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RBI May Raise Rates Second Time This Month as Subbarao Has Eye on the Ball

India’s central bank signaled it’s set to raise interest rates again after an unscheduled increase last week, on concern that increased consumer spending and higher fuel prices will stoke inflation.

The Reserve Bank of India, led by Governor Duvvuri Subbarao, on July 2 boosted the reverse repurchase and repurchase rates by a quarter point each, to 4 percent and 5.5 percent, and added it will “take further action as warranted.”

Subbarao may follow with another quarter point at the bank’s next meeting on July 27, Royal Bank of Scotland Group Plc and Barclays Plc said. India is acting ahead of counterparts in Asia from South Korea and Indonesia to the Philippines and Thailand as dangers from the fastest inflation among the Group of 20 nations outweigh risks from Europe’s debt crisis.

“The decision shows policy makers have their eye on the ball,” said Brian Jackson, a Hong Kong-based strategist at Royal Bank of Canada. “India needs to focus on inflation pressures rather than a potential impact from Euro-area weakness.”

India’s benchmark 10-year government bond yields climbed to the highest in more than a week, advancing seven basis points to 7.63 percent at 11:35 a.m. in Mumbai. The Bombay Stock Exchange’s Sensitive Index rose 0.2 percent to 17,498.09, while the rupee gained 0.2 percent to 46.71 against the dollar.

Photographer: Namas Bhojani/Bloomberg

Duvvuri Subbarao, governor of the Reserve Bank of India (RBI). Close

Duvvuri Subbarao, governor of the Reserve Bank of India (RBI).

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Photographer: Namas Bhojani/Bloomberg

Duvvuri Subbarao, governor of the Reserve Bank of India (RBI).

‘Desirable’ Move

Finance Minister Pranab Mukherjee on July 2 described the monetary tightening as “desirable.” Two days later, he indicated the RBI should incorporate last week’s move when it meets this month, according to the Wall Street Journal. The newspaper quoted him saying he hoped the increase would be “subsumed in the new policy statement,” speaking in Kolkata, where he attended a banking conference.

India’s $1.2 trillion gross domestic product expanded 8.6 percent in the first quarter of this year from a year earlier, the fastest pace after China and Brazil among major economies. Industrial output jumped 17.6 percent in April.

Growth in India’s services industry including software and telecommunications accelerated to a two-year high in June, according to the Purchasing Managers’ Index released by HSBC Holdings Plc and Markit Economics today.

“Demand conditions are pretty strong,” said Gaurav Kapur, a Mumbai-based economist at Royal Bank of Scotland. “The fuel- price increase of last month may have also prompted the RBI to act before the policy meeting,” he said, referring to the central bank.

Capacity Increase

Maruti Suzuki India Ltd., the nation’s biggest carmaker, is spending 17 billion rupees to increase capacity 23 percent, to 1.25 million units a year. Tata Steel Ltd., India’s largest producer, last month won environmental approval to expand capacity at its Jamshedpur unit as it seeks to benefit from increased demand from carmakers.

The strengthening demand in India parallels a trend across emerging markets from China to Brazil, where expansions are outpacing those of advanced economies. U.S. growth prospects have been undermined by reports in the past month showing fewer workers hired than forecast, a drop in home sales, deterioration in consumer confidence and slower manufacturing.

Concern that expansions in developed nations are sputtering sent the MSCI World Index of stocks down 4 percent last week.

India’s growth is pushing up inflation, undermining the purchasing power of households in a country where more than three quarters of the 1.2 billion population lives on less than $2 a day.

Inflation Woes

India’s benchmark wholesale-price inflation unexpectedly accelerated to 10.2 percent in May. Consumer prices paid by industrial and farm workers rose almost 14 percent in May, according to government data.

By contrast, consumer-price gains are running at 2.9 percent in Australia, 2 percent in the U.S., 1.6 percent in the euro zone and 3.1 percent in China.

Also boosting inflation are India’s steps to rein in its budget deficit, which widened to a 16-year high of 6.9 percent of GDP in the year through March. Prime Minister Manmohan Singh last month freed gasoline prices to cut subsidies, allowing refiners raise them by about 3.5 rupees a liter.

The government also permitted diesel costs to rise by 2 rupees in a country where 65 percent of the goods are transported by road. Diesel pricing will eventually be freed, the government said.

The fuel-price decision may boost the inflation rate by about one percentage point, the central bank said.

Nationwide Strike

The Reserve Bank’s action to slow price gains came after opposition parties led by the Bharatiya Janata Party called for a nationwide strike today to protest against the fuel-price increase. Flights were canceled, companies shut offices and taxis stayed off the roads in major Indian cities.

The central bank said that while growth and inflation were quickening, it was “inadvisable” to raise rates earlier because of a shortage of cash with lenders.

Cash availability dropped after businesses withdrew money to pay taxes and the government raised 1.06 trillion rupees from the auction of high-speed mobile phone permits and broadband internet airwaves to companies including Bharti Airtel Ltd.

To prevent the cash squeeze from hampering growth, the central bank added money to the banking system since May. The bank extended until July 16 a plan to allow lenders keep less money in government bonds as reserves. The facility was set to expire on July 2.

“Liquidity has begun to ease more recently,” HSBC Holdings Plc economists Frederic Neumann and Prithviraj Srinivas wrote in a note to clients. “There is still a long way to go” in raising rates, with another 1.25 percentage points likely in the coming 12 months, they forecast.

To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net Unni Krishnan in New Delhi at Ukrishnan2@bloomberg.net

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