Mumbai: India’s weakest monsoon since 2009 is poised to fuel the worst inflation among the largest emerging markets and leading banks from Goldman Sachs Group Inc. to Nomura Holdings Inc. to cut forecasts for interest-rate cuts.
Goldman Sachs now predicts the Reserve Bank of India will lower its repurchase rate by 25 basis points to 7.75 per cent by year-end, after paring an earlier estimate for a 75 basis point decrease last week. Morgan Stanley has scaled back its easing expectation to 50 basis points from 75, while Nomura sees no decline this year, after discarding a projection for a quarter percentage point drop.
Governor Duvvuri Subbarao left the repo rate unchanged and raised the RBI’s inflation forecast on July 31, as more than 50 per cent of India faced the threat of a drought because of below- average rainfall. India’s benchmark price index rose more than 7 per cent for a fifth month in June, boosting living costs in the country where about two-thirds of the population live on less than $2 a day. Similar gauges climbed 4.9 per cent in Brazil, 2.2 per cent in China and 4.3 per cent in Russia last month.
“India’s inflation outlook is becoming more challenging as poor monsoons mean further acceleration in food prices,” Chetan Ahya, a Hong Kong-based economist at Morgan Stanley, said in an interview on August 2. “There is limited room for easing policy as inflation will persist above the central bank’s comfort zone for longer.”
The cost to lock in borrowing costs for a year using interest-rate swaps has climbed 27 basis points from a 14-month low in June to 7.75 per cent in India, data compiled by Bloomberg show. Similar contracts fell 34 basis points in Brazil to 7.37 per cent.
India’s monsoon, which accounts for more than 70 per cent of the country’s total rainfall, may measure only 85 per cent of a 50-year average in 2012, L.S. Rathore, director general of the India Meteorological Department, told reporters in New Delhi on August 3. “There may be major negative implications” for India’s farm output if rains don’t improve, the World Bank said in a report on July 30.
The Reserve Bank raised last week its inflation forecast for the year through March 2013 to 7 per cent from 6.5 per cent, citing inflation risks fueled by inadequate rainfall. It also scaled back its estimate for economic expansion to 6.5 per cent from 7.3 per cent.
Subbarao boosted the repurchase rate by a record 375 basis points through 2010 and 2011 to slow price gains, before cutting it by 50 basis points to 8 per cent in April to support a slowing economy. The rate has been kept unchanged since then.
“The primary focus of monetary policy remains inflation control in order to secure a sustainable growth path over the medium term,” the central bank said July 31. “Lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth. As the multiple constraints to growth are addressed, the Reserve Bank will stand ready to act appropriately.”
Emerging-market central banks from Brazil to China and South Korea reduced borrowing costs last month to shield their economies from the impact of Europe’s debt crisis. On July 31, the RBI lowered the proportion of deposits Indian lenders are required to invest in fixed-income securities by 1 percentage point to 23 per cent to free up funds for lending and counter the economic slowdown.
Food, Fuel Prices
Higher food prices and rising fuel costs will stoke price pressures in India in the coming months, reducing scope for Subbarao to loosen policy, according to New York-based Goldman Sachs, the fifth-biggest U.S. bank by assets.
Indian Oil Corp., the nation’s biggest refiner raised gasoline prices July 23 for the first time in two months. Chakravarthy Rangarajan, chief economic adviser to Prime Minister Singh, said on July 20 that he hopes the government will increase diesel prices “as early as possible.”
“We expect weak monsoons to have a significant impact on food prices and keep them elevated in the near term,” said Tushar Poddar, a Mumbai-based economist at Goldman Sachs. “Any hike in domestic administered prices of fuel will likely put upward pressures on the fuel component of the wholesale-price index. With headline inflation remaining high, it would be difficult for the RBI to ease over the next few months.”
A deepening slowdown in Asia’s third-largest economy will temper the pace of price increases and increase pressure on policy makers to lower interest rates toward the end of the year, according to Mizuho Corporate Bank Ltd. Gross domestic product rose 5.3 per cent in the first quarter of 2012, the slowest pace in almost a decade, according to the most recent government data.
“Unequivocal policy easing is likely by year-end,” said Vishnu Varathan, a Singapore-based economist at Mizuho Corporate Bank, said in an interview on August 3. “In an economic down- cycle, pressures on growth due to negative demand shocks will more than offset inflationary pressures.”
Varathan predicts the RBI to reduce the repo rate to 7.5 per cent by December 31.
The yield on benchmark 10-year sovereign bonds jumped 14 basis points to 8.26 per cent last week as the RBI held the highest interest rates among Asia’s major economies. DSP Blackrock Investment Managers Ltd., the local unit of the world’s biggest money manager, sees it climbing to 8.4 per cent in three months on the risk of faster inflation.
The extra yield on India’s 10-year bonds over similar- maturity US Treasuries widened 17 basis points this quarter to 671. Rupee-denominated sovereign notes returned 5.7 per cent this year, trailing the 7.1 per cent earned by Indonesian securities in the region’s best performance, HSBC Holdings Plc indexes show. The rupee gained 0.4 percent to 55.525 a dollar today.
The cost of insuring the debt of government-controlled State Bank of India, a proxy for the nation, has climbed 40 basis points from this year’s low of 280 in February, according to data provider CMA. The average price of credit-default swaps for Asia’s 10 biggest economies dropped five basis points to 141 in the period.
“A drought would lower agriculture production and thus increase downside risk to growth,” said Sonal Varma, economist at Nomura Holdings Inc. in Mumbai. “Yet with WPI inflation above 7 percent, there is very limited room for aggressive rate cuts to kick-start the economy. If food prices rise as they did in 2009, then the RBI would be forced to stay put.”