India Raises Rate More Than Expected to Tame Prices

By Cherian Thomas

July 29 (Bloomberg) -- India's central bank increased its benchmark interest rate by a half point, more than economists predicted, and forecast slowing economic growth as inflation at a 13-year high erodes spending by consumers and companies.

The Reserve Bank of India raised its repurchase rate to 9 percent from 8.5 percent, the third increase in two months, according to a statement in Mumbai today. Governor Yaga Venugopal Reddy, scheduled to retire in September, also raised the cash reserve ratio to 9 percent from 8.75 percent.

Reddy indicated monetary policy may need to be tightened further amid an ``accentuation'' in inflation pressures. India's move today was the sixth rate increase by a central bank in Asia since late June as policy makers in the region grapple with soaring food and energy prices.

``India has kept open the option of more hikes in interest rates,'' said Vishnu Varathan, an economist at Forecast Singapore Pte Ltd. ``Higher borrowing costs are fast becoming an Asian phenomenon.''

Stocks and bonds declined 30 minutes before the scheduled release after an e-mail from an independent Internet account purportedly showing the central bank's decision was sent to media. The e-mail, which at the time couldn't be verified with the Reserve Bank, matched the official statement released later.

Only one of the 22 economists in a Bloomberg News survey forecast the magnitude of the central bank's action. A quarter percentage point increase was predicted by 16 of those surveyed.

Stocks Fall

India's benchmark stock index fell 3 percent to 13,919.01 at 12:05 p.m. in Mumbai, while the yield on the benchmark 10- year bond yield rose to 9.44 percent from 9.07 percent. The rupee gained to 42.545 against the dollar from 42.59 earlier.

Reddy today increased this year's inflation forecast to 7 percent from a range of 5 percent to 5.5 percent.

Inflation in India has accelerated even after the government cut import duties on edible oils, steel products and gasoline, foregoing revenue. The government also banned the export of corn, rice and edible oil to spur local supplies.

Wholesale prices in India jumped 11.89 percent in the second week of July, making life tougher for the 500 million people in India who survive on less than $2 a day and draining support for Prime Minister Manmohan Singh as he braces for elections due by May.

Credit Rating

Standard & Poor's said this month that India's BBB- credit rating, the lowest investment grade, may be cut to junk if faster inflation and higher government spending ahead of the election widens the budget deficit. The government has waived $17 billion of farm debt and kept oil subsidies, estimated to be $42.5 billion this year, outside its accounts.

``Growing off-budget liabilities and enhanced expenditures on subsidies, loan waivers and salaries'' need to be watched, today's statement said. The government's evolving financial position ``pose severe challenges to monetary management.''

Faster inflation is prompting other Asian central banks to increase interest rates. The Philippine central bank has raised rates at its last two meetings, while Bank Indonesia has boosted borrowing costs for three straight months. Thailand raised its benchmark for the first time in two years this month and Pakistan is expected to follow suit later today.

Reddy, who has been tightening monetary policy since 2004, was caught wrong-footed as inflation in India surged in the past two months after the government was forced to increase energy prices by as much as 17 percent to cut losses at refiners.

Bank Lending

Since June, Reddy has raised rates by 125 basis points and the cash reserve ratio by three-quarters of a percentage point. The governor is trying to discourage lending from banks that could stoke consumer demand and add to inflation fanned mainly by higher prices of oil. Money supply is growing at about 21 percent, more than the central bank's 17 percent target.

Today's rate increase was ``a signal to the banks that credit growth must be moderated,'' India's finance ministry said in a statement. Measures adopted by the central bank and the government over the last two months will help in ``containing'' inflation, it said.

India's $912 billion economy may expand 8 percent this year, the weakest pace since 2004 and lower than the central bank's previous forecast of between 8 percent and 8.5 percent, Reddy said today.

``Slowing growth is a concern, but controlling inflation will take precedence in an election year,'' said D. H. Pai Panandiker, president, RPG Foundation, an economic policy group in New Delhi. ``The bank will tighten rates further.''

To contact the reporter on this story: Cherian Thomas in New Delhi at cthomas1@bloomberg.net