India Cuts Key Rate for First Time Since 2009

India slashed its benchmark interest rate by a greater-than-forecast half a percentage point, seeking to bolster growth with the first reduction since 2009. Inflation might limit the room for further cuts, the central bank said.

Governor Duvvuri Subbarao lowered the repurchase rate to 8 percent from 8.5 percent, the Reserve Bank of India said in a statement in Mumbai today. The outcome was predicted by three of 25 economists in a Bloomberg News survey. Seventeen expected a 0.25 percentage-point cut and the rest predicted no change.

The move stoked gains in the rupee and government bonds, and may buttress demand in an economy hampered by political gridlock that’s restraining investment. Policy makers are seeking at the same time to contain inflation that remains the fastest among the BRIC nations.

“They are playing with fire,” said Jahangir Aziz, an economist at JPMorgan Chase & Co. in Washington who used to work at the International Monetary Fund. “I am increasingly assured that this is going to be last rate cut” given the risks to inflation from oil prices and loose fiscal policy, he said.

The yield on the most-traded 8.79 percent notes due November 2021 fell to 8.34 percent as of 4:28 p.m. in Mumbai, from the day’s high of 8.51 percent and yesterday’s close of 8.46 percent, according to the Reserve Bank of India’s trading system. The rupee strengthened 0.2 percent to 51.56 per dollar, according to data compiled by Bloomberg. It slumped 16 percent last year, spurring price pressures by boosting import costs. The BSE India Sensitive Index of stocks closed up 1.2 percent.

Photographer: Joshua Roberts/Bloomberg

India's central bank Governor Duvvuri Subbarao. Close

India's central bank Governor Duvvuri Subbarao.

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Photographer: Joshua Roberts/Bloomberg

India's central bank Governor Duvvuri Subbarao.

‘Upside’ Inflation Risks

“The reduction in the repo rate is based on an assessment of growth having slowed below its post-crisis trend rate which, in turn, is contributing to a moderation in core inflation,” the Reserve Bank said. “However, it must be emphasized that the deviation of growth from its trend is modest. At the same time, upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates.”

Gross domestic product may expand 7.3 percent in the year through March 2013, compared with the baseline projection of 7 percent for the previous 12 months, the central bank estimated today. Inflation will probably be at 6.5 percent by the end of the current financial year, it said.

Uncertainty about global commodity prices, particularly crude oil, India’s fiscal shortfall, a “very high” current- account deficit and food inflation are among risks to the outlook, the Reserve Bank said.

‘Price Stability’

“We will do everything possible to maintain price stability,” Finance Minister Pranab Mukherjee said in New Delhi today. “The monetary policy announcement should help in investment revival and strengthen business sentiment. We will take some further additional steps in the coming weeks to reinforce growth focus.”

Expansion has been hurt by declining investment and moderating consumer spending after the Reserve Bank raised rates by a record 3.75 percentage points from March 2010 to October last year to fight inflation.

India’s monetary easing today contrasts with such Asian neighbors as Thailand and Indonesia, which have halted rate cuts as inflationary pressures gain. Bank of Korea Governor Kim Choong Soo this week urged major central banks to plan an orderly withdrawal of excess liquidity and said further easing may hurt emerging economies and the global economic recovery.

China Slowdown

China’s growth slowdown may limit the region’s economic recovery. Singapore’s exports unexpectedly dropped in March as shipments of electronics eased and petrochemical sales fell amid a decline in demand from China, a report today showed. Non-oil domestic exports fell 4.3 percent from a year earlier, after a revised 30.4 percent increase in February.

Foreign direct investment in China dropped for a fifth straight month in March as economic growth slowed, with inbound investment falling 6.1 percent from a year earlier to $11.76 billion, a report by the Ministry of Commerce showed today.

In Australia, the central bank said a weaker expansion flowing through to slower inflation would increase prospects for the first interest-rate cut this year, minutes of its April 3 meeting showed. The minutes reaffirmed that the next rate reduction hinges on an April 24 report on first-quarter inflation, as recent data indicates the economy is growing slower than the central bank predicted.

The Reserve Bank of Australia decided against lowering borrowing costs at its three meetings this year as the global recovery stabilizes and a mining boom sustains domestic growth.

U.K. inflation accelerated to 3.5 percent in March, while Euro-area inflation was 2.7 percent, reports showed today.

U.S. Industrial Output

In the U.S., industrial production may have risen 0.3 percent in March from the previous month, according to the median forecast in a Bloomberg News survey ahead of a report today. Home starts increased to a 705,000 annual rate in March following a 698,000 pace the prior month, according to a Bloomberg survey median.

India’s Subbarao has already eased monetary conditions by reducing the amount of deposits lenders must set aside as reserves twice this year, by a combined 125 basis points, to 4.75 percent to ease cash shortages in the banking system. He left the cash reserve ratio unchanged today. Liquidity is “steadily moving towards” its comfort zone, the RBI said.

Recent patterns of inflation and expansion signal India’s trend rate of economic growth has declined from its peak before the financial crisis, the Reserve Bank said. Significant supply bottlenecks in infrastructure, energy, minerals and labor are among the main reasons why, it said.

Fastest BRIC Inflation

The 6.89 percent climb in March in India’s benchmark wholesale-price index exceeded the median 6.65 percent estimate in a Bloomberg News survey of 33 economists, data showed yesterday. While Indian inflation has eased from more than 9 percent recorded in most of 2011, it remains the fastest in the so-called BRIC group of largest emerging economies that also includes Brazil, Russia and China.

Monetary policy will continue to aim to “condition and contain perception of inflation” in the range of 4 percent to 4.5 percent, the Reserve Bank said. The central bank’s immediate comfort zone is inflation at 5 percent and that level is achievable, Subbarao said at a briefing in Mumbai today.

“The RBI is faced with a very difficult situation as growth is slowing and inflation remains high,” said Rupa Rege Nitsure, an economist at state-owned Bank of Baroda in Mumbai. India needs “efforts from the government’s side to boost the capacity of the economy by accelerating reforms,” Nitsure said.

Higher raw material costs and the rupee’s decline are leading companies including steelmakers to raise prices. Steel Authority of India Ltd., the nation’s second-largest producer, increased tariffs in April for the fourth time in three months.

Current-Account Deficit

Prime Minister Manmohan Singh’s government, grappling with fiscal and trade gaps and depressed industrial output, faces one of the most challenging periods since taking office in 2004.

In the budget on March 16, the administration announced record borrowing needs to plug a fiscal shortfall estimated at 5.1 percent of gross domestic product in 2012-2013. The current- account deficit reached $19.6 billion in the three months through December, the worst quarterly performance on record.

“From the perspective of vulnerabilities emerging from the fiscal and current account deficits, it is imperative for macroeconomic stability that administered prices of petroleum products are increased to reflect their true cost of production,” the Reserve Bank said.

A current-account gap at 4.3 percent of gross domestic product in the fourth quarter of 2011 is unsustainable, it said.

Policy reversals have further hindered Singh’s economic agenda, including the suspension of plans in December to open India’s retail industry to foreign companies.

To contact the reporter on this story: Kartik Goyal in Mumbai at kgoyal@bloomberg.net

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

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