Raghuram Rajan's surprise move to hold India's benchmark interest rate gives the central bank chief firepower to act if the U.S. Federal Reserve's guidance on monetary stimulus again triggers a plunge in the rupee.
Rajan, who left the repurchase rate unchanged at 7.75 percent yesterday, told reporters that even the Fed couldn't foresee the impact of reducing its monthly bond purchases. Most analysts expected a quarter-point increase from the Reserve Bank of India to stem consumer-price inflation that topped 11 percent last month, the highest in Asia.
"Any sell-off in the rupee from a hawkish Fed could raise inflationary expectations going ahead," Christian Maggio, a senior emerging-markets strategist at TD Securities in London, said by phone yesterday. The RBI may increase the benchmark rate 50 basis points if next month's inflation figures are "particularly adverse," he said, adding that the move could come in an unscheduled announcement after the data is released.
Rajan's pause tests moves to fight inflation and shield the rupee from the effects of Fed tapering since he took charge of the RBI in September, including increasing the key rate 50 basis points and boosting foreign-exchange reserves through a swaps window to raise dollars. The currency has climbed about 11 percent versus the dollar since reaching a record low in August after the first Fed signal of reduced debt purchases.
"It's the right decision to reserve your ammunition to deal with a situation post-Fed announcement," said Gaurav Kapur, a senior economist at Royal Bank of Scotland Group Plc in Mumbai. "While the RBI kept rates unchanged, there is no denying that inflationary pressures still remain alive in the economy and the RBI won't have room to ease the policy rates anytime soon."
Fed Taper
The Fed is trimming its monthly bond purchases to $75 billion from $85 billion, taking the first step toward unwinding the unprecedented stimulus that Chairman Ben S. Bernanke put in place to help the economy recover from the worst recession since the 1930s. The Fed's decision reflected "cumulative progress and an improved outlook for the job market," Bernanke said at a press conference in Washington yesterday after a meeting of the Federal Open Market Committee.
The rupee declined 0.1 percent to 62.105 per dollar at the close in Mumbai yesterday and has depreciated about 11.5 percent this year. The S&P BSE Sensex index of shares climbed 1.2 percent yesterday. The yield on the 10-year government note maturing November 2023 slid to 8.79 percent from 8.91 percent on Dec. 17.
India is better prepared for the Fed to taper stimulus than earlier this year, Rajan said yesterday, adding that he sees volatility rising on such a scenario. Expectations of reduced bond purchases are now mostly priced into asset prices, according to Jahangir Aziz, an economist at JPMorgan Chase & Co. in Singapore.
Muted Reaction
"Unless there is a very aggressive start to the tapering, which I doubt, I really don't think we'll get hit that badly," he said yesterday. "We are not going to see the kind of vicious reaction that we saw in May-June."
Rajan said he'll also be watching to see whether a spike in consumer prices last month is temporary. Indications that vegetable prices may fall combined with a more stable exchange rate and lag effects from the previous rate increases give reason to hold the rate even though inflation is "too high," the central bank said in a statement, adding that action may be taken on off-policy dates if warranted.
India's consumer prices rose 11.24 percent in November from a year earlier, the fastest among 17 Asia-Pacific economies tracked by Bloomberg. Wholesale inflation was 7.52 percent, a 14-month high. Gross domestic product grew 4.8 percent in the three months to Sept. 30.
Food Inflation
"We are vigilant for the possibility that food inflation may be more entrenched," Rajan, 50, told reporters. "We are not ignoring food inflation, but we would like to see through the noise. And for that, we want to wait for a month more."
Prime Minister Manmohan Singh's administration, which has overseen four straight quarters of economic growth below 5 percent and put India on the verge of a credit-rating downgrade, praised Rajan's decision as it looks forward to elections next year. Voters punished Singh's party in recent state elections, with the main opposition Bharatiya Janata Party winning the most seats in four of five polls.
"It helps in creating the right kind of sentiment for investment to come back," Economic Affairs Secretary Arvind Mayaram said in an interview in Seoul yesterday, referring to the decision to hold the rate. "The RBI has done a smart balance between inflation targeting and incentivizing growth."
Tesco Entry
Singh received a boost two days ago for his effort to bolster investment when Tesco Plc (TSCO), the U.K.'s largest supermarket company, said it plans to become the first global chain to enter India since the government allowed foreign companies to invest in multibrand retail more than a year ago.
Rajan said yesterday the government will have to cut some expenses to meet a deficit target of 4.8 percent of GDP. Tighter spending in the fourth quarter of the fiscal year ending March 31 add to concerns over economic growth, the central bank said in a statement.
"We believe the hurdle to hike rates is rising and expect the repo rate to stabilize at 8 percent," Rohini Malkani, an economist at Citigroup Inc. in Mumbai, wrote in a research report yesterday.
Rajan raised the repo rate a quarter point in both September and October, and lowered the marginal standing facility rate to 8.75 percent from 10.25 percent, the level reached when his predecessor boosted it 200 basis points on July 15 to curb the supply of rupees.
Trade Deficit
The narrowing of the trade deficit since June through November should bring down the current-account deficit to a more sustainable level for the year, the RBI said. Inflows into swaps windows opened by the RBI from August to November provided stability to the foreign-exchange market and helped build resilience to external shocks, the central bank said.
India's current-account deficit narrowed to $5.2 billion in July through September, the lowest level since 2010, compared with $21.8 billion for the prior quarter.
Even so, a "renewed battering" of the rupee after the Fed move could force Rajan to make a quick move on rates before the next scheduled policy meeting, said Robert Prior-Wandesforde, a Singapore-based economist at Credit Suisse Group AG.
"We suspect the RBI is hoping for the best but probably delaying the inevitable," he said. "Another rate increase is only a matter of time in our view."
To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net
To contact the editor responsible for this story: Daniel Ten Kate at dtenkate@bloomberg.net
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