By C Thomas and S Chandra/Bloomberg
New Delhi: India’s central bank may end its policy of increasing borrowing costs this year as rising interest rates since October 2004 will tame inflation in the world’s second-fastest growing major economy, economists said.
The Reserve Bank of India will probably keep rates unchanged in its next monetary policy announcement on 24 April after the Mumbai-based bank unexpectedly raised its key overnight lending rate and reserve requirement for lenders on 30 March, said John Praveen, chief investment strategist at Prudential International Investment Advisors LLC in New Jersey.
“We may see one more hike probably this year, but for the large part, they’re probably done raising rates,” Praveen said. “The timing of the central bank action last week was a bit of surprise, the action itself was not. The stock and bond markets may react a bit negatively.”
The stock and bond markets may fall on 2 April on concern over higher interest rates and reduced funds in the banking system that will weaken demand for shares and gilts. Economists at Credit Suisse, JPMorgan Chase & Co. and other banks expect India’s inflation rate, currently near a two-year high, to start declining soon.
India’s benchmark wholesale price inflation stood at 6.46% in the week ended 17 March compared with the central bank’s forecast of between 5% and 5.5% by 31 March. Credit Suisse economist Sailesh Jha estimates the inflation rate to be 5% by 31 March and 4.5% a year later.
Central bank Governor Yaga Venugopal Reddy has raised rates by 2.25%age points since October 2004, and increased the amount of cash lenders must set aside against deposits three times since December to slow inflation.
The yield on the benchmark 10-year government bonds climbed 39 basis points to 8% last quarter as the central bank raised the cost of money and sold bonds to mop liquidity in its battle against inflation. The Bombay Stock Exchange’s Sensitive index fell 5.2% during the period.
The Reserve Bank on 30 March increased the repurchase rate at which it lends overnight to 7.75% from 7.5% with immediate effect. It raised the cash reserve ratio to 6.5% from 6% in two stages starting 14 April. Credit Suisse’s Jha expects the repurchase rate to be increased to 8% in the current financial year ending March 31.
“The rise in interest rates will make commercial banks’ fixed deposits more attractive for investors than stocks or bonds,” said R.K. Gupta, who oversees $68 million (Rs293 crore) of assets at Credit Capital Asset Management in New Delhi. “The increase in cash reserve ratio also robs liquidity from the banking system, and that’s a big negative for the markets.”
ICICI Bank Ltd., India’s biggest by market value, raised its interest rate on deposits by as much as 100 basis points in February. India’s central bank is pursuing a policy of higher interest rates to slow commercial banks’ loans that have grown at an average 30% since 2004, the fastest pace since it started collating data in 1971.
Cheap money has boosted demand for cars and other manufactured products and created shortages in food products such as wheat and sugar, stoking inflation to near a two-year high of 6.46% last month.
“Part of the price pressures are demand driven,” said Lawrence Goodman, head of emerging market strategy for Bank of America Corp. in New York. “There could well be more tightening in the third quarter.”
Consumer demand helped India’s $854 billion economy to grow at a record 8.6% pace since 2003, the fastest in the country’s history since independence in 1947.
Finance Minister Palaniappan Chidambaram wants to tame inflation at the earliest after criticism from his Congress party for losses in two state elections last month.
The party faces polls again this week in the northern state of Uttar Pradesh, the country’s most populous. The election will be staggered over a month and will set the tone for general elections in about two years time.
“It is quite possible, though speculative, that the central bank is now reacting to political pressure,” said Rajeev Malik, economist at JPMorgan Chase & Co. in Singapore.
The rising interest rates have also invited criticism from companies such as Hero Honda Motors Ltd and Ashok Leyland Ltd, which say higher borrowing costs may dent sales.
“It is definitely not a good sign and it will hurt companies and all borrowers,” said K. Sridharan, executive director in charge of finance at Ashok Leyland, India’s second- biggest maker of trucks and buses.
Economic growth will be supported by consumer demand and higher government spending on roads, ports and other infrastructure, says Prudential International’s Praveen.
India may have the highest salary increase among Asian countries this year, according to Hewitt Associates Inc., boosting consumer demand.
The government plans to raise spending on infrastructure including ports, power generation and roads by 40% to $30.2 billion in the year that started 1April to attract investments from foreign companies such as Intel Corp.
“While this monetary tightening might raise fears that it will bring the current boom to an abrupt end, we think such concerns are overdone,” said Keith Gyles, an economist at Capital Economics in London. “The RBI had to act again to prevent the economy from overheating. If it had not, the risk of a boom-bust would be all the greater.”