India's central bank stepped up its fight against stubbornly high inflation on Tuesday, raising interest rates by a bigger-than-expected 50 basis points and vowing to battle price pressures even at the cost of some economic growth. The rate rise exceeded forecasts for a 25 basis point rise, although the case for stronger action had been building since data showed March inflation reached nearly 9 percent. It also cast doubt on the government's ambitious growth targets.
The Reserve Bank of India has been among the most aggressive central banks anywhere with nine rate rises since March 2010 but its gradual policy tightening has failed to cool inflation initially driven by high food and fuel prices, and more recently by demand pressures.
The RBI lifted its repo rate, at which it lends to banks, to 7.25 percent from 6.75 percent. The reverse repo rate was increased by a similar amount to 6.25 percent. It warned that wholesale inflation, the main measure of price pressures in Asia's third-biggest economy, would remain around March levels in the first half of the fiscal year that began in April, before easing.
It set an inflation target of 6 percent, with an upward bias, for the end of the fiscal year. The inflation warning and tough language prompted economists to raise their forecasts for interest rates this year. A snap Reuters poll showed they now expect India's repo rate to reach 8 percent by the end of 2011, a full percentage point higher than expectations in a poll in January.
The 1-year overnight indexed swap rate jumped as much as 20 basis points and the 5-year rate rose 11 basis points, flattening the curve after the central bank meeting. The 10-year benchmark bond yield rose as much as 8 basis points. Indian shares tumbled 2.44 percent, and banking shares dropped more than 3 percent as investors factored in a hit to earnings from higher credit costs.
The central bank's decisive action and comments restore some of the inflation-fighting credibility it lost while sticking with a "calibrated" approach to tightening in the face of the government's pro-growth bias, which some analysts said had underplayed inflation risks.
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