By Tony Munroe and Surojit Gupta
MUMBAI (Reuters) – The Reserve Bank of India (RBI) on Tuesday raised key interest rates by 25 basis points and said further rises were likely as it moves to return monetary policy towards pre-crisis settings and battles near double-digit inflation.
The Reserve Bank of India's move was in line with expectations, but some investors had bet on a bigger rise and RBI watchers said the measured tightening increased the likelihood of another hike before the next quarterly review in July.
Government officials, however, keen to keep the economy on track to exceed 8 percent growth this year, said inflationary pressures were waning and played down the need for aggressive tightening.
The yield on the 10-year benchmark bond fell by 10 basis points on Tuesday to its lowest level since April 13 as investors expecting a sharper rate rise unwound positions.
"The policy statement is not hawkish enough to address the concerns on the inflation front," said Rupa Rege Nitsure, chief economist at the Bank of Baroda in Mumbai.
The RBI lifted the reverse repo rate, at which it absorbs excess cash from the banking system to 3.75 percent and the repo rate, at which it lends to banks, to 5.25 percent.
The RBI said price pressures were spreading beyond food costs and there was evidence that companies were regaining their pricing power after a slow patch during the global economic crisis. March inflation reached 9.9 percent year-on-year, its fastest pace in 17 months.
However, the RBI is under pressure from the government not to raise rates aggressively, with New Delhi worried it could dent economic growth and complicate its borrowing, which will reach a record $100 billion this year.
"RBI at this juncture is more constrained by the management of the government's record borrowing programme," Nitsure said.
MORE TIGHTENING AHEAD
The RBI is expected to raise rates by a further 100 basis points over the next 12 months, according to the one-year overnight indexed swap (OIS) rate at 4.95 percent.
A Reuters poll conducted after Tuesday's policy review found a narrow majority of economists expect another increase in rates by the end of June, or before the RBI's quarterly review. The median forecast for increases in the two key rates by the end of the fiscal year in March was 100 basis points.
"At this point it looks like we have to move many times," RBI Governor Duvvuri Subbarao told reporters, adding that an off-cycle policy move was unlikely but could not be ruled out.
"Everything need not be done in one step and we believe that moving in several baby steps towards normalisation is better for the economy to adjust to pre-crisis growth levels," he said.
Tuesday's rise follows a surprise quarter-point hike in mid-March when India became the second Group of 20 country after Australia to lift interest rates as the global economy recovers from its worst downturn in generations.
"If incoming inflation data over the interim period show price pressures continuing to build, there is a good chance that the RBI will deliver another off-schedule rate hike," said Brian Jackson, an economist with Royal Bank of Canada in Hong Kong.
INFLATION OPTIMISM
Some economists said the RBI's prediction that inflation will ease to 5.5 percent by the end of March 2011 was too optimistic.
Finance Minister Pranab Mukherjee said on Tuesday inflation had peaked and was on its way down even as the economy was powering ahead, a hint for the RBI that it did not need to tighten aggressively despite rising protests over high food prices.
"I believe that it is time to move back towards 'neutral' policy rates, that is, rates that should prevail when an economy is stable and on track," Mukherjee said, predicting fiscal year-end inflation closer to 4 percent.
Only China is growing faster among major economies.
Montek Singh Ahluwalia, deputy chairman of India's planning commission, said that if inflation returned to a "reasonable path" further tightening might not be necessary. "Small adjustments that are well within the range of probability do not disrupt the market and they serve a useful purpose," he said.
As well as raising key interest rates, the RBI said it would increase the cash reserve requirement for banks by 25 basis points to 6.0 percent, effective from April 24. This will drain 125 billion rupees ($2.8 billion) from the system.
A successful summer monsoon would help ease the pressure from high food prices following last year's drought, although it might also add to demand-driven inflation.
A move towards market-based fuel prices, which the government has put on hold amid opposition attacks over rising prices, would also add to headline inflation.
Bond yields shot higher this month on worries over inflation and government borrowing, with the yield on the 10-year bond rising to an 18-1/2 month high of 8.13 percent last Thursday.
Editing by Ranjit Gangadharan, Tomasz Janowski and Stephen Nisbet
Reuters India
