Subbarao Begins India Battle to Contain Accelerating Inflation

March 22 (Bloomberg) -- India central bank Governor Duvvuri Subbarao may add to his first interest rate increase since the end of the global recession after falling in danger of being judged too slow to contain accelerating consumer prices.

The next move may come as soon as next month, according to Morgan Stanley and IHS Global Insight. The Reserve Bank of India boosted the benchmark reverse repurchase rate to 3.5 percent from a record-low 3.25 percent and the repurchase rate to 5 percent from 4.75 percent on March 19, saying curbing inflation has become “imperative.”

The announcement followed Nomura Holdings Inc. saying the RBI was “behind the curve” after inflation hit a 16-month high and exceeded the rate in all other Group of Twenty economies. Indian stocks may tumble today as investors anticipate higher borrowing costs, with the benchmark Sensitive Index at risk of a 200-point drop, according CNI Research (India) Ltd. in Mumbai.

“The strength of India’s domestic demand will keep inflation fairly high,” Jyoti Narasimhan, research director for India at IHS Global in Lexington, Massachusetts, said in an interview. “This is definitely the first of many rate increases to come. We could see another hike in April. Twenty five basis points is not a heroic move.”

The quarter-point rise was a down payment on 3 percentage points of increases that the central bank will need to enact this year to stem inflation, according to Goldman Sachs Group Inc.

Global Trend

India followed Australia and Malaysia in lifting borrowing costs this month, while Norway and Israel did so at the end of last year, as the global economy recovered from the worst recession since World War II.

Inflation has returned to Asia as the region leads the global economic recovery. India’s wholesale-price inflation rate touched 9.89 percent in February, exceeding the central bank’s 8.5 percent forecast by March-end.

Factory output in Malaysia rose 12.7 percent in January. Consumer prices in China rose to a 16-month high of 2.7 percent in February from a year earlier as industrial production grew 20.7 percent in the first two months of 2010, the most in more than five years.

Still lagging behind India are central banks in the Group of Seven economies with the Federal Reserve and European Central Bank among those waiting for evidence of a more concrete recovery before they reverse record low borrowing costs. Canada may be the first G-7 central bank to shift after data showed its core inflation rate unexpectedly accelerated last month.

Before Meeting

Subbarao moved a month before the bank’s scheduled April 20 monetary policy meeting after India’s industrial output gained 16.7 percent in January from a year earlier, following a 17.6 percent increase in December that was the biggest jump since at least 1994, according to Bloomberg data.

“Given the lags in monetary policy, it is better to respond in a timely manner, even if it is outside the scheduled policy reviews, than take stronger measures at a later stage when inflationary expectations have accentuated,” the central bank said in its March 19 statement.

The bank will “maintain this tightening path,” Morgan Stanley economist Chetan Ahya said in a note on March 19. He expects Subbarao to increase rates by another 25 basis points on April 20. The rates may go up by one percentage point in 2010, including last week’s raise, he said.

‘Growing Discomfort’

The rate increase will end a rally in the government bond market and the benchmark 10-year note yield may rise to around 8 percent this week, said Indranil Pan, chief economist at Kotak Mahindra Bank Ltd. in Mumbai.

India’s 10-year notes completed their best week since September on March 19, and stocks had their biggest weekly gain in nine months, after Standard & Poor’s upgraded the nation’s debt-rating outlook to stable from negative on optimism for economic growth and government plans to narrow the budget gap.

Yields declined 18 basis points to 7.83 percent in Mumbai last week, while the Sensitive index rose 2.4 percent to 17,578.23 during the period.

The central bank said economic “recovery is increasingly taking hold” and pointed to the latest industrial production data as evidence of a “revival of private demand.”

India’s passenger-car sales gained to a record in February amid rising incomes in the world’s second-most populous nation. The demand is encouraging Ford Motor Co. and Volkswagen AG to build plants and unveil new models in the South Asian nation.

India’s $1.2 trillion economy, Asia’s biggest after Japan and China, may expand 8.2 percent in the next fiscal year, compared with 7.2 percent in the year to March 31, the finance ministry said in February.

Inflation is politically sensitive in a country such as India, where the World Bank estimates almost three-quarters of the nation’s 1.2 billion people live on less than $2 a day.

Opposition parties led by the Bharatiya Janata Party repeatedly stalled proceedings in parliament this month, accusing Prime Minister Manmohan Singh’s government of being anti-poor and failing to curb prices.