Rajan Holds Rates for Third Meeting in India Inflation Fight

By Unni Krishnan

Photographer: Dhiraj Singh/Bloomberg

Raghuram Rajan, governor of the Reserve Bank of India (RBI), gestures as he speaks... Read More

India’s central bank left interest rates unchanged for a third straight meeting as retail inflation slowed and Prime Minister Narendra Modi released food stocks to offset the risk of higher prices from a weak monsoon.
Governor Raghuram Rajan kept the benchmark repurchase rate at 8 percent, the Reserve Bank of India said in a statement in Mumbai today, a move predicted by 39 of 41 economists in a Bloomberg survey. Two forecast a cut to 7.75 percent.
“The RBI in no way will hold rates high any longer than necessary,” Rajan told reporters in Mumbai after the rate decision. “Growth will be most benefited if we disinflate the economy and we don’t have to fight this fight again. Let’s fight the anti-inflation fight once and let’s win. That will create the best conditions for sustainable growth.”
Modi’s three-month-old government is pushing to stem price gains to allow the central bank to lower one of Asia’s highest policy interest rates. Elevated borrowing costs risk damping the region’s third-biggest economy as Modi banks on a jump in tax revenues to narrow
the budget deficit to a seven-year-low.
“There is an acknowledgment that inflation has eased but there is also an attempt to rein in expectations of premature rate cuts,” Radhika Rao, an economist at DBS Bank Ltd. in Singapore, said by phone. “We don’t think the central bank will lower rates anytime in this fiscal year.”
Rajan is pushing to slow consumer-price inflation to below 8 percent in January 2015 and 6 percent in the following 12 months. The index has dropped for two straight months to 7.3 percent in June. While that’s the slowest pace since its creation in 2012, price gains are still the second-fastest among 18 Asia-Pacific economies tracked by Bloomberg.

Inflation Moderation

The moderation in inflation is due to both base effects and a steady deceleration in CPI excluding food and fuel, Rajan said today. Upside risks include the pass-through from government price support for crops, uncertainty over the monsoon and higher oil prices from geopolitical tension, the RBI said.
India’s benchmark stock index rose 0.3 percent as of 11:43 a.m. in Mumbai, taking this year’s advance to 21.8 percent, the best in Asia. The rupee gained 0.2 percent to 60.84 per dollar today and the yield on the 10-year sovereign bond rose to 8.79 percent from 8.73 percent.
About $1.2 trillion was wiped from the value of global equities last week amid concern that a debt default by Argentina and a crisis at Espirito Santo SA would constrict credit markets as the U.S. Federal Reserve debates the timeline for interest-rate increases. The People’s Bank of China on Aug. 1 warned about fast credit growth and indicated it will refrain from broader monetary easing.

Monsoon Risk

The main threat to inflation comes from India’s monsoon, which accounts for more than 70 percent of annual rainfall and waters about half of India’s farmlands. Rainfall was 21 percent below average as of Aug. 1, according to the nation’s weather department, putting India on pace for its driest year since 2009.
A crop failure can spur consumer prices in the world’s second-most populous nation, where food accounts for about 50 percent of the CPI basket. The government has sold 25 percent of its rice and wheat stocks in the domestic market since June, ordered a crackdown on hoarders and set minimum export prices on onions and potatoes to discourage overseas sales.
“The RBI needs to see the full playout of the monsoon,” said Shubhada Rao, an economist at Yes Bank Ltd. in Mumbai. “We are still in an uncertain, even negative, environment.”
State Bank of India predicts retail inflation will ease to below 5.5 percent in November and average CPI for this fiscal year will be as much as 7.5 percent. The nation’s largest lender predicts the economy probably expanded about 5.5 percent from April to June, faster than the previous quarter’s 4.6 percent.

Fiscal Deficit

“The monsoon concerns have been literally overplayed by the markets,” said Soumya Kanti Ghosh, an economist at State Bank of India.
Finance Minister Arun Jaitley plans to narrow the fiscal deficit to 4.1 percent of gross domestic product in the year through March 2015 from 4.5 percent in the previous 12 months. The target is “over-optimistic,” Thomas Rookmaaker, an analyst at Fitch Ratings Ltd., said in a July 31 conference call.
“The past government and the current government have stated again and again they’re on the fiscal consolidation path,” Rajan said today. “I don’t think there’s any reason to doubt it.”
The RBI further lowered the proportion of deposits that must be invested in specified securities such as government bonds to 22 percent from 22.5 percent, saying space has opened for banks to lend to productive sectors as the government maintained the fiscal deficit target of 4.1 percent of GDP. The monetary authority unexpectedly cut the rate from 23 percent at its previous review in June.

Liquidity Boost

To boost liquidity in the money and debt markets, the RBI also lowered the cap on the amount of debt banks can hold without marking to market to 24 percent from 24.5 percent, with effect from the fortnight beginning Aug. 9. The RBI is also looking to hold more frequent term-repo auctions, Rajan said.
India’s April-June budget deficit was 56.1 percent of the full-year target, the Controller General of Accounts said in a July 31 statement. About 44 percent of India’s 2.6 trillion rupees ($43 billion) of subsidies go toward food in a nation where about half of the population is employed in the agricultural sector and more than 60 percent live on less than $2 a day.
India last month blocked part of the biggest trade deal in the World Trade Organization’s 19-year history as the government sought to protect its food subsidy program. The interest of farmers is paramount and can’t be compromised, Press Trust of India cited Jaitley as saying.

’On Guard’

Optimism that the new government will spur economic growth is boosting sales at companies including carmaker Maruti Suzuki India Ltd. and Asian Paints Ltd. Passenger vehicle sales rose 11.2 percent in June from a year earlier, the second month of recovery after the first annual decline in a decade. A private gauge showed the nation’s purchasing managers index for manufacturing rose to 53 in July, highest since February 2013.
“This means that the RBI will have to stay on guard,” Frederic Neumann, an economist at HSBC Holdings Plc in Hong Kong, wrote in an Aug. 1 report. “Supply side constraints still limit the pace with which growth can recover without stoking inflation.”