RBI may let Re rise to temper inflation

The Reserve Bank of India may allow the rupee to appreciate to temper prices, joining central banks across Asia, as the global rally in commodities stokes inflation, economists said.

Fighting inflation with the exchange rate may bolster measures announced by Prime Minister Manmohan Singh's government after an emergency cabinet meeting last night. India scrapped import duty on crude edible oil and banned the export of rice and pulses to augment local stocks.

Prices rising at the fastest pace in 13 months may harm the ruling coalition's chances of retaining power in elections scheduled before May 2009.

The rupee's 12.3 per cent advance last year, the best since at least 1974, helped the central bank curb inflation to a five- year low in October. A stronger currency may lower the cost of imports into India, the world's biggest buyer of vegetable oils after China. Asia's third biggest economy also depends on crude oil from overseas to meet three-fourths of its energy needs.

"At this stage, the Reserve Bank of India and the government may be more willing to let the rupee appreciate as a means of controlling inflation,'' said Robert Prior-Wandesforde, an economist at HSBC Group in Singapore. "It's more effective in our view, than raising interest rates.''

Central banks in Indonesia, Thailand and the Philippines may also let their currencies strengthen to combat inflation as food and energy prices soar, UBS and JPMorgan Chase said yesterday. The three countries will seek currency gains rather than raise interest rates as higher borrowing costs will crimp economic growth, the banks said.

'Unacceptably High'
India's currency may appreciate to 39.5 against the dollar by the end of this year and to 37.5 by the middle of 2009, Prior-Wandesforde said. The rupee, which has weakened 1.7 per cent this year, traded at 40.125 yesterday. The currency market is closed today for year-end book-keeping by banks.

The government also curbed exports of wheat and banned futures trading in some commodities. Last week, the government scrapped a tax benefit on exports of steel and cement to bolster domestic supplies.

Inflation is unacceptably high because of a spurt in the global prices of food, fuel and metals, Reserve Bank of India Governor Yaga Venugopal Reddy said in Mumbai yesterday. The central bank is ready to take steps to contain inflation after assessing the situation, Reddy said.

Palm oil prices rose 49 per cent in the past year, reaching a record last month, and wheat in Chicago has almost doubled during the same period to an all-time high of $13.495 a bushel on February 27. Crude oil gained 5.8 per cent in the first quarter and is up 54 per cent from a year ago.

Exporters' Concern
"The rupee appreciation is likely to be used to reduce the imported content of inflation to an extent, but a sharp appreciation is unlikely given exporters' concern,'' said Sonal Varma, a Mumbai-based economist at Lehman Brothers.

A stronger rupee makes exports more expensive to customers abroad, while eroding the earnings of companies when they repatriate their overseas income.

The central bank has kept its benchmark interest rate near a six-year high over the past year to contain price gains. Reddy has raised the central bank's policy rate nine times since October 2004 and ordered lenders to set aside more money as reserves five times since December 2006 to contain inflation. The Reserve Bank will meet at the end of this month to review the borrowing costs.

Tight policy
"The Reserve Bank is likely to maintain its tight policy stance for an extended period to keep inflation expectations well anchored,'' said Varma, who expects the central bank to reduce its rate in October rather than its July quarterly review.

India may settle for slower growth in its fight against inflation, Finance Minister Palaniappan Chidambaram said on March 28. Expansion may slow to 8.7 per cent in the fiscal year that ended yesterday, from 9.6 per cent, the fastest pace since 1989, according to government estimates.

"If growth is coming in the way of inflation, the government will choose to live with little less growth than higher inflation,'' said Dharmakirti Joshi, an economist at Mumbai-based Crisil, the local unit of Standard & Poor's. "The Reserve Bank may not cut rates anytime soon.'' Chidambaram expects the $906 billion economy to grow at about 8 per cent in the 12 months starting today, the weakest pace since 2005.

The government may also relax restrictions on overseas borrowings by companies, particularly if the rupee continues to soften, HSBC's Prior-Wandesforde said.

The cabinet yesterday banned the export of non-basmati rice and extended a ban on the export of pulses, which was ending yesterday, for one more year. It also scrapped the import duty on maize from 15 per cent under the tariff rate quota.