India to Use Rates for Rupee, Standard Chartered Says

By Anoop Agrawal

Sept. 8 (Bloomberg) -- India's new central bank Governor Duvvuri Subbarao may raise interest rates to halt the rupee's slide and cool inflation rather than dip into foreign-exchange reserves, according to Standard Chartered Plc.

The rupee's losses may be capped and the currency may end the year at 44.25 against the dollar, Thomas Harr, a senior currency strategist in Singapore for the U.K.-based bank, said in an interview. Subbarao, who started his three-year term on Sept. 5, may increase the benchmark rate by at least a half- percentage point this year to 9.5 percent as inflation stayed above 12 percent, Harr said.

A stronger rupee may not be effective in combating inflation, Subbarao had said as the top finance-ministry bureaucrat in a Bloomberg Television interview on July 28. His ``immediate priority'' is to anchor inflation expectations, he said after taking the top post at the central bank from Yaga Venugopal Reddy, who retired last week.

``They have signaled they don't see the currency as a way to damp imported inflation,'' Harr said. ``Interest rates have to be raised if inflation is above 12 percent. That will be a better support to the currency than using the reserves.''

The rupee has slumped 10.8 percent this year, erasing almost all of last year's 12.2 percent advance, which was the most in at least three decades. The rupee rose 1.1 percent to 44.1825 a dollar as of 10:09 a.m. in Mumbai. It closed at 44.66 on Sept. 5, the lowest level since March 2007.

India's inflation rate tripled this year to as high as 12.63 percent last month as a surge in crude oil prices forced the government to raise fuel costs. The rupee's slide exacerbated price increases by pushing up the import bill.

Raising Rates

Reddy increased the overnight lending rate, or the repurchase rate, three times starting June after a hiatus of more than a year, to stem inflation and curb the currency's decline. He has raised the benchmark rate 3 percentage points since late 2004 to a seven-year high.

Subbarao's tenure at the central bank begins at a time when crude oil has dropped 26 percent from its record and inflation slowed for a second straight week amid signs growth in Asia's third-biggest economy is slowing.

Seven of the 10 most-active currencies in Asia outside Japan have weakened against the dollar in the past three months as the threat of an economic slowdown in Europe and Japan prompted global funds to shun emerging-market assets.

India's central bank may intervene to curb rupee volatility rather than help reverse the slide as the U.S. dollar rallies against the euro, said Richard Yetsenga, a currency strategist at HSBC Holdings Plc in Hong Kong.

Dollar Rally

The Dollar Index traded on ICE futures exchange, which gauges the greenback against the currencies of six major U.S. trading partners, reached 79.077 on Sept. 4, the highest level in almost a year.

``The best central banks in Asia can do is probably to try and moderate the speed of moves rather than attempting to alter the direction,'' Yetsenga said in an interview, without giving a rupee forecast. ``Given the trend of de-leveraging in Asia it is clear that the rupee will see some weakness.''

India's foreign-currency reserves have dropped in all but four of the 13 weeks starting June, indicating the Reserve Bank of India sold dollars to slow the pace of the rupee's depreciation. Central banks intervene in currency markets by arranging sales or purchase of foreign exchange.

Foreign-currency reserves fell to a six-month low of $286.1 billion in the week ended Aug. 29, from a record $306.2 billion reached in May, central bank data show.

Negative Environment

The economy expanded 7.9 percent in the three months through June, the slowest pace since the last quarter of 2004, a government report showed last month. The benchmark Bombay Stock Exchange Sensitive Index is headed for the first annual loss since 2001.

Sales of Indian equities by foreign funds exceeded this year's purchases by $7.1 billion, which is more than a third of their net purchases of $17.2 billion in 2007. The record capital inflows last year helped the rupee climb to an almost decade- high in November, capping inflation at 3.07 percent in October, a six-year low.

``There is a negative investment environment'' as growth slows, said Craig Chan, a strategist at Lehman Brothers Holdings Inc. in Singapore. ``I don't think their preference is for the rupee to weaken but there seems to be no willingness'' to intervene.

Lehman expects the rupee to end the year at 44.50 a dollar, cutting its earlier forecast for a gain to 42.60.

To contact the reporter on this story: Anoop Agrawal in Mumbai at aagrawal8@bloomberg.net.