India Raises Banks' Reserve Limit to Curb Inflation

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July 31 (Bloomberg) -- India's central bank unexpectedly ordered banks to curb lending and investment for the third time this year to soak up cash and keep a lid on inflation.

Lenders must put aside 7 percent of deposits as reserves starting Aug. 4, up from 6.5 percent, the Reserve Bank of India said in a statement in Mumbai today. The central bank also held its benchmark interest rate at a five-year high of 7.75 percent.

India joins China in restricting bank lending this week as the world's two fastest-growing major economies struggle to prevent floods of cash from fueling asset bubbles and inflation. The central bank's purchases of dollars have also added funds to the banking system as it strives to curb gains in the rupee that may hit exports, which account for a third of India's economy.

``It's a similar problem of excess liquidity in both China and India,'' said Ramya Suryanarayanan, an economist at DBS Bank Ltd. in Singapore. ``We will see more cash reserve ratio hikes in India.''

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.

Wholesale prices in India rose 4.41 percent in the week ended July 14 from a year earlier, staying below the central bank's 5 percent inflation target for the eighth straight week. 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.

Bonds Fall

Indian bonds fell to the lowest in two weeks on concern the central bank's measures will leave less money to buy fixed- income securities. The yield on the benchmark 10-year government bond rose 6 basis points to 7.01 percent as of 1:30 p.m. in Mumbai. The rupee extended gains by 0.1 percent to 40.39 against the dollar after the announcement.

``The cash reserve increase will take away about 150 billion rupees from the banking system,'' said Mahendra Jajoo, who manages the equivalent of $2 billion in Indian debt at ABN Amro Asset in Mumbai.

Interest rates in India's call market have stayed near zero percent for three weeks as the central bank stepped up dollar purchases to prevent the local currency advancing from a nine- year high. In the process, it injected rupees faster than it could mop up.

`Upward Pressures'

Capital inflows are increasing as foreign investors buy more stocks in India, encouraged by unprecedented economic growth since 2003. Overseas funds have bought a record $10.4 billion stocks and bonds this year, helping the benchmark Sensitive index more than triple 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.

Asset Bubbles

China also has excess cash from record trade surpluses that threatens to fuel inflation and create asset bubbles. China yesterday ordered banks to set aside 12 percent of deposits 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 yuan gains to slow the inflow of money from exports.

``The difference between India and China is that India is using currency appreciation as well to curb inflation,'' said DBS economist Suryanarayanan.

The rupee has gained 9.4 percent this year, making it the best performer among the 10 most-traded Asian currencies. That's made imports cheaper. India's central bank has also increased its key repurchase rate six times in the past 18 months.

``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 the 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.''

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 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.