India raises rate to 7-year high

India raises rate to 7-year high By Joe Leahy in Mumbai Published: July 29 2008 09:15 | Last updated: July 29 2008 16:27 India’s central bank on Tuesday sought to send its strongest signal yet that it will not tolerate high inflation by announcing a larger than expected increase in its key lending rate and threatening more measures to come. The increase in the benchmark “repo” rate by 50 basis points to a seven-year high of 9 per cent represents the third time in two months that the Reserve Bank of India has raised interest rates to battle inflation that has reached a 13-year high of nearly 12 per cent. The RBI also increased the cash reserve ratio by 25 basis points to 9 per cent. The ratio is the amount of funds banks must keep on deposit at the central bank. It lowered its forecast for economic growth this financial year by half a percentage point to 8 per cent. “The hawkish move delivered a clear message that inflation dominates growth and that a slowdown in demand would be required to curtail inflation,” Sonal Varma, economist at Lehman Brothers in Mumbai, said in a note on the move. The global rise in oil and food prices has saddled India with inflation that is nearly triple its levels at the beginning of the year and more than double the RBI’s target of under 5.5 per cent. The Congress party-led ruling coalition, which must hold an election before May next year, has stemmed exports of essential food items and raw materials and cancelled futures trading of important commodities to try to rein in prices. RBI governor Yaga Venugopal Reddy said it was critical to demonstrate “a determination to act decisively” against inflation. But he said he was confident India could still sustain a relatively high rate of growth of 8 per cent, above the estimates of many private sector economists. Goldman Sachs economist Tushar Poddar said the tightening was stronger than the 25 basis points he had expected for the repo rate. Mr Poddar said: “The move continues the RBI’s objective to get ahead of expectations and slow demand.”He predicted the interest rate rises would begin to weigh on the economy in the next financial year and has lowered his forecast by one percentage point to 7.2 per cent for the year ending March 2010. The RBI also conceded that it had lost ground in its battle against inflation, saying while it would prefer to see it at 5 per cent, a more realistic target for the end of the March 2009 financial year would be 7 per cent. With real interest rates – the difference between inflation and benchmark rates – effectively negative, the RBI has faced rising pressure to increase interest rates even at the risk of slowing down economic growth. “While there are early signs of some moderation in money supply and deposit growth, they continue to expand above the indicative projections, warranting continuous vigilance and appropriate and timely policy responses,” the RBI said.