Subbarao May Raise Rates for Second Time in Month to Bring Down Inflation

India’s central bank may raise interest rates for the second time in a month to tame the fastest inflation among Group of 20 nations.

The Reserve Bank of India will probably increase the reverse repurchase rate to 3.75 percent from 3.5 percent and the repurchase rate to 5.25 percent from 5 percent, according to the median forecast of 25 economists in a Bloomberg News Survey. The announcement is due at 11:15 a.m. in Mumbai tomorrow.

Governor Duvvuri Subbarao’s struggle against inflation exposes the roadblocks in the Indian economy -- inadequate capacity in power, roads and ports that drive up prices. In China, where infrastructure spending is double that of India, the fastest growth in almost three years in the first quarter came with a slowdown in inflation, complicating the decision in the country on when to raise interest rates.

“Domestic demand pressures are building in the Indian economy without a commensurate increase in capacity creation,” said Chetan Ahya, a regional economist at Morgan Stanley in Singapore. “That coupled with a rise in global commodity prices is resulting in a spike in non-food inflation.”

Consumer prices paid by industrial workers in India rose 14.9 percent in February from a year earlier. The nation’s wholesale-price inflation rate held at a 17-month high of 9.9 percent in March.

India’s $1.2 trillion economy may grow 7.5 percent in 2010, the fastest pace after China among the major economies, according to the World Bank. Subbarao on March 19 raised interest rates by a quarter-point for the first time in almost two years.

Poor Roads

The Reserve Bank may also increase the cash reserve ratio, or the proportion of deposits that lenders need to set aside as reserves, to 6 percent from 5.75 percent, according to the Bloomberg survey. Nine of 25 economists surveyed forecast a half-point increase in the reverse repurchase rate.

India produces about 10 percent less electricity than it needs, while roads, which account for 65 percent of the nation’s cargo, are plagued by single lanes and irregular surfaces, boosting companies’ costs, according to government estimates.

Infrastructure spending accounts for just 4 percent of India’s gross domestic product compared with 9 percent of GDP in China, according to CLSA Asia-Pacific Markets. The Planning Commission of India estimated last month the country needs to more than double spending on infrastructure to $1 trillion in the five years to March 2017.

Oil Prices

Increasing costs for commodities such as oil, which India imports to meet three-quarters of its needs, are also spurring price pressures. Crude oil prices have surged 70 percent in the past year.

Wal-Mart Stores Inc., the world’s largest retailer, said last week India’s inflation would slow by at least two percentage points if the government agreed to allow foreign investment in retail.

Wal-Mart, Carrefour SA and Tesco Plc are betting that their supply chain network and sourcing ability will allow them to remove middle men and sell products directly to consumers in India at lower prices. Local laws, aimed at protecting small shop owners, let global companies operate only wholesale stores that sell groceries and goods to retailers and businesses.     An increase in the cost of Indian interest-rate swaps signaled investors are using the derivatives to guard against an increase in borrowing costs. One-year swap rates have added 12 basis points in the past two weeks, the most in such a period since December. The rate, a fixed payment made to receive floating rates, touched a four-month high of 5.14 percent on April 16.

Stronger Currency

The yield on benchmark 10-year Indian government bonds fell 2 basis points to 8.06 percent as of 9:20 a.m. in Mumbai today. It has added 46 basis points this year on the inflation outlook. The central bank has allowed the rupee to appreciate to make imports cheaper and fight inflation. The currency has gained 4.4 percent since Jan. 1 against the U.S. dollar.

“India has the highest inflation of any of the economies currently around Asia,” said Timothy Moe, Goldman Sachs Group Inc. chief Asian strategist. “The economy we felt was most in need of raising rates.”

Consumer prices in China rose 2.4 percent in March, less than economists expected. India, Australia and Malaysia have already raised borrowing costs, while Singapore last week announced it will allow its currency -- the city-state’s principal monetary tool -- to strengthen, as Asia Pacific economies recovered from the worst recession since World War II.

‘Cost Pressures’

Prices may rise further in India as the Purchasing Managers’ Index, released by HSBC Group Plc and Markit Economics, was 57.8 in March, indicating growing consumer demand. A reading above 50 indicates a gain in factory production.

HSBC economist Robert Prior-Wandesforde said the most “attention-grabbing” aspect of the March factory index data was the surge in input prices, which suggests that companies are facing “sizeable and mounting cost pressures.”

Toyota Motor Corp.’s Indian unit on April 1 raised prices of its Corolla, Innova and Fortuner vehicles to offset rising input costs, while Indian Oil Corp., the nation’s second-largest refiner, increased jet fuel prices.

To contact the reporter on this story: Cherian Thomas in Bangalore at Cthomas1@bloomberg.net

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