Rajan Signals India Inflation Target Amid Vote Tension

India central bank Governor Raghuram Rajan signaled he’s preparing to follow through on proposals to make inflation the bank’s top priority even at the risk of friction with Prime Minister Manmohan Singh’s government.

Rajan yesterday unexpectedly raised the repurchase rate by a quarter-point to 8 percent a week after a panel he appointed released proposals to reduce Asia’s highest inflation rate to 6 percent by 2016 from about 10 percent now. He made the move even after Finance Minister Palaniappan Chidambaram said in a Jan. 23 interview the central bank has a duty to support growth.

“If the government policies in aggregate prove to be expansionary, we will have to adjust policies ourselves to meet the overall disinflationary process,” Rajan told analysts on a conference call today. “We can’t throw up our hands in some sense and say there is nothing we can do because of the fiscal dominance.”

Rajan, 50, cited the panel’s targets in his policy statement and adopted a proposal it made to conduct monetary policy reviews every two months instead of every six weeks, part of recommendations for the most sweeping changes in the bank’s 78-year history. Chidambaram last week called the targets “ambitious,” risking tension as the ruling Congress party seeks to extend its 10-year rule in elections due by May.

“The Finance Ministry and the government may have reservations about a narrow inflation focus as against striking a balance between the objectives of supporting growth and controlling inflation,” said Gaurav Kapur, a senior economist at Royal Bank of Scotland Group Plc in Mumbai. “This is evident from the comments by the finance minister about the proposals.”

Rupee Strengthens

The rupee, down about 14 percent in the past year, rose 0.4 percent at 2:30 p.m. in Mumbai after climbing by the most in more than two months yesterday. The S&P BSE Sensex index gained 0.3 percent. The yield on the 10-year government bond rose to 8.76 percent from 8.75 percent yesterday.

Rajan followed Brazil’s central bank in raising the policy rate this month as the risk of capital flight weakens emerging-market currencies from the Turkish lira to South Africa’s rand. Turkey’s central bank raised all its main interest rates at an emergency late-night meeting in an effort to shore up the lira, resisting government pressure and reversing years of policy aimed at stoking growth.

Further tightening isn’t anticipated in the near term if consumer-price inflation slows from about 10 percent now to 8 percent by early 2015, the Reserve Bank of India said yesterday.

An RBI panel led by Deputy Governor Urjit Patel last week recommended making inflation the “predominant objective” of monetary policy for the first time. The panel suggested reducing consumer-price inflation to 8 percent within one year and 6 percent by 2016, at which point it would adopt a 4 percent target with a band of plus or minus two percentage points.

Standing Alone

“What we can do alone and we want to do, we’ll take up,” Rajan told reporters yesterday. “What we want to do and needs the cooperation of the government, we’ll take up with the government. It’ll be premature to say that we have moved towards inflation targeting.”

Consumer-price inflation will exceed 9 percent in the three months ending March 31, and range between 7.5 percent and 8.5 percent in the same period next year, the RBI said in a separate review yesterday. An increase in the policy rate “will set the economy securely on the recommended disinflationary path,” the central bank said in the statement.

“The move to raise rate endorses the views in Patel committee report,” said Rupa Rege Nitsure, an economist at Bank of Baroda in Mumbai and a member of the committee. “There is a risk that the rupee could again come under pressure due global volatility, and the move is also aimed at addressing that concern.”

Politically Sensitive

Inflation is a politically sensitive issue in India, where elections have been lost as prices quickened. Singh said this month his government could have done better on controlling prices while defending policies to buy farm produce at guaranteed prices, boost rural wages and distribute cheap food.

“Clearly, you have to push on the government to both increase the supply side but also reduce the incentives or the pressures on the food prices” that have contributed to inflation, Rajan said today.

The Congress party is set for its worst-ever performance, winning as few as 91 seats versus 210 now, according to a C-Voter poll for India Today published last week. The main opposition Bharatiya Janata Party is likely to win 188 seats in the 545-member lower house in elections due by May, surpassing the party’s previous high of 182 seats in 1999, the poll said.

Policy Criticism

Chidambaram clashed with Rajan’s predecessor in 2012 over interest rate levels, prompting the finance minister to say the government will “walk alone” if necessary to revive Asia’s third-biggest economy. Gross domestic product will expand “a little below” 5 percent in the year through March 31, and grow between 5 percent and 6 percent in the next fiscal year ending March 2015 if inflation slows, the central bank said yesterday.

The RBI and the government share a “cooperative relationship,” Rajan said today. “Countries across the world, the monetary authority and the fiscal authority cooperate as far as possible, but one has to adjust for the other.”

The central bank review criticized a move by Singh’s government to increase supplies of subsidized cooking gas cylinders after pressure from the Congress Party. In an address to party leaders this month, Vice President Rahul Gandhi appealed to Singh to increase the number of gas cylinders to 12 from the present nine per year.

Withstanding Pressure

“While diesel prices have been increased steadily, subsidy on gas cylinders remains large,” the central bank said in its quarterly review. “Adhering to fiscal discipline hinges upon the ability to withstand pressures to increase subsidies, including those on fuel and public utilities.”

Inflation numbers from February to April could bring a “nasty surprise,” according to Jahangir Aziz, an economist at JPMorgan Chase & Co. in Singapore. He expects rates to rise another 50 basis points by the end of the year.

“The RBI is moving towards informal inflation targeting Regime,” Aziz said. “At these levels of inflation, there is no trade off.”

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