Rupee decline fans inflation risk

Mumbai: India's sliding rupee, the worst performing major Asian currency in the past year, threatens to fuel inflation and limit room to revive an economy where growth probably slowed to levels last seen in the 2008 global crisis.

The rupee is down 18.1 per cent against the dollar in the past 12 months, the most in a basket of 11 Asian currencies tracked by Bloomberg that shows a 3.2 per cent climb in Japan's yen and a 2.4 per cent advance in China's yuan.

Gross domestic product (GDP) rose 6.7 per cent in the year ended March, matching the pace of growth in the 12 months through March 2009, the median estimate in a Bloomberg News survey shows before a May 31 report.

Investors have pared bets on further cuts in borrowing costs by Reserve Bank of India Governor Duvvuri Subbarao after the first reduction last month since 2009.

The cost of locking in interest rates for one year has climbed 16 basis points since April 17, when the central bank lowered its repurchase rate by 0.5 percentage point to 8 per cent while flagging price pressures from the rupee, the fiscal deficit and energy costs.

Inflation unexpectedly quickened to 7.23 per cent last month.

Disappointing growth

"India is likely to see disappointing growth in the coming quarters, and it seems growth may not exceed 7 per cent for the next two-to-three years," Dariusz Kowalczyk, a Hong Kong- based strategist at Credit Agricole CIB, said.

"The central bank doesn't have much room to break the vicious cycle of a weak currency causing high inflation."

Subbarao pledged last week to take steps as needed to curb swings in the rupee, helping it recover from a record low of 56.3875 per dollar on May 24. The currency closed 0.5 per cent stronger on May 25 at 55.375 per dollar.

Rupee weakness threatens to boost the cost of imports such as crude oil, intensifying price pressures in a nation already grappling with the fastest inflation among the biggest emerging markets. State refiners, including Indian Oil Corp., raised gasoline prices by 11 per cent to Rs73.18 (Dh4.87) a litre in New Delhi on May 24.

While growth has slowed in countries from Brazil to China as Europe's debt crisis saps global expansion, domestic risks are also weighing on India's outlook, contributing to a near 10 per cent decline in the BSE India Sensitive Index of stocks in the past year.

Faltering efforts to liberalise the economy and uncertainty over tax changes in March's budget are among the challenges, deterring investment from abroad. Prime Minister Manmohan Singh is also grappling with a record trade deficit and the widest budget shortfall in the so-called Bric group of major emerging nations that also includes Brazil, Russia and China.

Investors pull out

International investors have pulled about $274 million (Dh1.01 billion) from India's local-currency bonds since the April 17 rate cut. The yield on benchmark ten-year sovereign debt rose 17 basis points in the period to 8.51 per cent, and the extra yield on the notes over US Treasuries widened 39 basis points to 676, according to data compiled by Bloomberg.

The cost of locking in interest rates for one year rose four basis points, or 0.04 percentage point, to 8.02 per cent last week.

"What is ailing India is a lack of policies that would have opened the capacity of the economy and put India on the global map," Arun Singh, a Mumbai-based economist at Dun & Bradstreet Information Services India Pvt, said in an interview on Friday.

"Growth will remain sluggish."

Citigroup Inc said last week that "there is now near consensus that the India story has de-rated." Goldman Sachs Group Inc downgraded its growth forecast for the country on Friday, predicting a 6.6 per cent GDP increase this fiscal year, down from an earlier estimate of 7.2 per cent.

The Reserve Bank of India will probably be unable to lower borrowing costs until October-to-December, Goldman said. Tushar Poddar, an economist at the company in Mumbai, wrote in a note to clients that the RBI will now likely lower interest rates by half a percentage point in the final three months of 2012, compared with the 75 basis points previously forecast.

Bloomberg