Rajan Holds Key India Rate, Signals Easing If Inflation Slows

Photographer: Tomohiro Ohsumi/Bloomberg

Raghuram Rajan, governor of the Reserve Bank of India. Close

Raghuram Rajan, governor of the Reserve Bank of India.

Photographer: Tomohiro Ohsumi/Bloomberg

Raghuram Rajan, governor of the Reserve Bank of India.

India’s central bank left interest rates unchanged for a second straight meeting, while signaling it would ease monetary policy if inflation slows faster than anticipated.

Governor Raghuram Rajan kept the benchmark repurchase rate at 8 percent, the Reserve Bank of India said in a statement in Mumbai today, as predicted by all 38 analysts in a Bloomberg News survey. He has raised the rate by 75 basis points since taking office in September to fight Asia’s fastest price gains.

The RBI said further policy tightening won’t be warranted if consumer-price inflation stays on course to hit 8 percent in January 2015 and 6 percent a year later. If disinflation is faster than anticipated “it will provide headroom for an easing of the policy stance,” it said.

Prime Minister Narendra Modi’s landslide win last month is spurring optimism that he’ll take steps to reduce price pressures and lead a recovery among the world’s biggest emerging markets, which are forecast to grow at the slowest pace since 2009. India must move toward fiscal discipline to lower inflation, curb the budget deficit and spur growth, Finance Minister Arun Jaitley said on June 1.

“One critical factor that will pave the way for the RBI to cut rates will be a credible fiscal correction plan and the government policies that will set the economy for long-term growth,” said Sonal Varma, an economist at Nomura Holdings Inc. in Mumbai. “The RBI can’t lend a supporting hand as inflation remains uncomfortably high amid risks from a bad monsoon.”

Inflation Risks

India’s consumer price gains accelerated to a three-month high of 8.59 percent in April, the fastest pace among 18 Asian economies tracked by Bloomberg. Risks to the central forecast of 8 percent CPI by January 2015 “remain broadly balanced,” the RBI said.

Risks of higher prices from possible El Nino effects and geopolitical tensions that may impact fuel prices appear to be balanced by stronger government action on food supply, better fiscal consolidation and the pass through effect of previous rate increases, the RBI said.

Rajan also lowered the proportion of deposits banks must invest in government debt and similar approved securities to 22.5 percent from 23 percent. The cut reflects the need to balance lenders’ funding needs -- as a stronger economy boosts loan growth -- with the government’s financing requirements. Any more reductions in this rate will depend on the “likely path of fiscal consolidation,” the RBI said.

Outlook Brighter

“Easing of domestic supply bottlenecks and progress in the implementation of stalled projects should brighten the outlook for both manufacturing and services,” the RBI said. “The resumption of export growth is a positive development and as world trade gathers momentum, the prospects for exports should improve further.”

Economists surveyed by Bloomberg forecast average growth in the BRICS, which includes Brazil, Russia, India, China and South Africa, will be 5.3 percent this year, the slowest since 2009. It was 8.7 percent in 2010.

Jaitley agreed with Rajan on the need to curb inflation when the two met last week. Jaitley said he’d make it a priority to curb the fiscal shortfall when he unveils the budget in July, in line with Rajan’s wishes.

Morgan Stanley, Citigroup Inc. and Nomura Holdings Inc. raised their growth forecasts for India last month after Modi’s win. Gross domestic product will expand at a four-year high of 6.5 percent in the year through March 2016, Morgan Stanley forecast, compared with a previous estimate of 6.2 percent.

Fiscal Laxity

India’s economy grew 4.7 percent in the fiscal year that ended March 31, compared with a decade-low of 4.5 percent in the previous 12 months. The fiscal deficit was 4.5 percent of GDP, narrower than the previous government’s revised target of 4.6 percent.

Jaitley in February criticized his predecessor Palaniappan Chidambaram for fiscal laxity over the interim budget in effect for several months, saying the deficit was reduced by cutting capital expenditure instead of boosting revenues or reviving investment.

“Short term disciplining till we reverse the present trend will give us long term benefits,” Jaitley wrote on his website on June 1. Modi’s BJP pledged in its campaign manifesto to “break the vicious cycle of high inflation and high rates,” in part through creating price stabilization funds and taking measures to prevent hoarding of food, which makes up 50 percent of the CPI basket.

“A credible deficit-cut plan by the government is critical to enable the RBI to ease rates,” said Arun Singh, an economist at Dun & Bradstreet Information Services India Pvt. in Mumbai. “Right now, it’s difficult as there are clear risks to inflation from a bad monsoon due to a possible El Nino threat.”

Drought Chance

The monsoon, which provides most of the annual rainfall, will be below normal this year, with a 60 percent chance for the emergence of an El Nino that previously caused droughts, the country’s weather forecaster said April 24.

Higher borrowing costs and subdued economic growth has hurt some companies including carmakers. Sales of Maruti Suzuki India Ltd. and others dropped 10.2 percent in April from a year earlier, compared with a 5.1 percent contraction in March, the Society of Indian Automobile Manufacturers said May 9.

“The RBI will wait for a lot more clarity on the government’s fiscal stance before it can consider easing borrowing costs,” Anubhuti Sahay, an economist at Standard Chartered Plc in Mumbai, said before the report. “If weather conditions or rainfall distribution patterns are worse than expected, inflation may jump back to double digits, to the discomfort of the RBI.”

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

To contact the editors responsible for this story: Daniel Ten Kate at dtenkate@bloomberg.net Arijit Ghosh

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