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Reserve Bank may keep rates at 6-year high amid inflation fears

Reserve Bank may keep rates at 6-year high amid inflation fears
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First Published: Wed, Jan 30 2008. 11 51 PM IST
Updated: Wed, Jan 30 2008. 11 51 PM IST
Mumbai: The Reserve Bank of India (RBI) will probably keep interest rates near a six-year high as it judges the risk of accelerating domestic inflation a greater concern than slowing global economic growth.
RBI will maintain its repurchase rate at 7.75% at the next monetary policy announcement on 29 April, according to six of nine economists surveyed by Bloomberg.
RBI governor Yaga Venugopal Reddy kept all three of the bank’s policy tools unchanged in Mumbai on Tuesday.
The government faces elections in a year and wants to contain inflation, an issue that affects votes in a country where more than half of the 1.1 billion people live on less than $2 (about Rs80) a day. Though the central bank said a slowing global economy is a risk for India, it maintained its growth forecast for the year to 31 March at 8.5%.
“While the government favours elevated growth, it is well aware that voters do not favour it with the price tag of higher inflation,” said Rajeev Malik, senior economist at JP Morgan Chase & Co. in Singapore.
“There is a palpable feeling that inflation shouldn’t become an issue” for the elections. Rising prices in 2007 caused Prime Minister Manmohan Singh’s Congress party to lose power in two states and fall further behind in the most populous state of Uttar Pradesh.
Singh’s party faces 10 state elections this year and general election before May 2009. His coalition allies this month objected to a government plan to reduce subsidies on diesel and petrol, which would stoke inflation by passing oil costs onto consumers.
Bond yields rose for the fourth day on Wednesday as the central bank refrained from taking cues from the US and cut interest rates on Tuesday. The yield on the benchmark nine-year government bond gained 1 basis point to 7.56% at 5pm in Mumbai.
Bets on an interest rate cut had increased after the US Federal Reserve slashed its target rate to 3.5% from 4.25% on 22 January. Six of 18 economists had expected Reddy to lower the repurchase rate, compared with none surveyed before the Fed decision, because of widening interest rate differential between the US and India. For the moment, inflation is “suppressed”, the bank said this week, because prices don’t reflect last year’s 57% increase in crude oil costs.
The economists surveyed on Tuesday indicated the central bank would only cut rates before its 29 April meeting should events outside India affect the economy.
“India cannot be totally immune to global developments,” RBI said on Tuesday, adding it would respond “swiftly” to changes in the global economy.
The spread between two-year government bonds and similar maturity US treasury notes has widened to 5.19% from as low as 1.84% in June, the most in at least eight years. That fuelled speculation that inflows of capital from investors seeking higher returns could spur inflation.
Reddy said on Tuesday that it wasn’t clear if there would be an increase or decrease in capital inflows.
“While the focus has generally been on managing excess capital inflows, it is essential not to exclude the possibility of some change in course, due to any abrupt changes in sentiment,” the governor had said.
“It is more prudent for the central bank to keep the armory intact than shoot in the dark,” said Navneet Munot, executive director at Morgan Stanley Mutual Fund in Mumbai.
Overseas investors sold a net $3.01 billion (Rs11,859 crore) of shares this month after they bought a record $17.2 billion of stocks in 2007.
“The outlook is more fluid than usual and will depend heavily on external conditions,” said Sonal Varma, a Mumbai-based economist at Lehman Brothers Holdings Inc.
Varma expects the bank to increase the amount of money the central bank requires commercial banks to set aside in reserves by 100 basis points to 8.5% by March 2009 to limit lending. She only expects the bank to cut interest rates if the US economy slides into arecession.
India’s benchmark inflation rate has climbed to a four-month high of 3.83%. People’s tolerance level for inflation is 4%, according to finance minister Palaniappan Chidambaram.
Reddy on Tuesday reiterated India’s $906 billion economy will grow at “around 8.5%” in the year ending 31 March. That’s in line with the average 8.6% expansion India has recorded in the past four years, the fastest pace since the country’s independence in 1947.
Manish Modi in New Delhi and Anand Krishnamoorthy in Singapore contributed to this story.
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First Published: Wed, Jan 30 2008. 11 51 PM IST