India Cuts Key Rate to Spur Growth as Inflation Cools

India lowered interest rates for the first time since April and cut the amount of deposits lenders must set aside as reserves, easing policy to revive growth as inflation cools and the government curbs the budget deficit.

The Reserve Bank of India reduced the repurchase rate to 7.75 percent from 8 percent, it said in Mumbai today, as 30 of 35 analysts in a Bloomberg News survey predicted. Governor Duvvuri Subbarao also cut the cash reserve ratio to 4 percent from 4.25 percent, effective Feb. 9, adding 180 billion rupees ($3.4 billion) into the banking system.

India becomes the first major Asian economy to ease borrowing costs in 2013, after inflation moderated to a three-year low and the government called for cheaper credit as it vows prudence in next month’s budget to damp price pressures. The central bank cut the inflation forecast to 6.8 percent and said there’s space, “albeit limited,” to support a faltering economy. It estimated a record current-gap will widen further.

“The central bank was encouraged by easing inflation and banked on the delivery of fiscal policy tightening,” said Leif Eskesen, the chief India and Southeast Asia economist for HSBC Holdings Plc in Singapore. “The current-account deficit is too wide for comfort, and room for further easing would depend upon inflation risks receding and deficits narrowing.”

The yield on the 8.15 percent government bond due June 2022 fell to 7.84 percent as of 4:41 p.m. in Mumbai, compared with 7.86 percent yesterday. The BSE India Sensitive Index fell 0.6 percent. The rupee gained 0.2 percent to 53.7938 per dollar.

Policy Guidance

“There is an increasing likelihood of inflation remaining range-bound around current levels going into 2013-2014,” the Reserve Bank said. “This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks.”

The central bank added the policy guidance will be “conditioned by the evolving growth-inflation dynamic and the management of risks from twin deficits.”

Subbarao said at a briefing in Mumbai today that “the message that we are trying to give is that as much as there is some space, it’s going to be quite limited and we are going to use it with a lot of judgment, on both the timing and the quantum.”

The rupee has strengthened about 3 percent against the dollar since mid-September, when Prime Minister Manmohan Singh began a policy overhaul to contain subsidies, lure foreign investment and speed up infrastructure projects. Singh is trying to revive an economy expanding at the weakest pace in a decade.

Inflation Forecast

Growth will be 5.5 percent in the year through March 2013, below an earlier estimate of 5.8 percent, the Reserve Bank said. That would be the slowest since 2002-2003. The prediction for benchmark inflation was cut to 6.8 percent from 7.5 percent.

Five of 28 analysts in a Bloomberg survey predicted the reserve-ratio cut, the fifth since the start of 2012, with the rest seeing no change. Four in the repurchase rate survey expected a reduction to 7.5 percent and one no change.

Finance Minister Palaniappan Chidambaram said last week he’ll stick to his target of narrowing the budget gap to 4.8 percent of gross domestic product in the 12 months through March 2014, from an estimated 5.3 percent this fiscal year.

Officials are trying to give Subbarao more room to lower borrowing costs. They are also trying to avert a credit-rating downgrade after Standard & Poor’s and Fitch Ratings warned in 2012 that fiscal and trade shortfalls imperil India’s investment-grade status.

Current Account

The current-account deficit is expected to have widened in the quarter ended December, the central bank said. It was 5.4 percent of GDP in the previous three-month period. The Reserve Bank said it’s “critical now to arrest the loss of growth momentum without endangering external stability.”

Benchmark inflation was 7.18 percent in December, the highest in the BRIC group of major emerging nations that also includes Brazil, Russia and China. The current-account deficit was a record $22.31 billion in the quarter ended Sept. 30.

India partially freed diesel prices from state control on Jan. 17 to curb fuel subsidies, adding to recent policy steps. A rise of 0.45 rupees a liter every month until March 2014 will add around 64 basis points to inflation and lower the budget gap by 14 basis points, according to Nomura Holdings Inc.

Companies such as motorcycle maker Hero MotoCorp Ltd. have reported declining profits, while higher costs led mobile-phone operator Bharti Airtel Ltd. to increase prices this month.

“High inflation, a volatile exchange rate and commodity prices pose huge macroeconomic risks,” said Rupa Rege Nitsure, an economist at Bank of Baroda in Mumbai.

Elsewhere in Asia today, New Zealand’s annual trade deficit unexpectedly narrowed in December. In Australia, business confidence for December rebounded the most since 2001.

In Germany, consumer confidence will climb in February due to a stable labor market and higher income expectations, market research company Gfk SE said.

In the U.S., private reports may show home prices in November posted their biggest year-on-year advance since 2006, while consumer confidence as measured by the Conference Board likely weakened in January, surveys showed.

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