Fed’s Monetary Policy Stance May Fuel Inflation, India Central Bank Says

The Federal Reserve’s decision to keep record-low interest rates and the possibility of further steps to spur the U.S. economy may stoke commodity prices and fan inflation in India, the Asian nation’s central bank said.

“Given the fiscal limitations and growing signs of weakness in the U.S., the Fed has already indicated that it will pursue its near-zero rate policy at least till mid-2013,” the Reserve Bank of India said in a report in Mumbai yesterday. “It has also hinted at another dose of quantitative easing. This policy stance may keep the commodity prices elevated.”

The Reserve Bank has struggled to contain the fastest inflation among major economies even after raising rates 11 times since mid-March 2010. Emerging-market officials are waiting to see whether Fed Chairman Ben S. Bernanke will signal a third-round of asset purchases, known as quantitative easing, at a speech in Jackson Hole, Wyoming, today.

“All eyes are on whether there will be more quantitative easing,” said Siddhartha Sanyal, chief India economist at Barclays Plc in Mumbai, who worked at the Reserve Bank from 1999 to 2007. “Should there be a QE3 and commodity prices rise, the RBI would probably maintain its tight policy stance to quell inflation pressures.”

The yield on the 7.8 percent India government bond due April 2021 rose 2 basis points to 8.27 percent in Mumbai at 9:46 a.m. The Bombay Stock Exchange Sensitive Index gained 0.3 percent, and the rupee was little changed at 46.07 per dollar.

Bernanke Speech

Bernanke’s speech, entitled “Near- and Long-Term Prospects for the U.S. Economy,” is part of an annual symposium hosted by the Kansas City Fed since 1982 beside the Teton mountains.

India’s benchmark wholesale-price inflation rate has stayed above 9 percent since the start of December and was 9.22 percent in July after the government allowed state-run companies such as Indian Oil Corp. to increase diesel costs. The Reserve Bank’s repurchase rate is 8 percent.

“On a year-on-year basis, inflation may remain stubborn in the near term and start falling sometime in the third quarter of 2011-12,” according to the central bank’s report, which reiterated the Reserve Bank’s inflation forecast of 7 percent by the end of March 2012.

India’s growth prospects this fiscal year are “relatively subdued” compared with the previous year because of “increased” global uncertainties, “persistent” inflation pressures and higher borrowing costs, the central bank said.

‘Trend’ Growth

The economy may expand “close to the trend of about 8 percent” in the year through March after 8.5 percent growth in the previous year, the Reserve Bank said, repeating its earlier prediction.

If global financial problems “amplify and slow down global growth markedly,” it would “impart a downward bias” to the growth projection, the central bank said.

“While the immediate challenge to sustaining growth lies in bringing down inflation, growth sustainability over the medium-term depends on addressing the structural bottlenecks facing the economy,” the Reserve Bank said.

The cost of hauling goods on Indian roads is 30 percent more than in the U.S. because of inefficiencies, resulting in higher prices and lower competitiveness that curb growth, according to McKinsey & Co. India’s finance ministry estimates the nation produces about 10 percent less electricity than it needs.

‘Brace Up’

“The Indian economy needs to brace up for a difficult year from a macroeconomic perspective,” the central bank said. “With weak supply response, inflation remains an important macroeconomic challenge.”

As a result, both “fiscal and monetary space is limited for any counter-cyclical stimulus if global conditions deteriorate,” the central bank said.

Growth in the U.S. has slowed since early 2010, when gross domestic product expanded at a 3.9 percent annual pace. GDP rose at a 1.3 percent rate in the second quarter of this year after a 0.4 percent pace from January through March, according to the Commerce Department.

India’s central bank said “global uncertainties have increased markedly” since Standard & Poor’s downgraded the U.S. credit rating on Aug. 5.

“The S&P action came at a time when there were increasing signs of growth slowing down in the major advanced economies, especially the U.S.,” according to the Reserve Bank report. “The likely impact of these developments on the Indian economy, going forward, will depend upon the effect it will have on trade, capital flows and global commodity prices.”

While the risk of a global slowdown prompted nations from South Korea to Indonesia to keep rates unchanged this month, Reserve Bank Deputy Governor Subir Gokarn said yesterday India’s policy stance will change when inflation is “less of a problem.”

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

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