September 16, 2010 / 6:45 AM / 8 years ago

RBI lifts rates, pause in tightening seen near

MUMBAI (Reuters) – The Reserve Bank of India (RBI) raised interest rates more than expected on Thursday, extending its fight against inflation, but signalled that a tightening cycle that has seen five rate hikes this year may be nearing an end.

A man drinks next to the logo of the Reserve Bank of India (RBI), outside its head office in Mumbai April 20, 2010. REUTERS/Arko Datta/Files

The Reserve Bank of India lifted the repo rate, at which it lends to banks, by 25 basis points to 6 percent and raised the reverse repo rate, used to absorb excess cash, by 50 basis points to 5 percent. Analysts in a Reuters poll had forecast quarter percentage point increases in both rates.

Indian inflation shot up to double digits early this year and even though it has been coming down since June, the RBI said it would remain “unacceptably” high in coming months.

However, it also said that its policy tightening since October 2009 had brought monetary policy back close to normal from its crisis settings during the global financial turmoil and that future action would be driven by economic conditions.

“The tightening that has been carried out over this period has taken the monetary situation close to normal. Consequently, the role of normalisation as a motivation for further actions is likely to be less important,” it said.

The RBI, which has forecast a decline in inflation to 6 percent by the end of this fiscal year in March 2011 from 8.5 percent in August, said that its tightening cycle that began in October 2009 was having an effect.

Thursday’s sharper-than-forecast rate increase sent swap rates and bond yields higher as economists and market players took the move as a sign that the RBI was prepared to notch up rates further albeit less aggressively.

“This degree of tightening by the RBI reinforces the urgency in tackling the key policy challenge of the high and persistent inflation,” said Gaurav Kapur, senior economist at Royal Bank of Scotland in Mumbai.

“The Indian central bank can still be expected to go ahead with further tightening, though at a less aggressive pace in the second half of the year,” he said.

For a graphic on bank credit, deposits, click link.reuters.com/naw42p

For a graphic on industrial production, exports, click link.reuters.com/waw42p

India’s inflation remains well above the RBI’s perceived comfort level of around 5 percent, keeping real interest rates stuck in negative territory.

“They are signalling that mostly the rate hikes are done with. The stance taken is that the growth side is consolidating,” said Indranil Pan, chief economist at Kotak Mahindra Bank.

“In my opinion inflation remains a concern for them. I think they will probably want to raise rates by another 25 basis points on November 2, but dependent on upcoming data,” he said.

The spread between the one-year and five-year OIS rates narrowed to 72 basis points from 79 basis points at Wednesday’s close in a bear-flattening of the curve. However. traders said long-end rates will be supported by expectations that the RBI is nearing a pause in its tightening.

GLOBAL SLUGGISHNESS

Signs that global recovery was losing steam have persuaded several central banks in Asia-Pacific to hold off with rate rises that had earlier been largely factored in by markets.

Last week, South Korea’s central bank left rates on hold and New Zealand’s did the same earlier on Thursday.

That made Reserve Bank of India the most aggressive monetary authority in Asia this year at raising rates as its domestically-driven economy showed remarkable resilience to global headwinds. It grew by 8.8 percent in the April-June quarter from a year earlier, its fastest pace in nearly three years. Industrial output rose 13.8 percent annually in July, the fastest since April.

India is on track to grow at 8.5 percent this fiscal year, lagging only China among major economies.

A Reuters poll ahead of Thursday’s review showed that most economists expected just 50 basis points of policy tightening by the end of the fiscal year on March 31.

Thursday’s mid-quarter review was the first since the RBI said it would double the frequency of its policy reviews to eight per year.

(Additional reporting by Neha D’silva and Swati Bhat; Editing by Surojit Gupta and Tomasz Janowski)

For more business news visit Reuters India

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