RBI makes aggressive hike to fight inflation

By V Ramakrishnan and Anurag Joshi

MUMBAI (Reuters) - The Reserve Bank of India (RBI) raised its key lending rate to its highest in six years on Tuesday and hiked banks' reserve requirements in an aggressive step to combat 11 percent inflation, and signaled it would act again if needed.

The RBI said it wanted to reduce overall demand pressures to stop any instability developing in the buoyant economy due to inflation and said higher energy prices were no longer a temporary phenomenon.

Analysts said government bond yields were likely to jump sharply on Wednesday and stocks fall, as the rate decision, which came after market hours, was above expectations, although traders had been expecting a policy tightening soon.

The RBI raised its key lending rate by 50 basis points to 8.5 percent with immediate effect, its highest since March 2002 and the second hike this month.

It also increased its cash reserve ratio (CRR), the ratio of deposits banks must keep with it, to 8.75 percent from 8.25 percent in two 25-basis-point stages on July 5 and July 19.

The RBI said a "continuous heightened vigil" was needed to respond swiftly to further developments and anchor inflation expectations, and economists did not rule out more tightening.

"In the remaining part of the year, there will be 50 basis points increase in CRR and 25 basis points in the repo rate," said Rupa Rege Nitsure, chief economist at Bank of Baroda.

Tuesday's move would boost the CRR 125 basis points this year, after hikes in April and May to drain excess inflation-stoking cash from the money markets. Economists expect banks will also raise rates.