India’s central bank raised its key interest rates on Thursday by a quarter of a percentage point – its 10th hike in 16 months – in a bid to tame high inflation stuck at “uncomfortable levels.” Annual inflation accelerated to a higher-than-expected 9.06 percent in May, from 8.66 percent the previous month, heaping misery on hundreds of millions of India’s poor and piling pressure on the government.
The move by the central bank to raise the cost of borrowing, which is aimed at cooling the economy, was met with dismay by business leaders who said they feared an impact on investment. The Associated Chambers of Commerce and Industry of India (Assocham) said the hike would further slow down investments and restrict industrial growth.
“High input prices, rising finance costs and global uncertainties are adding to negative sentiments… and a high interest rate environment will most certainly put brakes on new investments,” said Assocham president Dilip Modi. The Reserve Bank of India defended its stance, insisting that monetary tightening was required in Asia’s third-largest economy and that inflation, not growth, was the main priority.
“Inflation persists at uncomfortable levels and much above our comfort zone of 5.0 to 6.0 percent,” RBI governor Duvvuri Subbarao said in a statement released after a meeting in Mumbai. The RBI raised by 25 basis points its repo rate – at which it lends to commercial banks – to 7.50 percent and increased the reverse repo – the rate it pays to banks for deposits – to 6.50 percent. The repo rate is now at its highest since November 2008 and the series of rate hikes is starting to have an impact on economic activity.
India’s economic growth slowed to 7.8 percent in the three months to March — its weakest pace in five quarters — while growth in industrial output in April halved compared with the same period last year. Indian Finance Minister Pranab Mukherjee said the rate hike was expected, adding that keeping prices stable was necessary to provide the conditions necessary for growth in the medium term.
“The RBI rate hike is as expected… India needs a better price stability to sustain growth,” he told reporters in New Delhi. Analysts had forecast the increase and they say further hikes are still likely in coming months. “The RBI has no option but to stay hawkish” as inflation levels are likely to remain elevated for few more months, said Siddhartha Sanyal, chief India economist with Barclays Capital,
Barclays expects the RBI to hike rates by 25 basis points again at its next meeting in July. India’s Sensex opened lower before the meeting, as investors sold heavily in anticipation of a hike. The benchmark 30-share index on the Bombay Stock Exchange was down 0.81 percent, below the key psychological level of 18,000, at the close Thursday.
Rate-sensitive banking, real estate and auto stocks were down in anticipation that loans for cars and homes will get costlier. The surge in inflation, triggered by spiralling food prices, rising global commodity prices and higher fuel costs, has been one of the biggest headaches for India’s government. Economists say food inflation has now spilled over into the general economy, pushing up wages and other costs.
Reducing prices has become a political priority for the Congress-led coalition in New Delhi, even as high growth is seen as key to reducing crushing poverty in the nation of 1.2 billion. The government has delayed a decision to increase prices of diesel and kerosene, which is widely used in rural areas and is seen as the “poor man’s fuel”. A possible hike in diesel would stoke inflation further, as it is a widely used in the transport of goods and services across the country.
The RBI on Tuesday said inflation was likely to face continued ‘upward pressure’ from the impact of high oil and coal prices, government subsidy expenditure and wage rises.
