India Holds Rate, Signals Maintaining Borrowing Costs

By Cherian Thomas

Oct. 24 (Bloomberg) -- India's central bank kept interest rates unchanged and signaled it may hold borrowing costs in the coming weeks to balance inflation and growth concerns.

The Reserve Bank of India maintained its repurchase rate at 8 percent, according to a statement in Mumbai, after lowering the benchmark by 1 percentage point on Oct. 20. The decision was expected by 11 of 16 economists in a Bloomberg News survey.

Governor Duvvuri Subbarao is waiting for the impact of pumping 1.85 trillion rupees ($37 billion) into the financial system in the past two weeks as India's inflation rate is still double the central bank's target. Still, Subbarao may have to reduce borrowing costs as the global credit crunch is spreading to Brazil, Russia, India and China, the so-called BRIC economies that generated half the world's growth last year.

``It's just a matter of time before India cuts rates again,'' said Dariusz Kowalczyk, chief investment strategist at CFC Seymour Ltd. in Hong Kong. ``No country can remain insulated from the effects of an impending global recession.''

The central bank lowered India's growth forecast to between 7.5 percent and 8 percent in the year to March 31, from 8 percent estimated in July. It kept its inflation estimate unchanged at 7 percent by March 31, while betting the decline in commodity prices will slow inflation. Still, some of that drop will get negated by the biggest slide in the rupee since 1991.

The rupee, which has slumped 21 percent since January, fell to a record low of below 50 versus the dollar today. The yield on the benchmark 10-year bond rose to 7.68 percent from 7.53 percent earlier, while the Sensitive stock index fell 4.5 percent to 9329.43, extending the day's declines.

`Current Challenge'

``The current challenge is to strike an optimal balance between preserving financial stability, maintaining price stability, anchoring inflation expectations and sustaining the growth momentum,'' Subbarao said in his statement today.

India's key wholesale price inflation is at 11.07 percent, more than double the 5 percent aim of the central bank. Crude oil prices have halved since their peak in July and the Reuters/Jefferies CRB Index of 19 commodities fell 18 percent this month.

The government does not want growth to falter ahead of elections due by May. Prime Minister Manmohan Singh told the nation this week to be prepared for a ``temporary slowdown.'' India's $1.2 trillion economy has expanded at a record annual average pace of 8.9 percent since he became prime minister in 2004.

Government Concerns

Subbarao has so far accommodated government concerns on growth. Last week, the governor was summoned back to New Delhi from Washington midway through the annual meetings of the International Monetary Fund and World Bank for crisis talks.

After the meeting Subbarao reduced the cash reserve ratio by one percentage point, adding to a 1.5 percentage point reduction a week earlier. He subsequently cut the repurchase rate for the first time in four years.

The relations between the government and Subbarao, a former economic adviser to Singh and the top bureaucrat in the finance ministry before he was appointed the central bank governor, contrasts with that of his predecessor Yaga Venugopal Reddy.

Reddy, who spent almost a decade at the central bank starting as a deputy governor, had disagreements with the finance ministry on monetary policy. Reddy wanted interest rates to be tighter to control inflation while Finance Minister Palaniappan Chidambaram favored a ``benign'' environment.

After finishing his term on Sept. 5 with inflation close to a 13-year high, Reddy said monetary policy would have been tighter ``if I'd had my way.''

`Toeing Line'

``Subbarao, unlike his predecessor, is toeing the government's line on monetary policy,'' said D. H. Pai Panandiker, president of the RPG Foundation, an economic policy group in New Delhi. ``He has no choice in the present context. Growth is suffering and policy rates must be reduced.''

China cut interest rates twice this month as its economy expanded last quarter at the slowest pace in five years. Brazil's central bank may halt six months of rate increases and keep its benchmark unchanged at its Oct. 28-29 meeting, according to 15 of 25 economists in a Bloomberg survey.

``The global downturn may be deeper and more protracted than expected earlier,'' Subbarao said today. ``Consequently, the adverse implications through trade and financial channels for emerging economies, including India, have amplified.''

The decline in demand is already showing in India. The nation's industrial production growth slowed to 1.3 percent in August from a year earlier after a 7.4 percent gain in July. JSW Steel Ltd., India's third-biggest producer, delayed the start of a new 3 million ton blast furnace by two months.

``The worry on growth is far higher than previously estimated,'' said Krish Ramkumar, who manages the equivalent of $1 billion in Indian debt at Sundaram BNP Paribas Asset Management Co. in Mumbai. ``With inflation showing a slightly easing trend, the central bank can give momentum to growth.''

To contact the reporter on this story: Cherian Thomas in New Delhi at Cthomas1@bloomberg.net.