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India Central Bank Raises Key Interest Rate

Friday, 16 Sep 2011 10:47 AM

India raised interest rates for the 12th time in 18 months and surprised markets by sticking with its anti-inflationary stance even as growth slows in Asia's third-largest economy and policymakers elsewhere focus on reviving flagging demand.

The Reserve Bank of India lifted its policy lending rate, the repo rate, by 25 basis points to 8.25 percent, in line with expectations, as it persisted in a fight to curb inflation that has thus far mostly proven futile.

The central bank said it was too soon to ease back from its anti-inflationary bias, dampening expectations that the RBI was finished with its current tightening cycle.

"A premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions. It is, therefore, imperative to persist with the current anti-inflationary stance," it said in a statement.

The RBI's hawkishness, which saw it raise rates by an unexpectedly steep 50 basis points in July, isolates it from other central banks that have turned dovish on the back of a festering global crisis.

This sets India apart as trouble looms in the west. The U.S. Federal Reserve has pledged to keep interest rates near zero for two years, while emerging heavyweights Brazil and Indonesia have eased policy.

India's headline inflation for August rose to 9.78 percent, its highest in more than a year. Growth and demand, however, have cooled following the cumulative impact of earlier rate increases and rising prices.

"The comments still sound predominantly hawkish as the RBI stressed that inflation was still above comfort and generalized, with the marked rupee depreciation also bearing adverse implications for inflation," said Radhika rao, economist at Forecast Pte in Singapore.

"Bottom line is that the central bank still wants to keep the door open for further rate tightening," she said.

The benchmark 10-year bond yield rose 4 basis points after the central bank kept up its hawkish tone, while the one-year swap rate surged 11 basis points. Shares too trimmed gains to rise about 0.4 percent from 1.4 percent before the announcement.

While inflation was initially driven by food and fuel, both largely beyond the scope of monetary policy, it has spread to the core non-food manufacturing sector and remains far above the central bank's perceived comfort zone of 4 to 4.5 percent.

Meanwhile, initiatives that would drive investment in agriculture and infrastructure and alleviate supply bottlenecks have been stalled as the government of Prime Minister Manmohan Singh has been preoccupied with managing a spate of scandals.

"We are using only one policy lever to control inflation, while inflation is multi-faceted. We need supply side measures simultaneously for a sustained decline in inflation," said Samiran Chakraborty, India research head at Standard Chartered.

Managing Expectations

While New Delhi leans towards a pro-growth bias, it has become increasingly resigned to the trade-off of managing inflation, with a key economic advisor forecasting growth of 7.5-8 percent for the next few years, below earlier government talk of a return to double-digits.

Corporate India, meanwhile, has become increasingly gloomy as rate increases continue and growth slows.

"There seems to be no other alternative for RBI ... but I think government has got to look at alternatives now," said Sunil Sikka, president of Havells India, which makes electronic equipment.

"Increasing the repo every now and then is a demand dampener," he said. "The cost in any case is passed on to the consumer. I don't know how it is going to help, so far it has not."

Most economists in a poll released on Monday expected the central bank to raise rates on Friday and then pause in a tightening cycle that has made RBI Gov. Duvvuri Subbarao one of the most aggressive central bankers anywhere over the past two years.

But Friday's tough talk means more rate hikes may be in the offing, starting with the central bank's next review on October 25.

Industrial output in July was the weakest in nearly two years, while India's June-quarter economic growth of 7.7 percent was the slowest in six quarters.

The rupee, which plunged to a near two-year low against the U.S. dollar on Wednesday, may further weaken on the rate rise, hitting India's import bill.

© 2017 Thomson/Reuters. All rights reserved.

 
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India raised interest rates for the 12th time in 18 months and surprised markets by sticking with its anti-inflationary stance even as growth slows in Asia's third-largest economy and policymakers elsewhere focus on reviving flagging demand. The Reserve Bank of India...
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Friday, 16 Sep 2011 10:47 AM
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