Home > India, World Economy > India raises key interest rates by a half point

India raises key interest rates by a half point

India raises key interest rates by a half point
May 3, 2011, 4:51 a.m. EDT

Journalist Calvin Lee Ledsome Sr.,

Owner and Founder of: http://www.LedSomeBioMetrics.com

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MUMBAI, India (AP) — India’s central bank raised its key interest rate by half a percentage point Tuesday, its ninth hike in just over a year, warning that persistent inflation has become a threat to growth in Asia’s third-largest economy.

The bank said the short term lending rate — or repo rate — will go from 6.75 percent to 7.25 percent, with immediate effect.

The bank said that from now on it will set only one policy rate, the repo rate, and fix the reverse repo rate — or short-term borrowing rate — at 1 percentage point below the repo rate. Tuesday’s rise automatically brings the reverse repo rate to 6.25 percent.

“High inflation is inimical to sustained growth as it harms investment by creating uncertainty,” Reserve Bank Gov. D. Subbarao said Tuesday. “Current elevated rates of inflation pose significant risks to future growth.”

“The Reserve Bank will continue to persevere with its anti-inflationary stance,” he added.

Sixty percent of forecasters had anticipated a quarter point hike, while 40 percent had projected a half point hike, according to a CNBC-TV18 poll Tuesday morning.

The bank said it expects economic growth to slow to around 8 percent this fiscal year, from 8.6 percent last fiscal year. It said growth would be between 7.4 and 8.5 percent, if monsoon rains are normal and crude oil prices average $110 a barrel for the year ending March 31, 2012.

That is lower than New Delhi’s projection of 9 percent growth and dents the ruling Congress party’s hopes of using the gains of double-digit growth to alleviate poverty and create jobs for millions of young Indians. Most Indians live on less than $2 a day.

Business leaders decried the Reserve Bank of India‘s move as too aggressive.

“This is certainly a very hawkish monetary stand and one which would make the investment environment even more difficult,” Rajiv Kumar, director general of the Federation of Indian Chambers of Commerce and Industry, said in a statement. “We are afraid that with growth slowing down, as now admitted by the RBI, employment targets will not be achieved and this could generate greater social pressure.”

India’s economic growth moderated from 8.9 percent in the first half of last fiscal year to 8.2 percent in the second half, and the bank said high oil prices, inflation, a possible slackening in global demand for India’s exports, and the impact of rising interest rates will further depress output.

The bank said it expects inflation for the fiscal year to average 6 percent, with the potential to rise. It said inflation would remain close to March’s 9 percent for the first half of the fiscal year, before softening in the second half, despite pressure from high oil prices — which would likely force New Delhi to raise regulated petrol and diesel prices — and a lagged passthrough of rising input costs to consumers.

“They’ve acknowledged they are willing to sacrifice some growth to control inflation,” said Samiran Chakraborty, head of India research at Standard Chartered in Mumbai. “This is a sea change in monetary policy. It will help bring down inflation.”

Wages in India have been rising faster than inflation, crimping corporate margins along with higher input costs.

“Inflation expectations arising from the demand side need to be contained,” Chakraborty said. “This rate hike was needed to make sure we’re not into a wage price spiral.”

India suffers from the worst inflation of any major Asian economy — economists describe India’s inflation as “virulent” and “unparalleled” — prompting the Reserve Bank of India to raise rates more than its regional peers.

It hiked the effective interest rate by 3.5 percentage points prior to Tuesday’s move. That has put pressure on growth, with capital goods production and investment both softening, but it hasn’t been enough to contain inflation.

High oil prices, loose fiscal policy and supply constraints have muted the impact of the Reserve Bank’s aggressive anti-inflation stance.

The Reserve Bank of India also increased the savings bank deposit rate Tuesday from 3.5 percent to 4.0 percent, as it considers deregulating bank deposit rates. The rise — and potential deregulation — will squeeze profit margins at Indian banks.

The benchmark Sensex index was down 1.7 percent in early afternoon trade in Mumbai, with autos and banks leading declines.

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