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India cbank surprises with 50 bps rate rise

Mumbai, July 26, 2011

India's central bank stunned investors by raising interest rates by 50 basis points on Tuesday, showing unexpected resolve in fighting persistently high inflation despite slowing growth in Asia's third-largest economy and uncertainty about global demand.

The Reserve Bank of India (RBI) increased the repo rate  at which it lends to banks to 8 percent, topping forecasts that it would raise rates by 25 basis points. It indicated it will continue with its anti-inflationary stance, catching unawares most economists and market participants who had expected the RBI to signal the end of its tightening spree.

The rate rise 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," 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 percent. Our forecast is 7.5 percent and such persistent rate hikes point to further downside risk to growth," she said.

The one-year swap rate jumped as much as 24 basis points to 8.22 percent after the rate decision, while the benchmark five-year swap rate rose 13 basis points to 7.71 percent, further inverting the yield curve in a sign that investors are worried about slowing growth.     

Manoj Swain, chief executive at Morgan Stanley Primary Dealership, said a one-year swap rate below 8.50 percent shows that the market is not pricing in further rate increases.     

India's benchmark 10-year bond yield rose as much as 10 basis points to 8.42 percent after the policy decision, while the benchmark share index was down to 1.76 percent 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 percent 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 percent, from 6 percent earlier.

The RBI retained its forecast for economic growth in the current fiscal year of around 8 percent. 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."     

Tuesday's half-point rate rise is the second since May for the RBI, which had leaned so far towards smaller 25 basis point rises and had come in for criticism for lacking vigilance in fighting inflation.     

The RBI warned on Tuesday that high non-food manufacturing inflation and upside risks to food inflation following an increase in government-set prices could keep broader inflation high in coming months.

All 23 analysts in a Reuters poll last week had expected the RBI to raise rates by just 25 basis points on Tuesday, and nine of them expected a pause in the tightening cycle after July amid signs of slowing domestic growth and global uncertainty.

"The over-arching thing here is that the RBI remains very wary of a wage-price spiral risk given that wage gains have been strong," said Vishnu Varathan, economist at Capital Economics in Singapore.     

"There may also be some sense in front-loading this move, despite its negative impact on borrowers, as it also means that the RBI has a lot of dry gunpowder left to react if global economic risks become enlarged," he said.

With 250 basis points of tightening over the past year, India is easily the most aggressive inflation fighter in the world, surpassing even Brazil. - Reuters




Tags: India | Interest rate | RBI |

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