Indian central bank chief Raghuram Rajan’s surprise move to raise the policy interest rate adds pressure on Prime Minister Manmohan Singh to take politically challenging steps to boost economic growth as elections near.
The Reserve Bank of India unexpectedly raised the benchmark repurchase rate Friday to contain price increases that have hit roughly 825 million citizens who earn less than $2 per day. In doing so, Rajan made it more urgent for Singh’s government to allow greater foreign investment and reduce food and fuel subsidies to bolster the economy.
“Removing some of the key structural impediments would be the key to revive growth,” Siddhartha Sanyal, chief India economist at Barclays Plc in Mumbai, said in an email. “Given that elections are just six to eight months away, you really can’t expect to see a lot.”
Rajan’s move two days after the Federal Reserve decided to maintain stimulus signaled his intention to bolster the bank’s inflation-fighting credentials amid the weakest economic growth since 2009. Stocks and bonds slid as the former chief economist of the International Monetary Fund refocused investors on the fundamental constraints facing Asia’s third-biggest economy.
“Macroeconomic imbalances such as high inflation and the current-account deficit still remain, and they won’t go away unless we address the structural issues,” said Gaurav Kapur, a senior economist at Royal Bank of Scotland Group Plc in Mumbai. “The government has taken measures over the last year but a lot remains to be done.”
The rupee, which has appreciated 5.5 percent this month, weakened 0.8 percent to 62.2775 per dollar at the close in Mumbai Friday. It’s down about 12 percent this year. The yield on the 7.16 percent government bond due May 2023 rose to 8.58 percent from 8.19 percent a day earlier. The S&P BSE Sensex index slid 1.9 percent.
Rajan, who became central bank governor two weeks ago, boosted the repurchase rate in his first policy review by a quarter point to 7.5 percent, the first increase since 2011, a Reserve Bank of India statement showed Friday. All 36 analysts in a Bloomberg News survey predicted no change.
At the same time, he relaxed liquidity curbs in the banking system by cutting the marginal standing facility rate to 9.5 percent from 10.25 percent and lowering the daily balance requirement for the cash reserve ratio to 95 percent from 99 percent, effective Sept. 21. The bank rate was reduced to 9.5 percent from 10.25 percent.
The steps start the process of a “cautious unwinding” of exceptional measures taken since July to reduce exchange-rate volatility, the central bank said. They also intend to address inflation risks to mitigate pressure on the rupee and create conditions for revitalizing expansion.
“We want to fight against inflation and we’ll bring inflation down,” Rajan told reporters Friday in Mumbai, adding that the goal is to slow wholesale-price inflation to below 5 percent. The gauge rose 6.1 percent in August from a year earlier.
India’s record current-account deficit and consumer-price inflation exceeding 9 percent left it vulnerable to the capital flight from emerging markets triggered by earlier concern that the U.S. would taper monetary stimulus as early as this month. The rupee sank to a record low in August.
The Fed buoyed stocks and currencies from India to Turkey by postponing the rollback of $85 billion in monthly bond purchases that boosted the cash circulating in the global economy.
“If we are stabilized, we are better prepared for the tapering whenever it happens,” Rajan said. “What we need to do is put our house in order before it comes back.”
Singh, in power since 2004, faces elections by May. The main opposition Bharatiya Janata Party is set to make gains in state polls this year in one of the final tests for the parties before the national vote, according to a survey by the Times Now TV channel and C-voter, a polling firm.
Singh’s government has been beset by graft scandals and trade and budget imbalances that have put India’s investment-grade credit rating at risk.