBI survey of price expectations of 4,000 households in urban areas indicated consumers anticipate inflation to quicken to 12.7 percent in the next year from a perceived pace of 12.1 percent now, the bank said in a Dec. 9 statement.

Prices are under pressure partly because growth in Asia’s third-largest economy is straining power and transportation capacity, said N. R. Bhanumurthy, an economist at the New Delhi- based National Institute of Public Finance and Policy.

The power deficit in India, for example, is 14 percent during peak hours, according to the finance ministry, forcing most companies to invest in their own supply back-ups.

Consumer Demand

Industrial output jumped 10.8 percent in October from a year earlier, the most in three months. India’s $1.3 trillion economy grew 8.9 percent for a second straight quarter in the three months through September, maintaining the fastest pace of growth among the world’s major economies after China.

Maruti Suzuki India Ltd., the nation’s biggest carmaker, relies on its own power plants to run its factories, which adds to the cost of doing business Chairman R.C. Bhargava said in an interview on Dec. 15. The New Delhi-based company sold a record 1.11 million cars in the 11 months through November.

China is also battling to rein in inflation, which is a result of unprecedented credit expansion to protect the economy from last year’s global recession. Consumer prices rose 5.1 percent in November from a year earlier, the fastest pace in 28 months.

Chinese authorities have refrained from adding to October’s interest-rate increase and instead have ratcheted up banks’ reserve requirements and relied on tools such as sale of food reserves to curb prices.

Fuel Price

Price pressures in India may also emerge after companies, including Bharat Petroleum Corp., raised gasoline prices this week and as the government plans to cut subsidies to state refiners, including Indian Oil Corp., that sell fuel below costs. The government partly compensates refiners for their losses, which increase as crude prices rise.

Crude in New York trading reached $90.76 a barrel on Dec. 7, the highest level since 2008. Oil has gained 11.3 percent this year. India, which imports three-quarters of its crude oil needs, is working on a plan to boost diesel prices, Petroleum Minister Murli Deora said Dec. 13.