RBI ups lending rate, cash ratio aggressively

The Reserve Bank of India raised its key lending rate by half a percentage point on Tuesday to its highest in seven years and combined it with a reserve hike in an unexpectedly aggressive bid to quash double-digit inflation.

The RBI raised the short-term repo rate as expected, but the size of the move, which brought the benchmark to 9.0 percent, surprised markets.

Most economists polled by Reuters had forecast a smaller step after last month’s two increases totalling 75 basis points.

The RBI also raised the cash reserve ratio, the amount of funds banks must keep on deposit with it, by 25 basis points to 9.0 percent to absorb surplus cash in the banking system. The increase will take effect on Aug. 30.

"Bringing down inflation from the current high levels and stabilising inflation expectations assumes the highest priority in the stance of monetary policy," the central bank said in its quarterly review.

Analysts, most of whom had expected the reserve ratio to stay unchanged, saw the double-punch as a sign the central bank was ready to accept slower growth as a price for dragging inflation down from its heady levels.

GROWTH ON BACKBURNER

"These are big strides taken to cool down the economy by reducing demand pressures," said Indranil Pan, chief economist at Kotak Mahindra Bank.

"Given the recent spate of tightening, the central bank has more or less aligned itself to the curve and it clearly highlights the central bank has moved to an inflation fighting mode and growth is now on the backburner."

India’s inflation, as measured by wholesale prices, stood at almost 12 percent in mid-July and has more than doubled since late February, reaching its highest level since 1995.

It accelerated into double digits after a sharp increase in government-set retail fuel prices in June, prompting the central bank to resume interest rate increases after a pause of more than a year.

Indian federal bonds yields rose sharply and the rupee strengthened after the news of the interest rate and reserve ratio rise.

The risk of slowing growth is rising up the agenda of the world’s central banks, diverting policy makers away from a battle to prevent food and fuel costs from spilling into wages and other prices. Expectations of rate rises this year have faded across much of the industrialised world including the United States and Japan.

In China, which like India raised subsidised fuel prices last month, financial markets scaled back expectations for the pace of yuan appreciation and interest rate increases after the ruling Communist Party and the central bank flagged a policy shift.

But India’s central bank has been criticised in the past for not acting quickly enough to counter mounting price pressures.

Analysts said Tuesday’s move would buy it some time to assess the results of its recent steps. They were divided, however, on whether and when the central bank would tighten policy again.

The central bank left the reverse repo rate at which it absorbs excess cash from banks and the bank rate, used by banks to price long-term loans, steady. Both remain at 6.0 percent.