RBI sends tough message on inflation with unexpected rate hike

NEW DELHI – The Reserve Bank of India’s new Governor, Raghuram Rajan, has delivered a surprise 25 basis points rate hike in his debut policy meeting. The increase brings the benchmark repo rate to 7.5%, after cumulative cuts of 125 basis points since April 2012.

At the same time, the RBI took advantage of recent stabilising trends in the rupee—aided by the Fed’s decision last week to delay QE tapering—to ease exceptional liquidity measures by cutting the overnight lending rate for banks to 9.5% (the so-called MSF rate was raised to 10.25% in July amid strong currency depreciation pressures).

BBVA Bank says the decision to raise the benchmark lending rate is a clear signal by the RBI that it aims to contain inflation expectations (August WPI and CPI inflation stand at 6.1% y/y and 9.5% y/y, respectively), even at the expense of near-term GDP growth, which fell to a disappointing 4.4% y/y in Q2. “Going forward, we would not rule out another rate hike before year-end if inflation and the rupee fail to stabilise, although the RBI appears to be adopting a neutral stance for the time being.:  www.bbvaresearch.com (ATI).