India Raises Interest Rates, Says Stance Near Normal

India Raises Interest Rates a Fifth Time
The Reserve Bank of India raised the repurchase rate to 6 percent from 5.75 percent and the reverse repurchase rate to 5 percent from 4.5 percent. Photographer: Adeel Halim/Bloomberg

The Reserve Bank of India increased interest rates for the fifth time this year and said its actions have brought the “monetary situation close to normal.”

Governor Duvvuri Subbarao boosted the repurchase rate to 6 percent from 5.75 percent, and the reverse repurchase rate a half point to 5 percent, the RBI said in a statement in Mumbai today. “The role of normalization as a motivation for further actions is likely to be less important,” the central bank said, signaling it has no pre-set plan to keep raising borrowing costs.

Stocks dropped after the reverse repo rate exceeded economists’ forecasts. At stake for the central bank is extending its success in restraining inflation that’s sparked demonstrations and a strike this month by millions of workers.

“It’s going to be open-ended for coming monetary policies whether they are going to raise because it is very much dependent on inflation,” said Prasanna Ananthasubramaniam, chief economist at ICICI Securities Primary Dealership Ltd. in Mumbai. “There will be some more hikes before the end of the financial year but it’s going to be much slower.”

The benchmark Sensex stock index dropped 0.4 percent to close at 19,417.49 in Mumbai, snapping seven days of gains. Bonds fell, with yields on the 10-year government bond rising by five basis points to 7.99 percent after the release, while the rupee gained 0.4 percent to 46.165 per dollar.

Regional Pauses

Today’s decision contrasts with pauses in rate increases by Malaysia and South Korea this month on concern that the global recovery is faltering. It also comes after an acceleration in industrial-production growth threatened to fuel price pressures.

“They remain hawkish on inflation and indicate that the inflation is still at unacceptably high levels,” said Indranil Pan, chief economist at Mumbai-based Kotak Mahindra Bank Ltd. The central bank will likely raise rates by as much as another half a percentage point, unless “global conditions worsen from now,” Pan said.

Only 2 of 16 economists in the Bloomberg News survey had forecast a half-point move in the reverse repo rate, which is used to withdraw funds from the financial system, with 11 expecting a quarter-point increase and 3 forecasting no change. The repo rate is used to inject liquidity.

“The Reserve Bank believes that the tightening that has been carried out over this period has taken the monetary situation close to normal,” it said in today’s statement. The central bank will monitor “macroeconomic conditions,” particularly the price situation, and take further action as necessary, it said.

Inflation Outlook

“Overall, our assessment is that growth remains steady,” the Reserve Bank said. Inflation “may remain high for some months,” it said in the statement.

Economic reports in the past week indicated both a pick-up in growth and moderation in prices. Industrial production expanded 13.8 percent in July from a year earlier, more than twice the pace in June. India’s merchandise exports increased 22.5 percent from a year earlier to $16.6 billion in August, Commerce Secretary Rahul Khullar said yesterday.

“With the economy running above trend at a time when spare capacity in both labor and product markets is already limited, the risk of a strong pickup in wages and inflation is high,” said Robert Prior-Wandesforde, an economist at Credit Suisse Group AG in Singapore. He expects the RBI to raise rates by 0.25 to 0.5 percentage point by March.

India’s accelerating economy has lifted incomes and stoked demand for Maruti Suzuki India Ltd. cars, TVS Motor Co. motorbikes and other goods, helping Maruti Suzuki, the nation’s biggest carmaker, sell a record 104,791 vehicles last month.

Prices Climb

Still, wholesale prices rose 8.5 percent in August from a year earlier, easing from July’s 9.8 percent gain, the commerce ministry said Sept. 14.

Prime Minister Manmohan Singh’s government has signaled increased acceptance of higher borrowing costs amid public protests over inflation, which most affects the three quarters of the population who live on less than $2 a day.

India needs to “continue to be vigilant and be prepared with the instruments of fiscal and monetary policy to use them as and when the need arises” to contain inflation, Finance Minister Pranab Mukherjee said Sept. 14. “There is no room for complacency.”

At the same time, one gauge of the outlook for rates suggests Subbarao may be approaching the end of the series of increases. The cost of fixing rates on money for three years in the market for so-called interest-rate swaps tumbled 37 basis points in August, the most in 20 months.

Economy Expands

Gross domestic product expanded 8.8 percent last quarter from a year earlier, the most among major economies after China and Brazil. Consumer prices paid by industrial and rural workers in India are rising more than 11 percent, faster than the consumer inflation in any other Group of 20 nation.

Worker unions, supported by the opposition communist parties, organized a nationwide strike on Sept. 7 to protest rising prices and state asset sales, prompting millions to stay away from work and forcing banks to shut offices in some cities and airlines to cancel flights.

Today’s meeting is the first of an expanded series of RBI meetings to consider monetary policy. The bank previously met quarterly, and has now increased that to eight times a year.

Policy Tools

As India’s role in the global economy rises, the central bank is also examining how it conducts monetary policy. The RBI has used banks’ reserve requirements along with the repo and reverse repo rates to manage liquidity and price pressures in the past year.

The RBI set up a panel this week to review its tools, including the difference between the repo and reverse-repo rates, which are respectively used to inject or remove funds from the system.

The Finance Ministry’s chief economic adviser, Kaushik Basu said today any further rate actions will likely depend on inflation and growth.

“I can’t rule that out,” he told reporters when asked if there will be more rate increases. “Growth figures are going to be watched, inflation figures will be watched and a decision will be taken.”

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