India hikes interest rates to contain inflation

[November 02, 2010]  MUMBAI, India (AP) -- India's central bank raised key interest rates by a quarter point Tuesday to contain persistently high inflation amid strong economic growth.

The Reserve Bank of India's sixth hike since March was expected and the bank indicated it has raised interest rates enough for now.

"The likelihood of further rate actions in the immediate future is relatively low," Governor D. Subbarao said in a statement.

The Reserve Bank hiked the repo rate -- the central bank's short term bank lending rate -- to 6.25 percent. It raised the reverse repo rate -- which the central bank pays on deposits -- to 5.25 percent. It left the cash reserve ratio unchanged at 6.0 percent.

Indian policy makers are caught between strong growth at home and a fragile global economy, and the Reserve Bank said it would take steps to mitigate "lumpy and volatile" capital flows as necessary.

The rate hikes "will not change things too much," said Naresh Kothari, president of Edelweiss Securities in Mumbai. "They don't want to punch out the growth cycle, also they're watching inflation carefully. They're in a delicate balancing act."

Ultra-loose monetary policy in the developed world has sent a flood of foreign money into emerging Asia as investors seek havens of high-growth. That has pushed stock markets, dealmaking and currencies to dizzying highs, hurting exports and creating fears of frothy equities, real estate and gold markets.

In raising rates, India has broken ranks with Thailand, South Korea, Indonesia and the Philippines, which have put rates on hold, worried that further hikes would attract even more foreign capital.

Unlike most emerging Asian economies, India is a net importer and needs to finance its widening current account deficit, making it more tolerant of large foreign capital flows than its neighbors.

"Although India needs capital flows to finance its widening current account deficit, large capital flows beyond the absorptive capacity of the economy could pose a major challenge for exchange rate and monetary management," the governor said.

The U.S. Federal Reserve is expected to this week join Japan in buying more government bonds and other assets to tamp down interest rates and competitively weaken the dollar.

That could drive even more capital offshore and put upward pressure on global commodities, further exacerbating inflation in India, which imports about three-quarters of its oil.

If the Fed goes ahead with a $500 billion buying program, liquidity could become a bigger driver of inflation than factors such as food shortages, prompting more aggressive action from the bank, said Enam Securities economist Sachchidanand Shukla.

"They will have to intervene more aggressively in currency markets because of the risks from liquidity flows into the country," he said.

The bank said rising global commodity prices, coupled with domestic demand pressures, have made inflation its overriding concern.

September's 8.6 percent headline inflation is above India's recent trend of 5 percent to 5.5 percent.

Food inflation for September was 15.7 percent, down from 21.4 percent in May. High food prices are partly due to people eating more protein as they get richer, the bank said, making it unlikely that good rains will alone wash away food inflation.

Rising real estate prices and the use of temporarily low "teaser" loan rates have made the bank wary of a U.S. style housing bust.

"It has been observed that many banks at the time of initial loan appraisal do not take into account the repaying capacity of the borrower at normal lending rates," the bank said.

It said it wants commercial banks to increase provisioning for such loans to 2 percent, given the higher risks.

India's economy grew 8.8 percent in the April to June quarter. From April to August, exports were 27.6 percent higher than the prior year and industrial output rose an average of 10.6 percent a month. Strong corporate earnings have boosted tax revenues, taking pressure off the fiscal deficit.

The bank left its growth forecast for the year ending March unchanged at 8.5 percent.

Despite the failure of a good monsoon to moderate food prices, the bank left its inflation forecast steady at 5.5 percent under India's new inflation data series, which the bank said is equivalent to 6.0 percent under the old series.

[Associated Press; By ERIKA KINETZ]

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