India Unexpectedly Appoints Subbarao as Bank Governor

Sept. 1 (Bloomberg) -- India unexpectedly appointed Duvvuri Subbarao as governor of the central bank, putting in place an economist who called raising rates the ``obvious'' choice to tackle the fastest inflation since 1992.

Finance Secretary Subbarao, 59, will serve for three years, replacing Yaga Venugopal Reddy, 67, whose term ends on Sept. 5, Finance Minister P. Chidambaram told reporters in New Delhi today. Eight of 10 economists surveyed by Bloomberg News expected the government to extend Reddy's term because of his decade-long experience at the Reserve Bank of India.

Subbarao may have to follow Reddy's four-year-old policy of raising borrowing costs as inflation has shown few signs of easing. Subbarao said on July 28, a day before Reddy's last monetary policy, that raising interest rates was the ``obvious'' solution to curb rising prices, a month after calling monetary policy ``the first line of defense'' against inflation.

``There has to be a continuation of the monetary policy,'' said Sonal Varma, a Mumbai-based economist at Lehman Brothers Inc. ``Moderating inflation has to be the new governor's top priority followed by ensuring growth.''

Reddy has been raising borrowing costs since 2004 to prevent the world's fastest growing major economy after China from overheating. Still, inflation in India surged to 12.63 percent last month after the government raised fuel costs to reduce its subsidy burden. That was the biggest gain in prices since the South Asian nation started to open its economy to foreign investors in the early 1990s.

`Big Challenge'

``That's the big challenge for any central bank governor in India -- it's hard to figure out when a sudden price spurt hits the economy,'' N. R. Bhanumurthy, an economist at Institute of Economic Growth in New Delhi, said before the announcement.

Subbarao, who was an economic adviser to Prime Minister Manmohan Singh before he became the top bureaucrat in the finance ministry, is an engineering graduate from the elite Indian Institute of Technology. He joined the civil service and was later deputed to the World Bank, where he was the lead economist between 1999 and 2004 on issue of public finance in Africa and East Asia.

Subbarao has a masters in Economics from Ohio State University and was a Humphrey Fellow at the Massachussetts Institute of Technology. He holds a doctorate from Andhra University.

Soviet-Style

India practices Soviet-style price controls, subsidizing oil and ordering cement and steel companies to keep prices unchanged even as costs go up globally.

That complicates monetary policy, because it makes the economy vulnerable to unpredictable price shocks, as happened in June when the government was forced to cut fuel subsidies to protect refiners from going bankrupt after oil prices surged.

India's inflation rate jumped to more than 12 percent from 8.75 percent in three months, forcing Reddy to raise the central bank's key repurchase rate by 125 basis points to 9 percent.

Cumulatively, Reddy has increased the repurchase rate by 300 basis points since October 2004. He also raised the cash reserve ratio, or the proportion of funds that lenders need to set aside as reserves, by 400 basis points to 9 percent, since December 2006 to check money supply from stoking inflation.

The repurchase rate will climb to between 9.25 percent and 9.5 percent by the end of October, according to eight of 12 economists surveyed by Bloomberg News after the last monetary policy announcement on July 29.

`Little Scope'

``There is little scope for an easing of monetary policy now,'' said D.H. Pai Panandiker, president of RPG Foundation, an independent research group. ``Growth may suffer in the near term, but there is a lot of liquidity in the system that could be potentially inflationary.''

Government expenditure not been included in the budget, such as the $17 billion farm loan waiver, has risen to 5 percent of gross domestic product, and can stimulate consumer demand and fan inflation, Chakravarthi Rangarajan, a former central bank governor, said before the announcement.

Inflation can win or lose elections in India, where more than half the population of 1.1 billion people live on less than $2 a day.

Singh, who announced a 21 percent salary increase for about 5 million government employees last month, is reaching out to voters with pre-election handouts after losing ground in nine of the 11 state polls since January 2007 because of rising prices.

To contact the reporters on this story: Cherian Thomas in New Delhi at cthomas1@bloomberg.net;