RBI Signals Inflation Needs to Ease to Boost Rate-Cut Scope

Indian monetary policy may have space in future to support growth if price pressures ease and fiscal and trade deficits narrow, even as caution is needed for now to focus on inflation, the nation’s central bank said.

“Monetary policy needs to be cautious in the interim, focusing on inflation while using the available space to support growth to the degree it can,” the Reserve Bank of India said in a report yesterday ahead of its interest-rate decision in Mumbai today. If threats from inflation and the deficits recede further, that “could yield space down the line for monetary policy to respond to growth concerns,” it said.

Finance Minister Palaniappan Chidambaram said yesterday India seeks to pare the budget shortfall to a near decade-low by 2017, after earlier this month calling for cheaper credit to back a policy revamp that included fuel-subsidy curbs. The central bank said further measures are necessary to contain the fiscal imbalance, adding there remains a risk India’s inflation rate of almost 8 percent may accelerate in the short term.

“The central bank will oblige only when inflation comes down,” said Indranil Pan, chief economist at Kotak Mahindra Bank Ltd. (KMB) in Mumbai. The comments indicate “they may do a token cut in the cash reserve ratio to lower the cost of funds for banks and support the economy.”

Governor Duvvuri Subbarao will leave the repurchase rate at 8 percent for a fourth meeting, 19 of 33 economists said in a Bloomberg News survey before the policy decision, while 13 predict a cut to 7.75 percent and one to 7.5 percent.

Interest Rates

Nineteen of 33 analysts in another survey estimate the central bank will reduce banks’ reserve requirements for the fourth time this year, to 4.25 percent from 4.5 percent, to spur lending. Four expect 4 percent and the rest no change.

The rupee has strengthened 2.5 percent against the dollar since Prime Minister Manmohan Singh’s administration began the policy overhaul on Sept. 13, paring its drop in the past year to 9.8 percent. It fell 0.9 percent yesterday to 54.0725 per dollar at the close in Mumbai, while the BSE India Sensitive Index of stocks rose 0.1 percent. The yield on the 10-year bonds due June 2022 was little changed at 8.13 percent.

“Recent policy measures have reduced macroeconomic risks, but speedy implementation and sustained reforms are important for turning the economy around,” the central bank said. Steps such as the push to curb spending on fuel subsidies “are welcome but are less than adequate to avert fiscal slippage in 2012-13. Further steps will need to be taken soon,” it said.

Growth Slowdown

The economy may expand 5.7 percent in the year through March 2013, based on a compilation of forecasts from other organizations, yesterday’s report showed. July’s survey projected 6.5 percent growth. Inflation may average 7.7 percent, the survey said, compared with an earlier 7.3 percent estimate.

The government last month raised diesel prices about 14 percent and limited supplies of subsidized cooking gas. It also opened industries such as retail to more investment from abroad, snapping months of gridlock over how to bolster growth.

Singh is trying to narrow the widest fiscal shortfall in major emerging markets to avert a credit-rating downgrade.

The government will aim for a gap of 5.3 percent of gross domestic product in the year that began April 1, 4.8 percent by March 2014 and 3 percent in the 12 months through March 2017, Chidambaram said in New Delhi yesterday as he outlined goals for fiscal consolidation.

‘Political Pressure’

The weakest stretch of economic growth since the 2009 global recession has hurt tax revenues even as subsidies stoke spending, exacerbating the deficit. Standard & Poor’s predicts it will widen to about 6 percent in the current fiscal year.

“The fiscal road map is a step in the right direction, but it lacks detail,” said Sonal Varma, an economist at Nomura Holdings Inc. in Mumbai.

Indian inflation quickened to 7.81 percent in September, the fastest pace in 10 months, stoked by food and fuel prices and supply congestion caused by choked roads and ports. Further currency gains will help damp costs, Chidambaram said on Oct. 12, adding “interest rates must come down.”

While near-term price risks are on the upside, inflation should start moderating in the three months through March next year, the Reserve Bank said. It has previously said the comfort zone for inflation may be about 5 percent.

Countries from Brazil to Thailand have cut borrowing costs this month as Europe’s debt crisis weighs on the world economy. Subbarao lowered rates in April by 50 basis points and has reduced banks’ reserve ratios 1.5 percentage points in 2012.

Indian GDP rose 5.5 percent in the three months through June from a year earlier, below Singh’s goal of about 8 percent. The current-account deficit narrowed to $16.4 billion in the second quarter of 2012, from $21.7 billion.

The “falling growth cycle appears to have reached its trough” and the government’s policy revamp may support a recovery later if successfully implemented, the central bank said. Bolstering investment remains the key to reviving the economy, it said.

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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