The Reserve Bank of India (RBI) raised interest rates by a higher-than-expected 50 basis points on Tuesday, stepping up its fight against persistently high inflation despite slowing growth in Asia’s third-largest economy.
The RBI increased the repo rate, at which it lends to banks, to 8 percent, exceeding market expectations that it would raise rates by 25 basis points and indicating it will continue with its anti-inflationary stance.
The rate increase was its 11th since March 2010, making the RBI one of the most aggressive inflation fighters among central banks, and sent bond yields and swap rates sharply higher and stocks lower.
“Quite a surprise. Clearly they are quite worried about inflation and the risk is they don’t stop with this rate hike. Our rate forecast is under review — we had forecasted 8 percent on the repo rate as the peak by end-October 2011,” said Ramya Suryanarayanan, economist at DBS Bank in Singapore.
“We think further rate hikes are going to slow growth considerably, below the RBI’s forecast of 8 per cent. Our forecast is 7.5 per cent and such persistent rate hikes point to further downside risk to growth,” she said.
The one-year swap rate jumped 17 basis points to 8.15 per cent after the rate decision, traders said, while the benchmark five-year swap rate rose 8 basis points to 7.66 per cent.
India’s benchmark 10-year bond yield rose as much as 9 basis points to 8.41 per cent after the policy decision, while the benchmark share index was down more than 1.3 per cent after starting the day in positive territory.
“Considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance,” RBI Governor Duvvuri Subbarao wrote in his quarterly review.
“A change in stance will be motivated by signs of a sustainable downturn in inflation,” he said.
Wholesale price index inflation was 9.44 per cent in June, more than double the central bank’s comfort level, and high prices are expected to persist in coming months.
The central bank, whose forecasts for inflation have proven optimistic in recent quarters, increased its outlook for wholesale inflation at the end of the fiscal year in March to 7 per cent, from 6 per cent earlier.
The RBI stuck with its forecast for economic growth in the current fiscal year of around 8 per cent.
While some interest-rate sensitive sectors are showing signs of moderating growth, it said, “there is no evidence of a sharp or broad-based slowdown as yet.”
Analysts in a Reuters poll last week had expected the RBI to raise rates by 25 basis points on Tuesday, and nearly half of them expected a pause in the tightening cycle after July amid signs of slowing domestic growth and global uncertainty.
Recent industrial output and manufacturing data was the worst in nine months, while sales of cars have slowed sharply and loan demand is easing, which had added to expectations the central bank was coming to the end of its tightening cycle.
Subbarao said Tuesday’s policy actions are expected to “maintain the credibility of the commitment of monetary policy to controlling inflation.”
The measures are also expected to “reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required,” Subbarao said in his report.
January-March quarter growth was a worse-than-expected 7.8 per cent, with economists expecting India to grow at 7.9 per cent in the fiscal year that began in April, according to a Reuters poll, less than the 8.5 per cent growth in the fiscal year that ended in March.
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