India raises key interest rate to battle high inflation levels

The Reserve Bank of India alo continued rolling back emergency liquidity measures intended to arrest the rupee's slide.

Food prices in India last month rose 18.4 per cent from the same period last year, with the cost of onions surging 322.94 per cent. Vivek Prakash / Reuters

India's central bank raised its key interest rate yesterday in an effort to keep high inflation levels in check.

The Reserve Bank of India (RBI) at the same time continued to roll back emergency liquidity measures that were taken over the summer to try to stem the slide of the rupee.

Raghuram Rajan, who took over as the RBI’s governor last month, raised the repo rate by 25 basis points for the second consecutive month. It now stands at 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,” he said.

“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.”

The RBI cut the marginal standing facility – a short-term borrowing rate for banks – from 9 per cent to 8.75 per cent.

The rate decisions might not have an immediate impact on saving and lending rates, analysts said.

“The RBI actions today would reduce rates in the short-term debt market and part of this can get reflected in the dated securities market also,” said Sujan Hajra, the chief economist at Anand Rathi Securities.

“Yet, this is unlikely to lead to any immediate change in bank lending or deposit rates. At the current juncture, with a stable rupee and high deposit rates offered to the NRIs [non-resident Indians], deposits of Indian banks would continue to be an attractive fund deployment opportunity for them.”

High food and fuel prices drove up the wholesale price index, India’s main gauge of inflation, 6.46 per cent last month, compared to a rise of 6.1 per cent in August.

The weak rupee, which plunged to a series of record lows this year, has exacerbated the situation by making fuel imports more costly.

Food prices last month rose 18.4 per cent from the same period last year, with the cost of onions surging 322.94 per cent.

“The RBI talked and walked like a hawk, further raising the inflation guards while continuing the roll-back of the currency stabilisation measures,” said Leif Eskesen, HSBC’s chief economist for India and Asean. “Zeroing in on inflation, despite the weak growth backdrop, is appropriate in light of the lingering inflation pressures.”

Markets cheered the decision. The benchmark S&P Bombay Stock Exchange Sensex rose 1.74 per cent to 20,929.01 yesterday.

The rupee strengthened marginally, with the US dollar down 0.11 per cent at 61.45 rupees in afternoon trading. India’s GDP slowed to a decade low of growth of 5 per cent this year.

“The upshot is that even after the full removal of July’s ‘exceptional measures’, monetary policy will remain on a tighter setting than it was earlier this year, which will be of little help to India’s struggling economy,” said Daniel Martin, the Asia economist at Capital Economics.

Analysts at Anand Rathi wrote in a report that they expect a further 25 basis point increase in the repo rate in the current financial year, which runs until the end of March.