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India Raises Key Rates Unexpectedly By 25 Bps

RBI-RaghuramRajan-012814.jpg

India's central bank raised its key interest rates unexpectedly on Tuesday to combat sticky inflation, but sees no further tightening in the near-term if consumer price inflation comes down.

The Reserve Bank of India raised its repo rate by 25 basis points to 8.00 percent from 7.75 percent. The repo rate is the rate at which the RBI lends to banks.

The RBI adjusted the reverse repo, the rate at which the central bank accepts deposits from banks, to 7 percent from 6.75 percent. The bank was widely expected to leave key rates unchanged.

The RBI also lifted the marginal standing facility rate and the bank rate by 25 basis points to 9 percent each. Meanwhile, the central bank decided to keep the cash reserve ratio unchanged at 4.00 percent.

Following the announcement, the Indian rupee climbed to 62.895 against the greenback, up by 1 percent from a near 2-1/2-month low of 63.51 reached on Monday.

Governor Raghuram Rajan has raised the key repo rates twice last year after taking the helm at the central bank in September. The bank has so far increased the rates by a cumulative 75 basis points since September.

The bank said the increase in policy rate is consistent with its December guidance and the move will set the economy securely on the recommended "disinflationary path".

The upward adjustment of rates suggests that RBI is planning to shift its policy based on consumer price inflation. An expert committee, led by Deputy Governor Urjit Patel, recommended that the RBI set its monetary policy in such a way to keep inflation at 4 percent.

The panel advised the RBI to bring inflation down to 8 percent within one year and to 6 percent in two years.

"The extent and direction of further policy steps will be data dependent, though if the disinflationary process evolves according to this baseline projection, further policy tightening in the near term is not anticipated at this juncture," the bank said in a statement.

At the press conference, Rajan said it is premature to talk about future rate cuts. But he sees more room for rate cuts if inflation eases. He pledged to do what is necessary for economy.

It is unlikely that the RBI will consider reversing its recent rate hikes before late-2014, Daniel Martin, the Asian economist at Capital Economics said. In the meantime, tight monetary policy will continue to weigh on the economy.

The central bank projects the economy to grow in the range of 5-6 percent in 2014-15, with risks balanced around the central estimate of 5.5 percent, if inflation eases.

Headline CPI inflation is expected to remain above 9 percent during the quarter ended March 2014 and range between 7.5 and 8.5 percent in the quarter ended March 2015, with the balance of risks tilted on the upside.

Inflation, based on the consumer price index, dipped to 9.87 percent in December from a record high 11.16 percent.

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