RBI may hold interest rates even if rupee fall impacts inflation

NEW DELHI, Nov 24 (Reuters): The sharp slide in the Indian rupee, Asia's worst performing currency, will add slightly to inflation by raising the cost of imported goods, but that may not be enough to prompt the Reserve Bank of India (RBI) to raise interest rates at its December policy review. The rupee has slid more than 14 per cent this year against the US dollar, with most of the losses coming in the last three months, as investors cut exposure to riskier assets amid Europe's raging debt crisis, fears of a global recession and signs of a domestic economic slowdown. Strains on India's current account balance and the fiscal deficit have heaped further pressure on the rupee, with a poll this week showing investors have turned the most pessimistic on the currency in more than three years. Much of the inflationary pressure from a falling rupee comes from crude oil, which makes up a third of India's total import bill. But the resulting impact may only add between 20 and 50 base points to headline inflation, economists say. That would be something that policymakers could live with, given worries that 13 rate hikes since March 2010 are now hurting growth even as global demand sputters. As far as the current cycle of tightening is concerned, I think we are done for now," said Shubhda Rao, chief economist with Yes Bank. Yes Bank says headline inflation will fall from December to about 7 per cent by end-March, in line with forecasts from the Reserve Bank of India. Inflation in October was stronger than expected, remaining above 9 per cent for the 11th straight month. "I do not completely rule out inflation breaching the double-digit mark in November but I think the base effect will come into play in December and we would expect inflation to trend down after that," Rao said. A senior finance ministry source said Wednesday that the rupee could stay in the region of 50 to a dollar for three months, indicating that inflation from commodity exports could continue to add pressure to prices. Others say that with the Indian economy showing definite signs of fatigue, the risks to growth for Asia's third-largest economy will be the key criterion that will shape RBI's policy response. "I expect RBI to pause in December because in deciding its monetary stance it would be more guided by risks to growth and other macro factors", said N Bhanumurthy, economist with National Institute of Public Finance and Policy, a Delhi-based policy think tank. While more than a dozen rate hikes have failed to cool price pressures, largely because of domestic constraints such as poor infrastructure and an addiction to subsidies, economic growth has definitely started to suffer as credit conditions tightened.