Finance news

India's central bank raised interest rates for the second time this month and asked lenders to set aside more money as reserves to cool inflation running at a 13- year high.

The repurchase rate was lifted to 8.5 percent from 8 percent, and the cash reserve ratio to 8.75 percent from 8.25 percent, the Reserve Bank of India said in a statement issued in Mumbai today. The increase was the biggest since 2000 and followed a quarter-point rise on June 11.

Governor Yaga Venugopal Reddy is under pressure from the finance ministry to tighten monetary policy after record oil prices drove inflation to 11.05 percent in the week ended June 7. That may further hurt consumer demand and threatens to derail India's record 8.8 percent annual economic growth since 2003, the fastest after China among the world's major economies.

“The latest inflation reading was a shocker because of the nature of the oil prices pass-through,'' said S. Ananthanarayan, chief bond trader at Kotak Mahindra Bank Ltd., a Mumbai-based primary dealer that underwrites government debt sales. “They probably felt all the measures they've taken so far have been inadequate, and now they're playing catch-up.''

The central bank signaled it is prepared to keep raising interest rates if necessary to tame inflation.

Inflation Expectations

“In view of the criticality of anchoring inflation expectation, a continuous heightened vigil over ensuing monetary and macroeconomic developments is warranted to enable swift responses with appropriate measures as necessary, consistent with the monetary policy stance,'' the bank said in the statement.

India's 10-year bond yields climbed yesterday as high as 8.64 percent, the highest since 2001, before declining to 8.56 percent in Mumbai today. The rupee was little changed today at 42.965 per dollar.

Traders expect the rupee to rise from near a 14-month low to reduce the import cost of fuel, food and other products.

Finance Secretary D. Subbarao said on June 21 that monetary policy is the “first line of defense'' as the government tries to rein in prices before elections by May.

“High prices will most definitely result in aggressive monetary tightening, even at the cost of lower growth, making things all the more unenviable for the government,'' said Rohini Malkani, a Mumbai-based economist at Citigroup Inc. “With inflation likely to remain at elevated levels for the rest of the year, political parties have started positioning themselves for the next elections.''

Election Issue

India's inflation rate has almost tripled this year, eroding the popularity of Singh's ruling Congress party, which lost ground in nine of 11 state elections since January 2007 free credit report.com. More than half of India's 1.1 billion people live on less than $2 a day.

Before today, Reddy had raised the repurchase rate eight times in the past 2 1/2 years and increased the cash reserve ratio seven times since December 2006 to slow money supply and cool inflation.

“A tight monetary stance will have to continue for another year to slow inflation to the desired level,'' said Rajiv Kumar, a former policy adviser in the finance ministry between 1992 and 1995 who is now the director of the Indian Council for Research on International Economic Relations. “Growth could come down to as low as 6.5 percent by 2010.''

Soaring Costs

Inflation is accelerating across Asia as crude oil and raw material costs climb, forcing governments from Indonesia to Sri Lanka to cut subsidies and let regulated fuel prices increase.

Singh increased retail prices of gasoline and diesel this month, joining China, Indonesia, Malaysia and Sri Lanka, as a near doubling of oil prices pushed up costs and eroded profits of refiners such as Indian Oil Corp.

“The Manmohan Singh government is squarely responsible for this dismal situation,'' the Communist Party of India (Marxist), the biggest ally of the government, said on June 20. “It cannot escape by blaming global inflation.''

Inflation is “a major political issue,'' said Tushar Poddar, an economist at Goldman Sachs Group Inc. in Mumbai, before the rate announcement. “There needs to be significant further tightening to arrest inflationary expectations, second- round effects and demand pressures.''

Strong Enough

China told lenders to set aside more money for a fifth time this year on June 7 to cool inflation that is close to a 12-year high. Banks must put aside a record 17.5 percent of deposits as reserves from June 25.

India has supported monetary policy steps with tax cuts to ease prices. On June 4 the government scrapped taxes on imports of crude oil and reduced duties on other fuel products, foregoing $5.3 billion of revenue to cushion consumers from high fuel costs.

“The RBI is essentially saying the economic fundamentals are looking strong and can bear higher interest rates,'' said Prasanna Ananthasubramaniam, a fixed-income analyst at Mumbai- based primary dealer, ICICI Securities Ltd. “Its main priority and concern is now to cool inflation.''

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