India’s Central Bank Signals Higher Rates for ‘Unfinished’ Inflation Task

By Kartik Goyal - Jul 25, 2011

India’s central bank said curbing inflation remains an “unfinished task” even as economic growth slows, signaling it may raise interest rates today.

“The policy exigency at this juncture warrants continuation of anti-inflationary stance,” the Reserve Bank of India said in a report yesterday before its policy meeting in Mumbai. The RBI cited a high share of production capacity in use, risk of a “wage-price spiral” and “stickiness” in food costs adding to price pressures.

The report followed signs of a clash between economists and bond traders over whether the RBI would keep increasing borrowing costs after today’s projected move of a quarter point in the benchmark rate. Swap traders last week bet that Governor Duvvuri Subbarao was approaching the end of India’s fastest credit tightening since 1974.

“The hawkishness of the RBI’s comments suggests that it’s nowhere near changing its stance,” said Dipankar Mitra, an economist at Motilal Oswal Securities Ltd. in Mumbai. “As long as inflation is uncomfortably high, it won’t give the central bank room to look anywhere else.”

The RBI is scheduled to release its monetary-policy announcement at 11 a.m. today. Subbarao, who raised borrowing costs 10 times since mid-March 2010, may boost the repurchase rate to 7.75 percent from 7.5 percent, according to 20 of 22 economists in a Bloomberg survey, with the remaining two predicting no change.
Bond Yields

The yield on the 7.8 percent government bonds due April 2021 fell 3 basis points, or 0.03 percentage point, to 8.29 percent in Mumbai yesterday, on speculation the central bank will slow the pace of rate increases as debt uncertainties in the U.S. threaten the global recovery.

Yesterday’s RBI report cited risks to world growth, including from the European debt crisis, and pointed to business surveys that have shown evidence of a moderation in the economy. At the same time, the RBI said “it is important to break” the dynamics sustaining inflation pressures.

Motilal’s Mitra expects the inflation rate to stay above 9 percent until October after Prime Minister Manmohan Singh’s government increased diesel costs in June for the first time in a year to cut subsidies and narrow losses at state-run refiners including Indian Oil Corp.
BRICS Inflation

Price gains in India are the highest among the so-called BRICS nations. India’s benchmark wholesale-price Inflation accelerated to 9.44 percent in June. By comparison, consumer prices rose 6.7 percent in Brazil, 9.4 percent in Russia, 6.4 percent in China and 5 percent in South Africa.

“Inflation pressures are still rising,” Abheek Barua, New Delhi-based chief economist at HDFC Bank Ltd., said before the report. “A rate hike is almost certain.”

India will take several months to reduce inflation to “an acceptable level” of 5 percent to 6 percent and the rate increases haven’t hurt the economy, Montek Singh Ahluwalia, the deputy chairman of India’s Planning Commission, said in a July 19 interview in New Delhi.

The RBI said it will need to maintain a tight stance until “there is credible evidence of inflation trending close to a level within the Reserve Bank’s comfort zone,” without specifying a level. It said “high inflation” may persist between July and September.
Rural Wages

Higher rural wages have both increased the input cost of agricultural goods and boosted demand for them, keeping food inflation elevated even as it has slowed, according to the RBI. A “near normal monsoon” may not ease food inflation, it said.

The central bank also warns that the government may overshoot the budget-deficit target, causing monetary policy effectiveness to “weaken.”

Inflation may average 8.6 percent in the fiscal year through March 31, according to a survey compiled by the central bank of forecasts from agencies including the International Monetary Fund and the Asian Development Bank, the report showed. The survey in May projected inflation of 7.5 percent.

Economists downgraded their projections for economic growth. According to the RBI survey, gross domestic product is seen rising 7.9 percent in the current financial year, compared with the previous estimate of 8.2 percent.

Industrial production in India grew 5.6 percent in May, the weakest pace in nine months. GDP in the South Asian nation will increase 8.2 percent this year and 7.8 percent in 2012 compared with more than 9 percent each year in China, according to the International Monetary Fund.

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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