India Rate Cut Eclipsed as Singh Ally Quits Coalition

The Indian central bank’s second interest-rate cut this year to spur growth was overshadowed by political drama as a key ally withdrew support for the coalition government, imperiling a push for reforms to revive investment.

The Dravida Munnetra Kazhagam, the largest ally, said today it would stop support for Prime Minister Manmohan Singh’s administration. The Reserve Bank of India in Mumbai lowered the repurchase rate to 7.5 percent from 7.75 percent, as predicted by 30 of 35 analysts in a Bloomberg News survey.

Singh’s coalition would be 44 seats short of a majority without the DMK, adding to the challenge of passing legislation such as bills to liberalize foreign investment in the pensions and insurance industries. The central bank said today inflation and the current-account deficit limit the scope for further monetary easing. The government is trying to contain the budget shortfall to help damp price pressures.

“This political development means scope for tough reform decisions is pretty much on the backburner,” said Rajeev Malik, an economist at CLSA Asia-Pacific Markets in Singapore. The government’s ability to deliver on its fiscal plan and further economic-policy changes will influence the RBI, he said.

Stocks tumbled on DMK’s move, with the BSE India Sensitive Index down 1.5 percent in Mumbai, the most this month. The yield on the 8.15 percent government bond due June 2022 rose to 7.90 percent from 7.88 percent yesterday. The rupee, down 7.7 percent versus the dollar in the past year, fell 0.4 percent to 54.375.

Policy Guidance

“Even as the policy stance emphasizes addressing the growth risks, the headroom for further monetary easing remains quite limited,” the central bank said in today’s statement.

The DMK, one of nine parliamentary partners in the governing alliance, withdrew its backing after a dispute over the government’s approach to alleged war crimes in Sri Lanka, while signaling a patch-up is possible if its demands are met.

The Congress Party-led administration lost its majority in parliament last year when another ally ended its backing over the decision to allow overseas businesses such as Wal-Mart Stores Inc. to set up supermarkets.

Finance Minister Palaniappan Chidambaram said today the government is stable and that there is no crisis. A general election is due in India by May 2014.

Chidambaram has spearheaded policy changes since September to woo capital inflows, curb fuel subsidies and speed up stalled road, rail and port projects.

He called for lower borrowing costs in a March 15 interview, and said that India is reviewing foreign-direct investment caps and may scrap or relax many of them.

Economic Challenges

The window for further rate cuts may close unless consumer inflation of almost 11 percent and a record current-account gap abate, according to Deutsche Bank AG. India is the only major Asian economy to have lowered borrowing costs in 2013.

Reserve Bank Governor Duvvuri Subbarao’s quarter-point rate cut on Jan. 29 was the first since a half-point reduction in April last year.

The statistics agency forecasts 5 percent gross domestic product growth in the fiscal year through March 2013, the least since 2003. Wholesale-price inflation accelerated to 6.84 percent in February from a year earlier. The consumer gauge climbed 10.91 percent. Core inflation eased to 3.8 percent.

“You can see the central bank’s discomfort in saying there’s lot of room for monetary action because the CPI number doesn’t suggest that,” Raghuram Rajan, chief economic advisor to the finance ministry, said in an interview today. “But, the growth number and WPI core inflation suggest that. So, it’s sort of caught between the two.”

Food Inflation

Costlier food and diesel, supply bottlenecks and the drop in the rupee in the past year have fanned the cost of living. Consumer prices are rising at the fastest pace in the Group of 20 major nations, according to data compiled by Bloomberg.

“Although there has been notable softening of non-food manufactured products inflation, food inflation remains high, driving a wedge between wholesale price and consumer price inflation, and is exacerbating the challenge for monetary management,” the Reserve Bank said.

The finance minister’s goal is a budget gap of 4.8 percent of GDP in 2013-2014, from 5.2 percent this fiscal year.

Chidambaram has said the current-account deficit is the bigger concern, and estimates India may need more than $75 billion of foreign capital this year and next to fund it.

The International Monetary Fund predicts 6 percent Indian growth in 2013-2014 as investment moderates. While that’s better than the U.S. and Europe, supported by consumer spending in a nation of 1.2 billion people, it’s below India’s average of about 8 percent in the past 10 years.

Using monetary policy to support the economy may not be the right strategy, said Rupa Rege Nitsure, an economist at Bank of Baroda in Mumbai. The onus instead is on the government to cut red tape and graft to encourage investment, she said.

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