India May Debate Rate Increase, Tell Banks to Boost Reserves

Jan. 29 (Bloomberg) -- India’s central bank may debate whether to start raising interest rates today and will probably ask banks to set aside more cash to temper inflation as the second-fastest growing major economy accelerates.

The Reserve Bank of India may raise the cash reserve ratio to 5.5 percent from 5 percent, the first increase since 2008, according to the median forecast of 25 economists in a Bloomberg News survey. Seven respondents said the benchmark reverse repurchase rate may rise to 3.5 percent from 3.25 percent, while the rest see no change.

Governor Duvvuri Subbarao’s task is to head off a surge in inflation that would undermine purchasing power in the nation of 1.2 billion people. India is forecast to follow China this month in tightening monetary policy; part of a global withdrawal of stimulus measures that’s led to a decline in stock prices.

“Subbarao has to walk a tightrope,” said Sanjay Mathur, a Singapore-based economist at Royal Bank of Scotland Group Plc. “He has to be careful not to jeopardize India’s nascent growth while attempting to tame inflation.”

The bank is scheduled to release its monetary policy decision at 11:15 a.m. in Mumbai today.

Investors have already begun to anticipate the central bank taking its biggest step yet to rein in monetary stimulus. India’s generic 10-year government bond yields reached 7.71 percent this month, the highest level since November 2008, and closed at 7.56 percent yesterday in Mumbai. The benchmark stock index yesterday reached its lowest level since November, while the rupee has dropped about 2 percent since Jan. 11.

Inflation Concern

Inflation has emerged as a “major concern,” the central bank said in a report yesterday. The bank said economic recovery has coincided with “significant” build-up of price pressures. Subbarao said last week that he wants to support the recovery without “compromising” price stability.

India’s benchmark wholesale-price inflation accelerated to 7.3 percent in December, the fastest pace since November 2008. The RBI in October forecast price gains would reach 6.5 percent by March 31. Manufacturing inflation surged to 5.2 percent in December from 1.6 percent in October.

Industrial production rose 11.7 percent in November, the fastest pace in two years, as sales at companies including Hindustan Unilever Ltd. and Hero Honda Motors Ltd. surged.

Corporate Profits

Hindustan Unilever, India’s biggest maker of household products, said this week profit grew in the three months through December for the first time in three quarters. Hero Honda, the nation’s biggest motorcycle maker, reported a better-than- estimated 79 percent increase in third-quarter net income.

“What we’ve seen in India is a fairly strong recovery in domestic demand,” Jorg Decressin, deputy director of the International Monetary Fund’s monetary and capital markets office, told reporters in Washington this week. “It’s one of the countries where we’re pretty bullish.”

The IMF three days ago boosted its gross domestic product growth projection for India to 7.7 percent from 6.4 percent in October.

China, whose economy expanded the most since 2007 in the fourth quarter, is also acting to rein in price pressures. The People’s Bank of China has ordered some banks to pare lending, raised the ratio for deposits banks must set aside as reserves and guided bill yields higher this month after lending surged in January.

Commercial Loans

India’s credit growth has been more subdued. Commercial loans, which rose 13.7 percent in the two weeks ended Jan. 1 from a year earlier, are growing near the slowest pace in six years.

Most of the nation’s inflation is due to food costs, which shot up after deficient rains last year. They accounted for 80 percent of December’s inflation reading, government data showed.

“Policy makers should avoid any tightening of monetary policy to contain food-price inflation,” said Harsh Pati Singhania, president of the Federation of Indian Chambers of Commerce and Industry in New Delhi. “It will derail the growth momentum.”

India’s central bank prepares monetary policy in consultation with the finance ministry, which has faced criticism from opposition political parties in the past two months for failing to check surging prices.

Subbarao cut the cash reserve ratio in late 2008 to inject cash into the banking system and protect the Indian economy from the global recession. He has kept the reverse repurchase rate and the repurchase rate at a record low of 3.25 percent and 4.75 percent, respectively, since April.

Asset Sales

The Indian central bank may also delay raising interest rates to avoid “spooking” the markets before the government’s asset sales program, said Rohini Malkani, a Mumbai-based economist at Citigroup Inc.

The government plans to sell as much as 250 billion rupees ($5.4 billion) of stakes in companies including NMDC Ltd., the nation’s largest iron-ore producer, by the end of March as it tries to trim its budget deficit projected at a 16-year high.

“Monetary tightening will be incremental,” said Sashi Krishnan, chief investment officer at Bajaj Allianz Life Insurance Co., India’s second-largest private insurer. “The economy is just returning to growth and the central bank may not want to cap that.” Krishnan expects interest rates to rise as much as 1.25 percentage points in 2010.