Indian Central Bank Unexpectedly Raises Interest Rate - Bloomberg

India's central bank raised a key interest rate a month before its scheduled policy review because of a failure to bring down inflation from a near two- year high.

The Reserve Bank of India increased its overnight lending rate by a quarter percentage point today to a 4 1/2 year high of 7.75 percent. The Mumbai-based bank also raised banks' reserve requirements for the third time since December, and said it is shifting policy away from balancing inflation with economic growth to focusing solely on prices.

Governor Yaga Venugopal Reddy has raised borrowing costs six times in 14 months to curb record bank lending and tackle inflation, which has stayed a percentage point above the bank's highest estimate. In the past two weeks, overnight borrowing costs rose to the highest in at least a decade and the rupee rallied to an eight-year high, as Reddy's actions squeezed cash from the banking system.

``The central bank is overdoing it to curb inflation,'' said Rajeev Malik, senior economist at JPMorgan Chase & Co. in Singapore. ``After the aggressive policy tightening so far, one would have thought the central bank would wait for some time to see their impact on inflation. This move will hit growth.''

Analysts Surprised

Analysts have been surprised three times since December by Reddy's actions, inviting criticism from companies including Hero Honda Motors Ltd. Borrowing costs in the overnight money market rose to the highest in at least a decade after companies paid their quarterly tax, forcing banks to sell dollars to replenish cash holdings. This sent the rupee to the highest in almost eight years on March 28.

Bankers and industry officials said Reddy has abandoned the central bank's policy of keeping a firm check on volatility in the rupee-dollar market and allowed the currency to appreciate so that costs of imports would be lowered, in turn reducing inflation.

``The central bank is looking at the rupee as a second instrument to rein in inflation, and that is why it is accepting the volatility,'' said Prabal Banerji, chief financial officer at Hinduja Group in Mumbai, which has businesses in banking, automobiles and entertainment.

The yield on the benchmark 10-year government bonds climbed 39 basis points to 8 percent this quarter as the central bank raised the cost of money and sold bonds to mop liquidity in its battle against inflation.

Reserve Ratio

The Reserve Bank increased the repurchase rate at which it lends overnight to 7.75 percent from 7.5 percent with immediate effect. It raised the cash reserve ratio to 6.5 percent from 6 percent in two stages starting April 14.

Reddy has raised the key overnight lending rate since January 2006, and increased the cash reserve ratio since December to slow loans that have grown at an average 30 percent since 2004, the fastest pace since the central bank started collating data in 1971.

``In the light of the current macroeconomic, monetary and anticipated liquidity conditions, and with a view to containing inflation expectations, it is critical to take demonstrable and determined action on an urgent basis,'' the central bank said in its statement.

The benchmark wholesale price inflation has held at near a two-year high of 6.46 percent for three weeks ending March 17, the government said.