India May Signal Plans to Reverse Deepest Rate Cuts on Record

Oct. 27 (Bloomberg) -- India’s central bank may today signal plans to reverse its deepest interest-rate cuts on record as inflation pressures build in Asia’s third-largest economy.

The Reserve Bank of India will probably raise its inflation forecast and indicate policy is at a “turning point,” said Macquarie Group Ltd. economist Rajeev Malik. Morgan Stanley’s Chetan Ahya said the bank may ask lenders to set aside more cash as reserves in its quarterly statement due 11:15 a.m. in Mumbai.

At stake: safeguarding the purchasing power of India’s 1.2 billion people without a premature boost to borrowing costs that endangers the nation’s economic recovery. Benchmark 10-year bond yields have advanced to the highest level in more than a month on concern accelerating inflation will prompt the central bank to increase borrowing costs.

“We expect the RBI to set the foundation for the upcoming reversal of its expansionary measures,” said Sonal Varma, a Mumbai-based economist at Nomura Securities Co., Japan’s largest brokerage. “There are incipient signs of recovery as well as of rising inflationary pressures.”

The majority of economists surveyed by Bloomberg News expect no change in policy rates today. Governor Duvvuri Subbarao may keep the benchmark reverse repurchase rate at 3.25 percent and the cash reserve ratio at 5 percent, according to the median forecast of 24 economists in a Bloomberg News survey.

Central banks globally have stepped up their vigil against inflation and asset-price increases.

Global Shift

The Reserve Bank of Australia was the first among the Group of 20 nations to increase rates three weeks ago, citing costlier real estate as a reason. Norway’s Norges Bank is set to raise borrowing costs on Oct. 28, according to a Bloomberg survey. Bank of Korea Governor Lee Seong Tae said Oct. 23 that keeping rates at a record low may not be healthy for the economy.

At the Federal Reserve, officials under Chairman Ben S. Bernanke are reviewing whether recent gains in asset prices and narrowing credit spreads are justified as they try to ensure near-zero borrowing costs don’t create bubbles.

Subbarao this month said policy makers within the Reserve Bank agree on the need to tighten policy, while not on “when and how” to exit. The yield on India’s 6.90 percent note due July 2019 was 7.44 percent at 1:35 p.m. in Mumbai yesterday, the highest level since Sept. 4.

Political Context

India’s government has also commented on the central bank’s decision, adding a political dimension to today’s decision, analysts said. Finance Minister Pranab Mukherjee told Bloomberg- UTV television channel on Oct. 8 that promoting growth and containing inflation are both important and the central bank shouldn’t “compromise” one for the other. He stressed the need to “strike a balance” while setting interest rates.

Subbarao and Mukherjee met in New Delhi on Oct. 23 for an hour-long meeting to discuss the state of economy, a practice held before monetary policy announcements in India.

“The Reserve Bank could make a case for pre-emptive monetary tightening,” said Robert Prior-Wandesforde, senior Asian economist at HSBC Group Plc in Singapore. “But, with bank lending so low and political pressure not to act, the likelihood is that all rates will be left unchanged.”

Commercial bank loans grew 10.75 percent in the week ended Oct. 9, according to the central bank, which is almost a third of the pace a year ago and indicates demand remains diminished. The Reserve Bank expects economic growth of around 6 percent in the current financial year ending March 31, the weakest pace since 2003.

Inflation Rate

At the same time, consumer-price inflation in India is running above 10 percent and may accelerate further after the smallest monsoon rains since 1972 create food shortages. India’s $1.2 trillion economy depends on the June to September rains to water crops.

“Inflation is a concern in India and could quickly develop into a problem,” said Kevin Grice, an economist at Capital Economics Ltd. in London.

Subbarao wants to ensure that monetary and fiscal stimulus, which the central bank estimates is worth more than 12 percent of gross domestic product, doesn’t cause demand for goods and services including cars and mortgages to surge and worsen inflation.

India uses wholesale price data as its key inflation gauge; consumer price indexes are calculated on the basis of rural and urban workers and don’t capture the aggregate price picture.

Wholesale prices rose for a sixth week on Oct. 10, gaining 1.21 percent. HSBC’s Prior-Wandesforde expects the rate to hit 8 percent by March 31. Asset prices are also rising, evidenced by the 75 percent climb in the Bombay Stock Exchange’s Sensitive index since January.

“The central bank faces a very delicate situation to manage growth and inflation,” said Ravi Sud, chief financial officer at Hero Honda Motors Ltd., India’s biggest motorcycle maker. “On balance, inflation is the risk as it will hurt consumption and eventually hurt growth as well.”

It will be a “big challenge” to sustain Hero Honda’s profit margins because of rising commodity prices, Sud said last week. Hero Honda, based in New Delhi, is the Indian affiliate of Japan’s Honda Motor Co.