Subbarao Inflation Fight Buffeted By Volatile Indian Markets

By Cherian Thomas

Oct. 31 (Bloomberg) -- Reserve Bank of India Governor Duvvuri Subbarao, in the job two months, insists his priority is to fight inflation. The trouble is, the battlefield keeps changing.

As traders left work on Oct. 29 for a national holiday, they speculated that a surge in Indian money-market rates would force Subbarao to cut the amount of money that banks hold in reserve.

Instead, the retreat across Asia yesterday means he may have some breathing room to assess the inflation threat and whether the risk of a global recession is a bigger danger. What isn't clear is whether that breathing room could disappear as swiftly as it materialized.

``The markets may give him space to make a better assessment of the inflation outlook,'' said N. R. Bhanumurthy, an economist at the Institute for Economic Growth in New Delhi. ``He wants time to decide if inflation is really a problem, and a drop in money-market rates may give him that.''

Inter-bank lending rates in India doubled to 13.5 percent in the four trading days to Oct. 29. While banks were shut for the holiday, rates elsewhere in Asia tumbled after central banks from the U.S. to China cut rates and the Federal Reserve made more dollars available to emerging economies.

Hong Kong's three-month interbank offered rate, or Hibor, slid 15 basis points to 3.39 percent. The rate for U.S. dollar loans in Singapore, or Sibor, declined 15 basis points to 3.28 percent, the 12th straight drop and the lowest since Sept. 17.

Time to Assess

Once he has time to assess where inflation is heading, Subbarao ``may veer around to the point that growth may be a bigger problem now,'' said D. H. Pai Panandiker, president of the RPG Foundation, an economic policy group in New Delhi.

Commerce Ministry figures yesterday validate that view: the country's inflation rate fell below 11 percent for the first time since May, rising 10.68 percent in the third week of this month.

``Inflation is not going to be a big problem in India going forward,'' said Hugo Navarro, international economist at Capital Economics Ltd. in London. ``We expect a further easing in monetary policy to support economic growth.''

Subbarao lowered the benchmark repurchase rate by 1 percentage point last week to 8 percent to cushion Asia's third- largest economy from a global credit crunch.

He followed the cut with a quarterly monetary policy statement on Oct. 24 that placed equal emphasis on controlling inflation and backing economic expansion. The stance caused bonds to decline the most in almost three months and the stock index to fall by 11 percent.

Food Prices

Subbarao, 59, told reporters that food prices may pick up because the country's winter crop harvest will be less than previously anticipated. And global crude oil prices -- while coming down -- are subject to volatility, he said.

The governor also said a weakening rupee, which increases import costs, adds to the inflationary risks. The rupee has dropped 21 percent against the dollar this year.

Meanwhile, Prime Minister Manmohan Singh is piling on the pressure to lower rates. He told parliament two weeks ago that there is a ``clear deceleration'' in inflation, while warning of a ``temporary slowdown'' in the Indian economy. Singh said the precise impact would depend on the depth and duration of the global slowdown.

``The central bank seems to be giving more emphasis than perhaps is necessary on inflation, especially given the significant drop in commodity prices,'' said Rajeev Malik, regional economist at Macquarie Group Ltd. in Singapore. ``In the current global setting, it should be putting more policy easing in place because the economy is screaming for it.''

Reserve Bank economists are already paring their forecasts. The central bank on Oct. 24 cut its economic growth forecast to 7.5 percent from 8 percent in the year to March 31. It retained its forecast for inflation to slow to 7 percent by March 31.

Investors also anticipate a shift. Ten-year bonds recovered this week, pushing 10-year yields to the lowest since February. The benchmark Sensitive stock index has gained 4 percent this week. India's financial markets were closed yesterday because of a Hindu festival.

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