RBI raises interest rates, further moves seen

The Reserve Bank of India (RBI) logo is pictured outside its head office in Mumbai November 2, 2010.

MUMBAI (Reuters) - The Reserve Bank of India (RBI) raised interest rates on Thursday for the eighth time since last March, in line with expectations, and warned both of inflationary pressures and emerging risks to growth.

The RBI said it was likely to maintain its anti-inflationary bias, reinforcing market expectations that further rate increases are in the pipeline, and raised its forecast for headline inflation at the end of March to 8 percent, from its earlier 7 percent.

"The underlying inflationary pressures have accentuated, even as risks to growth are emerging. Rising global commodity prices, particularly oil, are a major contributor to both developments," the central bank said in its mid-quarter policy review statement.

India's finance ministry expects economic growth of about 9 percent in the fiscal year starting in April, significantly higher than many private forecasts, and several economists have lowered their growth expectations in recent weeks.

India is on track to grow at 8.6 percent in the fiscal year ending this month, but inflation has proven naggingly persistent, adding pressure on a Congress party-led government that is also reeling from a spate of corruption scandals.

The RBI raised the repo rate , its main lending rate, by 25 basis points to 6.75 percent, and raised the reverse repo rate , or borrowing rate, by 25 basis points to 5.75 percent , in line with expectations in a Reuters poll.

"The stance of the policy has become more hawkish," said Gaurav Kapur, senior economist at Royal Bank of Scotland in Mumbai.

"While it is clear that the RBI will continue to raise rates 25 bps each over the next two policy meetings, it would be crucial for the central bank to start paying attention to growth conditions also. Investment activity has slowed down and consumption too would slow down going forward," he said.

The benchmark five-year swap rate rose 8 basis points to 7.88 percent after the rate rise, while the one - year rate rose as much as 6 bps to 7.39 percent.

The yield on the most-traded 8.08 percent 2022 bond climbed 3 basis points to 8.09 percent after the statement in expectation of more tightening to come. The benchmark 10-year bond yield rose 4 bps to 7.95 percent.

The partially convertible rupee held steady at 45.24/25 per dollar but later strengthened to 45.14 on hopes higher rates would lure foreign funds into the country, while a decline in bank stocks helped drag stocks down.

"We have penciled in plus-25 basis points hike every quarter, with risks that they could do more," said Radhika Rao, economist at Forecast Pte in Singapore.

"Unfortunately, monetary policy faces the complete burden of anchoring inflationary expectations, and risks of generalisation in price pressures seems more glaring than earlier," she said.

FROM FOOD TO FUEL

While inflation in India has been driven for much of the past year by rising food prices, it has spread into the broader economy, and the prospect that global oil remains above $100 a barrel for a prolonged period adds to inflationary pressure.

The RBI raised rates despite the uncertainty posed by the unfolding disaster in Japan, which has prompted some investors to scale back expectations for rate rises elsewhere.

The Indian central bank said it was too early to assess the macroeconomic impact of the Japan crisis, and said that while spending on reconstruction could provide an economic boost, the substitution of thermal energy for nuclear power in Japan could add further pressure to petroleum prices.

The RBI has been among the most aggressive central banks anywhere over the past year, but inflation continues to outrun its forecasts. While supply-side bottlenecks, including in food production, are beyond the scope of monetary policy, inflation pressures have become more generalised.

SUBSIDY DILEMMA

The spectre of persistently high energy prices complicates matters for India, which subsidises diesel and cooking fuels.

While New Delhi may opt not to raise fuel prices ahead of upcoming elections in five states, maintaining subsidies to offset high global oil prices worsens its fiscal position. Passing on more of the cost to end users, however, adds to inflation.

India's annual food inflation eased slightly to 9.42 percent in the year to March 5, data on Thursday showed, but the fuel price index surged to 12.79 percent from 9.48 percent a week earlier on higher coking coal prices. India's wholesale price index unexpectedly rose in February to 8.3 percent on an annual basis.

Standard Chartered this week ratcheted up its forecast for India's average headline inflation in the fiscal year that starts in April to 7.9 percent, from 6.5 percent earlier, citing rising oil and metal prices.

(Writing by Tony Munroe; Editing by Ranjit Gangadharan)