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India's government, facing slowing economic growth and runaway inflation, should limit cash available to banks to lend instead of raising interest rates, former central bank governor Bimal Jalan said.

“In this kind of a situation, when there is a great emergency, I don't think it is the rate of interest that is the answer because of the delay in transmission,'' Jalan, 67, said in an interview from New Delhi. “It would be much more the liquidity side.''

India this week is holding the biggest sale of bonds and bills since January to slow the supply of money in the financial system. Bond yields rose to an eight-month high today on expectations the Reserve Bank of India will increase the amount of cash banks must hold in reserve to the most since 2001.

Economists including Goldman Sachs Group Inc. have said Governor Yaga Venugopal Reddy will raise rates for the first time in more than a year to rein in inflation from a three-year high. Growth in money supply, which stokes prices, averaged near a decade-high in the past year as the fastest economic growth since independence in 1947 boosted consumption.

`Firefighting'

“The government appears to be in a firefighting mode now and would want immediate results on inflation control,'' said Prasanna Ananthasubramaniam, a fixed-income analyst in Mumbai at ICICI Securities Ltd. “The central bank may raise the cash reserve ratio this month as persistently higher inflation numbers are feeding price expectations.''

Reddy raised key policy rates nine times since 2004 and the cash reserve ratio, or the proportion of deposits banks need to hold in reserve, five times since December 2006. He kept the repurchase rate unchanged at 7.75 percent, the highest since 2002, and the cash ratio at a seven-year high of 7.5 percent of at the last monetary policy meeting on Jan. 29. The next statement is scheduled for April 29.

Wholesale price gains in Asia's third-largest economy accelerated to 7 percent, the fastest since December 2004, in the week ended March 22, a government report showed on April 4. Inflation has outpaced the central bank's 5 percent target level since February. Growth in money supply has exceeded the bank's target for a year.

Containing Inflation

Prime Minister Manmohan Singh yesterday pledged to take all measures to contain inflation, two days after the government said it would crack down on hoarders of food and essential commodities. The government needs to keep food affordable to shore up support before general elections within 13 months.

“We are all concerned,'' Singh said in New Delhi cash advance. “Whatever more can be done, will be done.''

India may settle for less growth in its fight against inflation, Finance Minister Palaniappan Chidambaram said March 28. He expects the $906 billion economy to expand at about 8 percent in the year starting April 1, the slowest since 2005. Economic growth has averaged 8.7 percent since 2003, the fastest after China among major economies.

“Whether the rate of growth is 8 percent, 9 or 7.5 percent, it doesn't change anything particularly in terms of national policy,'' said Jalan, who headed the Mumbai-based Reserve Bank for six years starting 1997, helping tackle the impact of the Asian financial crisis. “What they are talking about is a slight slowdown and then if you have excess demand, those are not issues of any great conflict of interests.''

Rising Yields

The yield on the benchmark 7.99 percent note due July 2017 rose as much as 2 basis points to 8 percent, the highest since August in Mumbai. The rupee rose as much as 0.2 percent to 39.8925 per dollar. A basis point is 0.01 percentage point.

The government said on April 4 it will sell 90 billion rupees ($2.25 billion) of bonds and bills in the first such sales since February.

“Technically speaking, you can't have inflation, unless there's demand-side pressures,'' said Jalan, who was succeeded by Reddy in September 2003. “By definition, if you're worried about inflation, then there has to be excess demand, excess liquidity. Otherwise prices wouldn't rise, they cannot rise.''

Allowing rupee gains to cut the cost of imports and slow inflation can only be a “temporary'' measure, Jalan said. Goldman Sachs last week forecast the rupee to climb to 38.3 per dollar in 12 months as policy makers allow currency gains, with the aid of higher interest rates, to temper prices of imported goods and commodities.

“It is an option but it doesn't solve the issue,'' he said. “Unless you have a crisis of the type which we don't have, this is a phenomenon which you'd call a more short-term measure.''

Jalan said he didn't use currency “appreciation by design'' to control prices during his tenure at the central bank. The rupee, which had the first loss in seven quarters in the three months through March, is Asia's third-worst performer this year.

“We had the opposite problem at that time,'' he said. “We were in the midst of the East Asian crisis.''

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