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Indian central bank Governor Duvvuri Subbarao prepared investors for higher interest rates in coming months, shifting policy focus toward stemming inflation as the world emerges from the worst recession since the 1930s.

Subbarao yesterday said “it may be appropriate to sequence the ‘exit’ in a calibrated way” from record monetary stimulus, and told banks to set aside more cash in government bonds to restrain credit. The Reserve Bank of India also told lenders to hold more funds as provisions for loans to property companies.

Central bank watchers said policy makers may start raising rates at or before their next quarterly meeting, in January. India’s announcement underscored evidence of a strengthening rebound across Asia, with China projecting an acceleration in industrial production yesterday and the Bank of Japan saying the economy is improving in all of the nation’s nine areas.

“It’s absolutely critical that the monetary stimulus is withdrawn in an orderly way to curb inflation without upsetting economic growth” in India, said D. H. Pai Panandiker, president of RPG Foundation, an economic policy group in New Delhi. “Inflation is like a tax on the poor.”

Stocks from India to China dropped yesterday amid concern among some investors about policy makers’ steps to reverse stimulus measures. The Bombay Stock Exchange’s Sensitive Index fell 2.3 percent, the most in two months. The Shanghai Composite Index slid 2.8 percent.

Earnings Momentum

The Reserve Bank of India’s injection of 5.85 trillion rupees ($130 billion) of cash since September 2008 to sustain credit to companies and households has paid off. Companies from automobile makers Tata Motors Ltd. and Maruti Suzuki India Ltd. to home appliance firm Whirlpool of India Ltd. reported rising demand in recent weeks.

Maruti, the New Delhi-based maker of half the cars sold in India, reported that profit almost doubled last quarter on higher consumer spending. Sales at Mumbai-based Tata Motors, India’s largest truckmaker, rose in the three months through September, the longest-winning streak in at least two years, helped by a decline in auto-loan rates and increased spending by the government spurred.

Whirlpool of India, which has headquarters in New Delhi, this week said its second-quarter earnings were the highest on record.

‘Central Issue’

Now, draining the central bank’s liquidity injections has become a “central issue in our policy matrix,” Subbarao, a 60- year-old former top Finance Ministry bureaucrat who was appointed governor for a three-year term in September 2008, said yesterday. There are “definitive” signs that the economy is recovering, he said.

India’s industrial production rose 10.4 percent in August, the most in 22 months after the government announced tax cuts and the central bank cut rates and injected cash into banks since September last year. Cumulatively, the stimulus added up to more than 12 percent of the economy.

Subbarao, a career civil servant who studied under a fellowship at the Massachusetts Institute of Technology, said prospects for Indian industry are rising. The revival in Indian stock and global financial markets will spur investment, he said, maintaining a growth forecast for India’s $1 payday advance.2 trillion economy at 6 percent “with an upward bias.”

He raised the inflation estimate to 6.5 percent from 5 percent by March 31. The benchmark wholesale inflation rate was 1.21 percent in the week ending Oct. 10, a sixth straight gain.

‘Nervous’ Markets

“Inflation pressures are mounting,” said Dariusz Kowalczyk, chief investment strategist at SJS Markets Ltd. in Hong Kong. “Markets are nervous that the stimulus will be taken away — much of the gains in stocks and other assets were driven by the liquidity from the stimulus.”

The Sensitive Index is up 70 percent this year, outpacing the MSCI World Index’s 34 percent advance in the same period. Elsewhere in Asia, the Shanghai Composite Index has climbed 66 percent and Hong Kong’s Hang Seng 54 percent over the same period, contributing to concerns that asset-price bubbles will threaten to roil economies in the region.

The Reserve Bank of Australia raised rates three weeks ago, citing costlier real estate, and Bank of Korea Governor Lee Seong Tae said Oct. 23 that keeping rates at a record low may not be healthy for the economy. Regulators from Hong Kong to Singapore to South Korea have also told banks in recent weeks that they need to tighten lending standards.

In Europe, Norway’s Norges Bank may become that continent’s first central bank to increase interest rates today, according to the median forecast in a Bloomberg News survey.

Policy Rates

The RBI kept its policy rates unchanged yesterday, with the reverse repurchase rate at 3.25 percent, the repurchase rate at 4.75 percent and the cash reserve ratio at 5 percent, in line with the median forecast of 24 economists surveyed by Bloomberg News.

“By revising the inflation target, the RBI has clearly highlighted that inflation will be an area of concern going forward,” said Yashika Singh, a Mumbai-based economist at Dun & Bradstreet Information Services India Ltd. Singh expects the central bank to rely on higher cash reserve ratio to contain inflation before raising interest rates. She expects a 25 basis point increase in the reserve ratio in December.

Goldman Sachs Group Inc. predicted a reverse-repurchase rate increase at the January meeting, and recommended that investors buy the rupee against the dollar. India’s currency will appreciate to a projected 44 per dollar in three months and 43.4 in six months, according to the note by Goldman Sachs economist Tushar Poddar sent to clients yesterday.

The rupee closed at 46.925 yesterday in Mumbai.

With yesterday’s move, Indian banks will be required to hold 25 percent of their deposits in government bonds, up from 24 percent previously. That won’t affect their ability to lend because most have holdings amounting to 27.6 percent, Subbarao said. Bonds climbed the most in more than a month yesterday.

“The economy is on a comeback track,” Finance Secretary Ashok Chawla said in New Delhi yesterday. “At this stage, the central bank’s done what it needs to contain inflation and support growth.”

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