India raises rates for second month

India raised interest rates for a second month on Tuesday in a bid to contain consumer prices that have been among the fastest rising in the world’s large economies.

It is the largest economy to tighten monetary policy with successive rate rises as its recovery from the global economic downturn gathers steam. India’s industrial production has picked up during the past six months to record double-digit growth, while the agricultural economy is expected to regain its strength this year with better seasonal rains.
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“With the recovery now firmly in place, we need to move in a calibrated manner in the direction of normalising our policy instruments,” said Duvvuri Subbarao, governor of the Reserve Bank of India, in a policy statement.

The wholesale price index, India’s most closely watched inflation measure, rose 9.9 per cent in March, similar to the previous month but the biggest rise since October 2008. Food inflation has been running at 15-20 per cent, a particular concern in a country where much of the 1.2bn population survives on meagre incomes.

Australia, which is slightly smaller in gross domestic product terms, is the only other Group of 20 nation that has tightened monetary policy with rate rises since the downturn. This month, its central bank raised interest rates to 4.25 per cent, its fifth rise since October. Within the region, Malaysia and Vietnam have also raised rates.

The Reserve Bank of India at its quarterly policy meeting on Tuesday raised the repo rate, a key lending rate, 25 basis points to 5.25 per cent and raised the cash reserve ratio, the amount of money banks are required to hold with the central bank, 25bp to 6 per cent.

In an unscheduled move last month, the bank increased the repo rate 25bp to 5 per cent. In January, it raised the reserve ratio 75bp to 5.75 per cent to soak up excess liquidity.

Economists predict steady tightening throughout the year as the government withdraws fiscal stimulus measures introduced to help the economy weather the effects of the global financial crisis. They have recommended that the central bank aggressively tackle domestically generated price pressures, which they say are not well captured by the wholesale index or consumer price index.

“While recovery in private demand needs to be stronger to reinforce the growth momentum, the already elevated headline inflation suggests that the weight of policy balance may have to shift to containing inflation, since high inflation itself will dampen recovery in growth,” the RBI said in a statement on Monday night.

In the weeks ahead of its next policy review in July, the RBI is likely to focus on the strength of the monsoon rains, on which much agricultural activity depends across south Asia.

“Provided there is a normal monsoon, agricultural production will rebound, sharply reducing food price inflation and boosting consumer confidence,” said Nikhilesh Bhattacharyya, associate economist at Moody’s Analytics. “This has been the pattern following prior food price spikes.”

Last year’s rains were the worst in 37 years. They badly hit agricultural output, which has a declining share of GDP. India rarely suffers two bad monsoons in a row. Some of the highest temperatures in March and April for a century have encouraged forecasts that heavy monsoon rains are on their way. Better agricultural performance would spur the economy to the government’s goal of reaching 9-10 per cent economic growth.

Montek Singh Ahluwalia, deputy chairman of the planning commission, said: “I don’t know what it is that causes a system or a private sector to be optimistic. It’s not the case that it depends on little instruments like whether you raise interest rates or lower the repo rate.

“The positive thing about India at the moment is that there is a tremendous amount on optimism. This will certainly keep the momentum going.”