India’s economic growth will slow after the central bank raised its benchmark lending rate to a five-year high to curb inflation, Goldman Sachs Group Inc., HSBC Holdings Plc and the Asian Development Bank said.
Asia’s fourth-largest economy will grow at 8% in the year ending 31 March, ADB chief economist Ifzal Ali and Goldman economists Tushar Poddar and Mark Tan said. HSBC economist Robert Prior-Wandesforde pegs it at 7.8%.
India’s economy grew at 9.2% in the previous year, according to government estimates.
Prime Minister Manmohan Singh wants to tame inflation at the earliest to win voter support in the key Uttar Pradesh elections this week, after losing two state elections—in Punjab and Uttarakhand—in February.
The Reserve Bank of India has been raising banks’ reserve requirements and interest rates to slow record loan growth and curb inflation from a two-year high.
“The risks to our projections are now skewed to the downside due to the aggressive tightening,” Poddar and Tan said in a note to clients. “Given the political pressures on RBI and the long lags associated with policy, we see another 25-50 basis point increase in rates before they stabilize.”
The political pressure began after the Congress blamed inflation for losing power in Punjab and Uttarakhand. And the pressure is not likely to ease off anytime soon, given that the month-long Uttar Pradesh elections, which begin on 7 April, will set the tone for India’s general elections in about two years’ time.
India’s benchmark wholesale inflation rate stood at 6.47% in the week ended 17 March, and may exceed RBI’s inflation forecast of between 5% and 5.5% by 31 March.
With inflation a percentage point above its forecast, RBI Governor Yaga Venugopal Reddy on 30 March unexpectedly raised the cash reserve ratio, or the amount of cash lenders must set aside against deposits, for the third time since December, along with an increase in the key overnight lending rate.
In response, most banks increased their lending rates by between 200 and 250 basis points in the past four months. ICICI Bank Ltd, India’s biggest by market value, on 31 March increased its prime lending rate for the fourth time since December.
“We expect Indian growth to cool down significantly in the coming two years,” ADB’s Ali said in an interview in Washington on Tuesday. “In the process, I think inflation will be ironed out.”
Government 10-year bonds slumped the most in almost three months on Tuesday, the biggest fluctuation in any government debt market, on concern of rising rates. The yield on the notes on Wednesday held near the highest in eight months.
The Prime Minister may be losing out in the attempt to balance economic growth and inflation. The government is betting on accelerating growth to as much as 10% a year by 2012 to generate jobs and reduce poverty.
Prospects of growth helped the Bombay Stock Exchange’s Senex to more than double in the past three years. The index, which has declined 7% since 1 January, may decline further as the market may be “overvalued,” says HSBC’s Prior-Wandesforde.
“I’d be very cautious about the hype coming out of India,” Ali said. “With increasing incomes, the demand for food items is going up. The country cannot respond,” which suggests it is “reaching capacity constraints.”
Inflation accelerated in India as bank loans grew at 30% annually in India since 2004, the fastest pace since 1971, boosting demand for manufactured and farm products and creating shortages.