India Lifts Banks' Reserve Limit to Curb Inflation

India's central bank unexpectedly ordered lenders to set aside larger reserves for the third time in a year to remove excess money that may stoke inflation.

Reserve Bank of India Governor Yaga Venugopal Reddy will lift the cash reserve ratio, or the proportion of cash commercial banks must put aside against deposits, to 7 percent from 6.5 percent. The Mumbai-based central bank today also held its benchmark interest rate at a five-year high of 7.75 percent.

Reddy's move comes a day after China's government curbed bank lending for a sixth time this year. The world's two fastest growing major economies are both struggling to prevent floods of cash from fueling asset bubbles and fanning inflation.

``It's a similar problem of excess liquidity in both China and India,'' said Ramya Suryanarayanan, an economist at DBS Bank Ltd. in Singapore. ``The difference is that India is using currency appreciation as well to curb inflation. We will see more cash reserve ratio hikes in India.''

Interest rates in India's call market have stayed near zero for three weeks as the central bank stepped up dollar purchases to prevent the local currency from advancing from a nine-year high. In the process, it injected rupees faster than it could mop up. A stronger rupee may hurt exports, which make up a third of India's $854 billion economy.

`Upward Pressures'

Capital inflows are increasing as foreign investors are buying more stocks in India, encouraged by unprecedented economic growth since 2003. Overseas funds have bought a record $10.4 billion stocks and bonds in India this year, surpassing the net $8.87 billion in stocks and bonds bought in 2006 and $9.46 billion in 2005. India's benchmark Sensitive index has more than tripled in the past three years.

``Surges in capital inflows and large changes in liquidity conditions are obscuring an accurate assessment of risks,'' the central bank said in today's statement. ``It is necessary to note that while there is an abatement of inflation in the recent period, upward pressures persist.''

Additions to foreign-currency reserves, which are an indication of the Reserve Bank's dollar purchases, rose $8.7 billion this month after a $5.1 billion increase in June. Dollar purchases in March and April were $2.3 billion and $2.1 billion respectively, according to the central bank.

The central bank today also scrapped the 30 billion rupees ($740 million) cap on funds it will absorb each day from lenders through its reverse-repurchase auction. The limit spurred banks with spare cash to lend more in the money market, making borrowing cheaper. The cap will be lifted effective Aug. 6, while the increase in the cash reserve ratio takes effect Aug. 4.

Excess Cash

China also has excess cash from record trade surpluses that threatens to fuel inflation, create asset bubbles and overcapacity in manufacturing. China yesterday ordered banks to set aside 12 percent of deposits as services to curb lending and investment after the economy grew at the fastest pace since 1994. China is under pressure from trade partners, particularly the U.S., to allow faster appreciation of the yuan to slow the inflow of money from exports.

India's central bank in April twice raised the limit on the sale of so-called market stabilization bonds, used to drain surplus cash.

Debt outstanding from the sale of the stabilization bonds reached about 890 billion rupees as on July 27, according to estimates by JPMorgan Chase & Co. The debt outstanding must reach 950 billion rupees before the government and the central bank can review the limit of 1.1 trillion rupees on such sales.

Stronger Currency

To tame inflation, the central bank also increased its key repurchase rate six times in the past 18 months and slowed dollar purchases to strengthen the rupee and make imports cheaper. The rupee has gained 9.4 percent this year, making it the best performer among the 10 most traded Asian currencies.

India's benchmark wholesale price inflation rate, which reached a two-year high of 6.7 percent in January, was 4.41 percent in the week ended July 14. Loans to consumers and companies grew 24.3 percent in the year to July 6 compared with a 31 percent gain in the same period last year, the central bank said July 27.

``Managing the rising quantum of capital flows without stoking inflation and containing the rupee's appreciation, are likely to be the central bank's foremost priority for rest of this year,'' said Gaurav Kapur, senior economist at ABN Amro Bank N. V. in Mumbai. ``Its actions on this front will have repercussions for the economy.''

Interest Rates

Higher interest rates are hurting companies such as carmaker Hero Honda Motors Ltd., while gains in the rupee are curbing earnings at the country's largest software makers such as Infosys Technologies Ltd. and Wipro Ltd. The government estimates growth may slow to around 8.5 percent in the current year to March 31 from 9.4 percent in the previous year.

``No company will be able to manage that kind of rupee appreciation in such short a time,'' said Suresh Senapaty, chief financial officer at Wipro , India's third-largest computer- services provider.

Wipro last quarter posted the slowest profit growth in more than two years after the rupee's appreciation eroded earnings. Its larger rival Infosys Technologies this month cut its profit and sales forecasts for the year. Mahindra & Mahindra Ltd., India's biggest maker of tractors and sport-utility vehicle, yesterday reported its lowest profit in more than a year as it struggled to overcome higher interest rates.

source:bloomberg.com