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India central bank hikes key interest rate

Mumbai: India’s new central bank governor raised the key interest rate on Tuesday for a second straight month, disregarding calls for lower borrowing costs as he stays focused on battling high inflation.

After its monetary policy meeting in the financial capital Mumbai, the Reserve Bank of India (RBI) said the benchmark repo rate, at which it lends to commercial banks, would be increased by 25 basis points to 7.75 per cent.

“The policy stance and measures… are intended to curb mounting inflationary pressures and manage inflation expectations in a situation of weak growth,” bank chief Raghuram Rajan said in a statement.

Most economists had predicted the hike because wholesale inflation has been above the RBI’s comfort zone of 5.0 per cent for four successive months.

Annual inflation jumped to a seven-month-high of 6.46 per cent for the month of September, led by surging food and fuel prices.

Shares on the Bombay Stock Exchange, which hit their highest level in nearly three years last week, were up 1.52 per cent at 20,883.87 points in Tuesday afternoon trade.

After taking office in September, Rajan — who had warned he was prepared to take unpopular steps to bring the economy back on track — surprised markets by raising interest rates in his first monetary policy meeting.

At his second such meeting on Tuesday, the bank also kept the cash reserve ratio — the percentage of deposits banks must keep with the central bank — unchanged at 4.0 per cent.

Rajan did, however, relax some curbs imposed on banks in July to support the rupee when it was plunging against the dollar.

The marginal standing facility — used to lend to commercial banks when there is a shortage of funds in the market — was cut by 25 basis points to 8.75 per cent.

The rate rise disappointed the Confederation of Indian Industry (CII). It is among industry groups pushing for a cut to spur growth in Asia’s third-largest economy, which is running at a decade low of five per cent.

“A high interest rate regime deters consumption and investment demand,” said Chandrajit Banerjee, CII director general, adding that raising the rate would “hurt growth”.

Dampening business sentiment

A rate rise dampens business sentiment by increasing borrowing costs for the economy and pushing banks to raise their rates on loans for property and cars.

But cutting rates risks pushing inflation higher and further weakening the rupee, which hit record lows in the weeks before Rajan took charge on September 4.

Despite improved investor sentiment and a strengthening of the rupee since Rajan took charge, the bank warned on Monday night that anchoring inflation expectations would be key to monetary policy.

“It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth,” Rajan said in Tuesday’s announcement.

“The Reserve Bank will closely monitor inflation risk while being mindful of the evolving growth dynamics.”

The RBI expects India to grow at 5.0 per cent in the current fiscal year that ends in March, below its earlier forecast of 5.5 per cent.

Huge expectations have been riding on Rajan, a former International Monetary Fund chief economist nicknamed ‘The Guv’, since he came to office in a period of economic turmoil.

The rupee has gained ground from record lows since he took charge and announced steps to increase foreign capital flows into the country and bolster foreign exchange reserves.

Shubhada Rao, chief economist with private Yes Bank, said that with Tuesday’s decision, Rajan had firmly established himself as an anti-inflation central banker.

“The RBI is unlikely to drop its vigil on inflation soon,” she told AFP.

The scandal-tainted Congress-led government of Prime Minister Manmohan Singh is anxious both to tame inflation and to revive the economy as it seeks a third term in office, with elections due by next May.