Rajan Seen Raising Key India Rate as RBI Flags Inflation Threat

Indian monetary policy must tackle elevated inflation even as most analysts see growth in Asia’s third-largest economy slowing to an 11-year low, the central bank said on the eve of today’s interest-rate decision.

“Monetary policy faces an unenviable task of anchoring inflation expectations, even while growth remains tepid,” the Reserve Bank of India said in an economic review yesterday. The central bank will probably raise its benchmark interest rate for the second straight month to fight the fastest consumer-price inflation in Asia, a Bloomberg survey showed. The decision is expected at 11:00 a.m. local time.

Governor Raghuram Rajan, who pledged to contain price increases after taking charge of the RBI last month, faces consumer inflation of almost 10 percent as the rupee’s drop over the past year stokes import costs. Making credit more expensive risks further hampering Prime Minister Manmohan Singh’s efforts to revive economic expansion before elections due by May.

“It’s clear that bringing down inflation is the dominant mandate which will be adhered to by the central bank,” said Shubhada Rao, chief economist at Yes Bank Ltd. in Mumbai. “A quarter-point increase is already expected, but after this report we can expect another increase of a similar amount, though not immediately.”

Rajan, a former International Monetary Fund chief economist, will raise the benchmark repurchase rate by 25 basis points to 7.75 percent, 32 of 42 analysts said in a Bloomberg News survey. One saw a rise to 8 percent, while the rest expected no change.

Simplifying Policy

He will cut the marginal standing facility rate by a quarter of a percentage point to 8.75 percent as he rolls back emergency liquidity curbs imposed on the banking system three months ago, nine of 14 economists said in a second Bloomberg survey. One predicted 8.5 percent and the rest no change.

Banks borrow in the marginal standing facility window when they exhaust the amount they can access at the repo rate, which was curbed in July. Rajan has said he aims to lower the gap between the two rates to 100 basis points.

“The governor is moving towards simplifying monetary policy,” Tirthankar Patnaik, a strategist at Religare Capital Markets Ltd. in Mumbai, said before yesterday’s report. “He’s aiming to restore the repo as the operative policy rate and prioritizing the need to anchor inflation expectations, which should be good for the rupee and economy longer term.”

Rupee Falls

The rupee, down 12 percent against the dollar over the past year, fell 0.1 percent to 61.525 per dollar at the close in Mumbai. The S&P BSE Sensex, up 5.9 percent this year, slid 0.6 percent. The yield on the 10-year government bond has increased to 8.66 percent from about 8 percent at the start of the year.

Consumer prices rose 9.84 percent in September from a year earlier, the most in a basket of 17 Asia-Pacific economies tracked by Bloomberg. Wholesale inflation was 6.46 percent, pushing up prices of onions and other food staples for the roughly 800 million Indians who live on less than $2 per day. The gauge may average 6 percent this fiscal year, yesterday’s survey said, compared with an earlier 5.3 percent estimate.

The economy may expand 4.8 percent in the year through March 2014, based on a compilation of forecasts from other organizations, yesterday’s report showed. That would be the slowest pace since 2003, and compares with a July projection of a 5.7 percent expansion.

Rajan, 50, unexpectedly raised the repo rate by a quarter point in his first policy review on Sept. 20. He’s lowered the marginal standing facility rate to 9 percent from 10.25 percent, the level reached when his predecessor boosted it 200 basis points on July 15 to curb the supply of rupees.

Singh Scandals

The governor has also offered concessional swaps for banks’ foreign-currency deposits and borrowings to encourage them to raise dollars. That window will attract about $15 billion before it closes next month, two officials with direct knowledge of the matter said.

Economic woes add to the challenges facing Singh, whose government has been beset by graft scandals. He took steps in September last year to revive investment and avert a credit-rating downgrade, including speeding up infrastructure projects, easing foreign-investment curbs and narrowing trade and budget deficits.

Rajan said this month India’s expansion is probably near the low point and should accelerate.

Exports have risen since July, while investments worth 3.84 trillion rupees ($62 billion) have been cleared up to Aug. 27 by a panel Singh set up to kick-start stalled projects. Deutsche Bank AG expects record food grain output in the year ending June.

For now, Indian companies are grappling with conditions akin to stagflation. Mahindra & Mahindra Ltd., the country’s biggest maker of sport utility vehicles, this month increased prices as much as 2 percent on higher input costs.

“Inflation isn’t going away unless the government addresses the main reasons for it: insufficient investment in infrastructure and poor productivity,” said Arun Singh, an economist at Dun & Bradstreet Information Services India Pvt. in Mumbai.