RBI raises rates to tackle price pressures

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The Reserve Bank of India (RBI) on Friday unexpectedly raised interest rates from record-low levels for the first time since it began cutting in 2008, citing intensifying inflationary pressures and a steady economic recovery.
The central bank raised the repo rate, the rate at which it lends to banks to 5% from 4.75% and reverse repo rate, the rate which it absorbs funds from the system to 3.50% from 3.25% with immediate effect.
"Given the lags in monetary policy, it is better to respond in a timely manner, even if it is outside the scheduled policy reviews, than take stronger measures at a later stage when inflationary expectations have accentuated," the RBI said.
Analysts were expecting the Reserve Bank of India to raise interest rates by 50 basis points at its policy review on April 20, as a central bank deputy governor had ruled out any inter-meeting rate action.
"RBI had fallen behind the curve on inflation. So it's not surprising they have gone in for an inter-meeting correction. The concern is not so much on food prices, but that core inflation is picking up," said Abheek Barua, chief economist, HDFC Bank.
India is the second major economy after Australia to start raising interest rates with signs of global recovery emerging and local price pressures picking up.
China has raised its banks' reserve requirements but has left its rates unchanged.
The surprise timing of the rate action may lead to sell-off in the federal bonds and swaps market when they open on Monday, with borrowing concerns adding to the pain, dealers said.
"Most people thought they would wait before a policy statement, which is still a month away. So it is a big surprise," said Surjit Bhalla, chairman, Oxus Investments.
A Reuters poll early this month had showed that most analysts had expected the central bank to raise interest rates by up to 50 basis points in April.
RISING INFLATION
The wholesale price index in Asia's third-largest economy accelerated to 9.89% in February, the highest since October 2008 and well above the central bank's end-March projection of 8.5% and the 8.56% January reading.
"In the emergent scenario, low policy rates can complicate the inflation outlook and impair inflationary expectations, particularly given the recent escalation in the prices of non-food manufactured goods," the RBI said in a statement.
The central bank has been under increasing pressure to raise rates as inflation is nearing 10%. Key policymakers had said the RBI ought to carefully consider a return to normal monetary policy.
Rising prices have sparked opposition-backed street protests and made India's government reluctant to push through reforms such as relaxing fuel price controls, even though the ruling Congress party faces no risk of losing power any time soon.
The RBI had began its aggressive rate cut cycle in October 2008 to insulate Asia's third-largest economy from the global slowdown and reduced policy rates six times since then by 475 basis points.
India government is scheduled to borrow a record Rs 4.57 trillion (USD 100 billion) in the fiscal year starting April to finance its fiscal deficit estimated at 5.5% of gross domestic product in 2010-11.
"I don't think (the rate rise) will affect the borrowing programme as it is dictated by fiscal deficit and they must have taken it into account," said Oxus Investments' Bhalla.
With inflation racing above the central bank's projected level, analysts expect another rate action in April. A top adviser in the finance ministry said on Friday that there could be another rate increase when the RBI reviews policy in April.
"The timing was clearly a surprise which means inflation is clearly above their comfort zone and that means another rate action of 25 basis points in April," said A. Prasanna, economist, ICICI Securities Primary Dealership in Mumbai.
"...while the recovery in growth has proceeded broadly along expected lines, the inflationary pressures have intensified beyond our baseline projection," the central bank said.
India's industrial output grew 16.7% in January, a tad higher than a Reuters poll forecast for 16.65%. Between April and January, industrial growth expanded 9.6%.
India is seen growing over 7.2% in the year to March 2010, and 8.5% the year after and 9% in 2011-12.