Moderating inflation will enable India’s central bank to hold interest rates steady at its policy review on Tuesday, although analysts said it could take steps to cut cash in circulation to help it manage robust capital flows.
It would be the second policy review in a row where interest rates have been held steady after the Reserve Bank of India (RBI) raised its key short-term lending rate five times between mid-2006 and end-March to 7.75%.
Not only has inflation moderated from two-year highs hit in January, but with the rupee having risen about 10% against the dollar to nine-year highs, a rate rise could attract more foreign money, something the central bank wants to avoid.
“We do not expect change in policy rates as it has the potential to attract more capital inflows and its effectiveness in moderating aggregate demand and inflationary expectations in view of surplus liquidity conditions is very uncertain,” the Securities Trading Corp. of India said in a note.
The reverse rate is at 6%. It was last raised in July 2006.
A Reuters poll of 11 economists earlier in July found the key rates were expected to be left unchanged, but more tightening was possible later in 2007 if inflation picked up.
Annual inflation is running at 4.4%, off a two-year peak of 6.7% in January, and analysts say the tightenings since the middle of 2006 are still working their way through the economy.
India, which is Asia’s third largest economy, grew 9.4% in the fiscal year that ended in March and the central bank’s forecast for 2007-08 is a strong 8.5%, but there are some signs that activity is moderating, easing concerns about overheating.
Credit growth has moderated to an annual pace of 24% from an average of 30% over the last three years, although it is still running faster than the central bank would like.
Business confidence fell sharply in the April-June quarter, mainly due to rising borrowing costs, according to the National Council of Applied Economic Research.
India’s economy and its booming markets—the stock market has hit record highs 14 times this month—are attracting foreign money that is complicating liquidity management and pushing up therupee.
“With the kind of inflows that are coming in, it is very difficult to keep the rupee stable as well as keep inflation from getting out of control,” said Ajit Ranade, chief economist of the Aditya Birla group.
But M3 money supply, which is an estimate of the entire supply of money within an economy, is growing at an annual pace of 22%, above the central bank’s comfort zone of 17-17.5%, in part fuelled by the central bank buying $23.4 billion (Rs94,770 crore) in the first five months of the year trying to contain the rupee.
The intervention releases rupees into money supply and, along with increased government spending, the surplus cash has pushed overnight call rates down to near zero.
The central bank raised the cash reserve ratio (CRR) three times between early December and late March and has been issuing market stabilization bonds to absorb some of the extra cash.
Analysts also expect the central bank to raise or remove the daily cap of Rs3,000 crore under the reverse repo auction to push up overnight rates closer to policy rates.