May 27, 2024

India Raises Interest Rates to Battle Inflation

MUMBAI — In a bid to rein in persistently high inflation, India’s central bank raised interest rates Tuesday more than analysts had expected and signaled that it would be willing to raise borrowing costs even further.

The action, which caused the country’s stock market to close 2.4 percent lower, will make it harder for India to achieve the 9 percent growth target set by the government for the current financial year, which ends in March 2012.

The central bank, the Reserve Bank of India, acknowledged that concern but said it had to act to make sure the economy did not suffer long-term damage from rising prices; the central bank said it expected the economy to grow 8 percent, down from 8.6 percent in the previous year.

That slower growth will make it harder for India, the second fastest growing major economy in the world, behind China, to pull hundreds of millions of people out of poverty. And it will most likely exacerbate the Indian government’s already large fiscal deficit.

India has been struggling to control rising prices over the past year, especially for food and energy. But in recent months the cost of other goods has also jumped, raising concern that the Indian economy is overheating. In March, the country’s benchmark wholesale price index jumped 9 percent and a consumer price index for industrial workers was up 8.8 percent.

On Tuesday, the bank raised its repo rate at which it lends money to banks one-half percentage point, to 7.25 percent. Most analysts had expected an increase of 0.25 point, which would have been in keeping the modest increases the central bank has been making in the past year. The central bank also raised rates on bank savings accounts by one-half point, to 4 percent.

Including the most recent increase, the central bank has raised the repo rate 4 percentage points in the past year. The governor of the central bank, Duvvuri Subbarao, said the bank was willing to risk slowing the economy in the short run to prevent inflation from damaging the longer-term prospects for growth.

“Current elevated rates of inflation pose significant risks to future growth,” Mr. Subbarao said in a statement. “Bringing them down, therefore, even at the cost of some growth in the short-run, should take precedence.”

Even before this most recent interest rate increase, India’s economy had been slowing down in recent months because of a drop in private investment by domestic and foreign companies. Now, analysts say they expect growth to slow faster, even as inflation remains high.“In the near term, it’s going to be a difficult adjustment for the economy,” said Sonal Varma, an economist at Nomura Securities in Mumbai. “That is the sacrifice that the R.B.I. is making.”

The central bank’s more aggressive stance on inflation will most likely increase pressure on the government to implement structural policy changes and increase investment in infrastructure.

For instance, Indian officials have long discussed changes to improve productivity and reduce waste in its agricultural sector, where more than half of its people work. But the government has been reluctant to implement many of those changes because they are politically unpalatable.

“There are a whole gamut of administrative measures that are needed to bring down structural inefficiencies in the system to bring down inflation,” said Samiran Chakraborty, head of research at Standard Chartered Bank in Mumbai. “As long as those measures are not taken, monetary policy has to do double duty.”

Separately, the central bank announced new rules for the country’s troubled microfinance companies, which saw a sharp drop in loan repayment rates in a large south Indian state last year after politicians accused lenders of driving some borrowers to suicide. The central bank imposed an interest rate cap of 26 percent on new micro loans and limited loans to no more than 50,000 rupees ($1,125) per family. The rules also allow borrowers to choose how they want to repay loans – weekly, every two weeks or monthly.

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