Insurers Drag Bonds Down to Worst Month Since December '09: Credit Markets

India’s central bank Governor Duvvuri Subbarao may need to raise interest rates as capacity constraints in power and roads and record borrowings fuel inflation, an adviser to Prime Minister Manmohan Singh said.

“He has very little flexibility,” M. Govinda Rao, who is also the director of the New Delhi-based National Institute of Public Finance and Policy, says in the May 17 issue of Bloomberg BusinessWeek magazine.

Having helped India avoid the worst of the downturn, Subbarao has put the Reserve Bank of India at the forefront of Asian banks that are stepping away from easy money to control prices. Inflation in India is at a 17-month high.

Manufacturers in India are struggling to pay for more expensive fuel and other raw materials, and unlike China, the South Asian nation lacks world class infrastructure that lowers the cost of goods.

Subbarao has raised interest rates by 50 basis points so far this year, and may increase them by another 100 basis points to 6.25 percent by the year-end, says Rahul Bajoria, an economist at Barclays Capital in Singapore. Despite the tightening, the government expects the economy to expand close to 9 percent in the financial year ending March 2010.

A former World Bank economist, Subbarao became governor in September 2008, just days before Lehman Brothers Holdings Inc. and American International Group Inc. collapsed. He spent his first months slashing interest rates to keep India growing.

Monsoon Failure

Then the crucial monsoons failed, sending food prices skyrocketing. Now, India stand outs in Asia for both its budget deficit--7 percent of GDP--and inflation of almost 15 percent.

It’s not an easy hand to play for the 60-year-old Ohio State graduate, who nevertheless earns praise from many economists.

Subbarao and his team “have done a very good job,” says Tim Condon, Singapore-based chief Asia economist for ING Groep NV.

Some economists believe the budget deficit won’t overwhelm India.

Most of India’s debt is held by investors inside India and so a bond holder panic is unlikely, said Dharmakirti Joshi, chief economist at Crisil Ltd., the Indian unit of Standard & Poor’s. Robust GDP growth helps too, he said.

“If you get high growth, you can run high deficits” Joshi said.

Subbarao is already looking ahead to his next battle, taming the hot money that flows into countries like India, often fueling bubbles and then exiting fast. India “may well employ” capital controls to protect its financial system, Subbarao said on April 26.

To contact the reporter on this story: Unni Krishnan in New Delhi at ukrishnan2@bloomberg.net.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.