Subbarao's Inflation Fight Hit By Volatile 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.

India's money-market rates tumbled earlier this month after Subbarao reduced the amount of money that lenders must hold in reserve, giving the new central bank chief room to keep benchmark interest rates unchanged in his first quarterly monetary-policy statement on Oct. 24.

Since then, the rate at which Indian banks lend to each other overnight has more than tripled, increasing speculation that Subbarao will be forced to cut the reserve requirement again. Elsewhere in Asia, rates have declined as the Federal Reserve pledged to inject more U.S. currency into money markets and global central banks cut borrowing costs to spur lending.

``Subbarao's policy stance is dictated by movements in India's money-market rates, which aren't following the rest of the region,'' said N. R. Bhanumurthy, an economist at the Institute of Economic Growth in New Delhi. ``Rising call rates don't give him time to assess whether inflation is a problem.''

The rate at which Indian banks lend to each other touched 21 percent today. India's 10-year bonds gained, heading for their best month in almost a decade, on speculation policy makers will be forced to step up efforts to boost cash with banks and ease a credit squeeze.

`Bigger Problem'

Hong Kong's three-month interbank offered rate, or Hibor, fell 4.6 basis points today to a one-week low of 3.35 percent, according to the 11 a.m. fixing by Hong Kong Association of Banks. The similar rate for U.S. dollar loans in Singapore, or Sibor, plunged 19 basis points to 3.09 percent, the lowest since Sept. 17, according to the Association of Banks in Singapore.

Inflation in India may be easing, making Subbarao more comfortable about reducing interest rates to support growth.

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: India'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.''

Credit Crunch

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.

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.

Slowing Growth

``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.

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