RBI begins unwinding loose monetary policy

By Surojit Gupta and John Mair

MUMBAI (Reuters) - The Reserve Bank of India (RBI) laid the groundwork on Tuesday for a rise in interest rates by tightening credit to the commercial property sector, lifting its inflation forecast and warning of the threat of asset price bubbles.

As expected, the RBI left key interest rates on hold but surprised markets by removing emergency liquidity support measures that were implemented to protect Asia's third-largest economy from the global downturn.

Stocks extended losses to close 2.31 percent lower after the quarterly policy review and property shares dropped 6.24 percent as the RBI raised bank provisioning requirements for commercial real estate loans.

The index of bank stocks fell 3.82 percent, with dominant lender State Bank of India off 4.45 percent and top private sector lender ICICI Bank down 6.11 percent.

"This could be one way for them to signal rate hikes are imminent. It is tightening of course," said Ramya Suryanarayanan, economist at DBS in Singapore.

Despite the tightening, government bond yields fell after the central bank raised the amount of deposits banks are required to keep in government securities, soothing worries about the market's ability to digest this year's record borrowing.

The central bank, which has been under pressure from government officials to maintain its loose monetary policy, kept its growth forecast for the fiscal year ending in March 2010 at 6 percent with an upward bias.

India's economic growth slowed to 6.7 percent in the year through March after three years of growth at 9 percent or more.