India’s central bank raised its key lending rate by half a percentage point on Tuesday to its highest in seven years.

The Reserve Bank of India also raised the cash reserve ratio of banks in an unexpectedly aggressive bid to quash double-digit inflation.

The bank 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 Reserve Bank of India 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 August 30.

Following the rate hike, Indian shares dived sharply on worries that the cost of home and car loans will soar.

In noon trade, the Bombay Stock Exchange’s benchmark 30-stock Sensex was down 606 points, or 4.2 percent, at 13,743 points. On the broader National Stock Exchange, the 50-company S&P Nifty index declined 3.9 percent to 4,163 points.

’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.

’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. - Reuters