India yesterday surprisingly raised interest rates to dampen inflation, saying it was now better prepared to deal with the risk of major capital outflows roiling emerging economies.
The Reserve Bank of India (RBI), however, said that if retail inflation eases as projected, it does not foresee further near-term monetary policy tightening.
India’s rupee sank 11 per cent last year as emerging markets sold off sharply after the US central bank announced it would taper its aggressive bond-buying programme that had fuelled global demand for risk assets.
Expectations the Federal Reserve will further scale back stimulus this week have renewed pressure on emerging economies although the rupee has fared better than other currencies this time. India’s 25-basis-point rate hike was driven by expectations of high but moderating consumer price index (CPI) inflation, an indication the central bank intends to adopt a recent proposal to base its rate decisions on a CPI target.
RBI Governor Raghuram Rajan faces the daunting challenge of reviving an economy growing at its slowest in a decade while battling stubbornly rising prices, especially for food, fuelled by supply-side shortages beyond the control of monetary policy.
HSBC economist Leif Eskesen expects more rate increases from the RBI.
“This was the right decision, but it does not constitute the end to the tightening cycle, in our view. If RBI wants to knock out core inflation, the policy rate will likely have to be hiked further.”
The RBI raised its policy repo rate to eight per cent amid market worries over slowing growth in China and the prospect of further tapering of US stimulus.
“We have injected some medicine, 75 bps in rate hikes since September, and we have to watch to see how that medicine works along with, again, the weak state of the economy as well as the stabilisation of the rupee,” Rajan told a news briefing.
Lifting rates lends support to an Indian currency which strengthened slightly yesterday.
India’s rate hike was driven by expectations of high but moderating consumer price index inflation
The Indian economy, which not long ago aspired to double-digit growth, has been weakened by sluggish investment and persistent inflation in recent years under the corruption-scandal battered Congress party government of Manmohan Singh, which faces an uphill battle in elections due by May.
Most economists in a Reuters poll last week had expected no change in rates. However, expectations for a rate hike had increased after a central bank panel proposed to make CPI the main inflation benchmark.