The Reserve Bank of India’s decision to double the magnitude of interest-rate increases signals it is ready to step up the battle against inflation even at the risk of damping the nation’s economic growth.
The central bank’s half a percentage point increase in the benchmark repurchase rate to 7.25 percent yesterday was the biggest move since July 2008. Governor Duvvuri Subbarao indicated he would tighten borrowing costs further and predicted inflation will stay at “elevated levels” until September.
Bond yields rose to the highest level in more than three months yesterday as Subbarao accelerated monetary tightening after eight quarter-point moves since mid-March 2010. India’s inflation, already the fastest among Asia’s major economies, may quicken as surging oil costs put pressure on Prime Minister Manmohan Singh to allow higher fuel prices this year.
“The RBI’s focus on inflation over growth signals a major shift in its policy,” said Samiran Chakraborty, Mumbai-based chief economist at Standard Chartered Plc. “Controlling prices must be the priority now, even if it comes at the cost of sacrificing growth in the short term.”
The yield on the 7.80 percent note due April 2021 gained nine basis points to 8.23 percent at the close of trading in Mumbai. The rate is the highest level for a 10-year security since Jan. 17. A basis point is 0.01 percentage point.
‘Significantly Overshot’
Indian stocks dropped the most among major indexes in the world yesterday, with the Bombay Stock Exchange’s Sensitive Index losing 2.4 percent, the biggest decline since Feb. 24. The Indian rupee weakened 0.4 percent to 44.5175 per dollar, a one- week low.
India’s benchmark wholesale-price inflation accelerated to 8.98 percent in March and exceeded the central bank’s 8 percent estimate, prompting Subbarao to say yesterday that price gains have “significantly overshot even the most pessimistic projections over the past few months.”
By comparison, consumer prices rose 5.4 percent in China and 4.2 percent in South Korea.
“There is going to be some sacrifice of growth,” Reserve Bank Deputy Governor Subir Gokarn told Bloomberg-UTV in an interview yesterday. “The choice was to address the more significant risk and that is why we decided to shift our orientation by taking a more aggressive action.”
Growth Forecast
Rising borrowing costs will slow India’s economic growth this year and help ease inflation to 6 percent “with an upward bias” by March 31, 2012, Subbarao said. India’s economy may expand “around 8 percent” in the year through March from 8.6 percent in the previous 12 months, he estimated.
“With 9 to 10 percent levels of inflation, the RBI has no option but to slow the pace of growth in the near-term,” said Jahangir Aziz, an economist at JPMorgan Chase & Co. in Mumbai and a former economic adviser in India’s finance ministry. “Growth has to be sacrificed now if you want to keep it going in the medium-term.”
The Reserve Bank yesterday sought to curtail risks tied to defaults by borrowers that may emerge if economic growth slows, asking lenders to set aside more funds to cover bad loans and double provisions for restructured debt.
The move came less than two weeks after it asked commercial banks to keep surplus funds as a buffer for when the economy slumps. India’s central bank is joining global policy makers in seeking to toughen rules after the 2008 credit crisis forced U.S. and European regulators to bail out lenders including Citigroup Inc. and Royal Bank of Scotland Group Plc.
Fuel Prices
“The inflation rate will remain close to the March 2011 level over the first half of 2011-12, before declining,” Subbarao said in yesterday’s statement. “These projections factor in an upward revision of petrol and diesel prices.”
The end of provincial elections gives the government room to ease fuel-price controls on state refiners such as Indian Oil Corp., the nation’s biggest refiner.
Goldman Sachs Group Inc. (GS) said in a report April 27 that the government may start allowing Indian Oil and others to charge more for the fuels once elections in four states and one union territory conclude on May 10.
Prime Minister Singh has sought to appease voters with price caps on diesel, kerosene and cooking gas after inflation triggered nationwide protests earlier this year.
Policy Stance
Inflation erodes spending power in India, where the per capita income is about $1,230, versus $40,580 in the U.S.
Indian Oil hasn’t increased diesel prices since June 26 and gasoline since Jan. 16, according to the company’s website.
Oil has climbed 23 percent in New York this year as revolts that overthrew governments in Tunisia and Egypt raised concern that supplies from the Middle East would be disrupted as protests spread.
“While the persistence of inflation over the next few months has been incorporated in this policy, the Reserve Bank will continue to persevere with its anti-inflationary stance,” Subbarao said.
Recent economic indicators such as the purchasing managers’ index and credit expansion signal consumer demand is holding up, stoking price pressures.
Factory output grew at the fastest pace in five months, with the purchasing managers’ index climbing to 58 in April from 57.9 in March, HSBC Holdings Plc (HSBA) and Markit Economics said May 2. A number above 50 indicates expansion.
Loan Growth
Commercial loans rose 22 percent from the previous year as of April 8, more than the 20 percent rate prescribed by the Reserve Bank.
Inflation pressures are also building up as companies including Videocon Industries Ltd. and Maruti Suzuki India Ltd. (MSIL) increase prices to counter higher costs of raw materials.
“The relentless rise in input costs is adding to the cost of doing business,” Suresh M. Hegde, head of finance at Videocon, an Indian maker of washing machines and television sets, said in an April 29 interview. “We are also facing wage pressures and will be forced to raise prices.”
Maruti, India’s largest carmaker, boosted prices of its vehicles by as much as 9,000 rupees ($202), the automaker’s sales chief, Mayank Pareek, said April 5.
“The extent to which the increase in input prices translates into output prices will have an influence on the inflation path,” the central bank said.
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