India's central bank raised its key interest rate for the second time in two months Tuesday, underlining the determination of its new chief to control inflation despite concerns economic growth could slow further.
Reserve Bank of India Gov. Raghuram Rajan said the benchmark interest rate was raised by a quarter percentage point to 7.75 percent. His hard line against inflation increases pressure on the government to revive growth through reforms to make the economy more efficient, instead of relying on the short-term fix of cheap credit.
"It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth," Rajan said. He said he expects both wholesale and consumer price inflation to remain elevated in the coming months.
India's September wholesale inflation rose to 6.5 percent, well over the RBI's target of 4.0-4.5 percent. Consumer price inflation, which factors in volatile food prices and hits hundreds of millions of poor Indians hardest, was even higher at 9.8 percent in September.
Rajan has a tough balancing act of stemming stubbornly high inflation while Asia's third-largest economy stumbles. India's economy expanded just 4.4 percent in the April-June quarter, far below the 8 percent rate the country averaged in the past 10 years.
"We are very conscious of the state of the economy," he told a news briefing Tuesday.
He said he expects growth of 5 percent for the fiscal year that began April 1, an improvement from the nadir of the April-June quarter but lower than the bank's original forecast of 5.5 percent.
A pickup in growth could come from government moves to unblock stalled industrial projects and an uptick in agriculture from a favorable monsoon season, he said.
Since Rajan became governor early last month, he has shown skepticism about the capacity of monetary policy to spur economic expansion in India, which is plagued with bureaucratic obstacles and creaking infrastructure that inhibit business investment and make moving goods more expensive.
The former IMF chief economist known for having predicted the 2008 global financial crisis surprised many when the first policy statement under his leadership hiked the benchmark interest rate instead of letting it stand — or even cutting it as many business leaders would have liked.
By doubling down with another raise in the rate, he makes his priorities clear as well as his view that the economy needs to attract more investment rather than cheaper rates.
"Zeroing in on inflation, despite the weak growth backdrop, is appropriate in light of the lingering inflation pressures and the elevated inflation expectations," said Lief Eskesen, HSBC's chief economist for India and Southeast Asia.
Others, though, worried about further dragging down growth with the tight credit policy.
"The RBI must realize that if India Inc. and Indian citizens curb borrowing and stop investing, the economy may end up in coma," said Siddhartha Upadhyay of the think tank Interactive Forum on Indian Economy.
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