India lifts rates to curb inflation

India has aggressively raised benchmark interest rates as the central bank tacitly acknowledged that the incremental steps it had taken over the past year to tighten monetary policy had failed to tackle rampant inflation.

The Reserve Bank of India on Tuesday increased its two main monetary policy rates by 50 basis points – double most economist forecasts. The measure was taken as the bank warned inflation was higher than expected, threatening prospects for economic growth.

However, industry figures warned the move would hit investment and growth.

Headline inflation jumped to 8.9 per cent in March, compared with an official RBI target of 4-5 per cent.

“Elevated rates of inflation pose significant risks to future growth. Bringing them down ... even at the cost of some growth in the short run, should take precedence,” said Duvvuri Subbarao, RBI governor.

Tuesday’s move took the repo rate – the rate at which the central bank lends to commercial banks – to 7.25 per cent. The reverse repo – the rate at which the RBI absorbs money from the system – was raised to 6.25 per cent.

The rate rise was the ninth in just over a year and has raised questions over the effectiveness of RBI efforts to curb inflation. “The 50bp hike is a clear sign they are starting to get a little desperate,” said A. Prasanna, chief economist at ICICI Securities. “The RBI has few shots left to tackle inflation.”

India’s manufacturing sector has been hard hit by the persistent rate rises, which have sharply increased borrowing costs and hurt investment plans.

“Going after inflation the way the RBI is, is like chasing your own shadow,” said Shankar Raman, senior vice-president at Larsen & Toubro, the heavy engineering and construction group. “With these rates we are going to have more tough times ahead.”

He said that many of the country’s vital infrastructure projects, which were primarily financed with debt, would be hindered by the hawkish monetary policy.

Chandrajit Banerjee, director-general of the Confederation of Indian Industry, said the rate rise would have “an adverse impact” on growth and investment: “The continued monetary tightening without any movement on structural reforms to address supply side bottlenecks will have an added impact on capacity creation and expansion.”

Ashutosh Limaye, a director at Jones Lang LaSalle India, the property agent, said the rate rise would also hurt India’s real estate sector as companies struggle to raise funds amid high credit costs.

The RBI on Tuesday also approved a new regulatory framework that imposes a 24 per cent interest rate cap and a 10-12 per cent margin on microloans for the poor.

The industry has been in crisis since October, when the state of Andhra Pradesh ordered a halt to microlending in a backlash over interest rates and debt collection tactics. The move prompted banks to cut the flow of credit to microlenders amid uncertainty over the industry’s ability to operate across the country.

SKS Microfinance, India’s largest microlender, said the new rules brought “regulatory clarity”.