MUMBAI: India’s new central bank governor surprised markets yesterday with a bold decision to hike interest rates on fears of rising inflation, triggering sharp falls on the stock market.
Reserve Bank of India (RBI) chief Raghuram Rajan, who had earlier warned he was prepared to be unpopular, increased the benchmark interest lending rate to 7.50 percent from 7.25 at his first policy review meeting since taking the reins.
The Bombay Stock Exchange’s index of leading shares fell by as much as 2.88 percent to a day’s low of 20,051.43 points, with interest-rate sensitive stocks in banking, auto and property hardest hit.
“Bringing down inflation to more tolerable levels warrants raising the repo rate by 25 basis points immediately,” Rajan said after announcing the first rates hike since October 2011.
He had been widely forecast by economists to keep rates on hold despite annual inflation hitting an unexpected six-month high of 6.1 percent this week.
While businesses and the government would like a rate cut to help revive sluggish growth, this would risk pushing inflation higher and further weakening the rupee, which hit record lows in the weeks before Rajan took charge on September 4.
Rajan did, however, relax some liquidity tightening measures introduced by the RBI in July to try and help stem the rupee’s freefall.
The cash reserve ratio, the amount banks must set aside with the central bank as reserves, was reduced to 9.5 percent from 10.25 percent while the marginal standing facility — used to lend to commercial banks when there is a shortage of funds in the market — was cut by 75 basis points.
“Now things are back to normal, he is using the policy rate to target inflation and that will allow the rupee to do what it likes,” Daniel Martin, Asia Economist at Capital Economics, said.
Nicknamed “The Guv”, Rajan stepped up to the plate faced with the unenviable task of propping up a weak rupee, reviving slowing economic growth and curbing rising inflation.
“Absolutely we want to fight inflation and we will bring inflation down, but it is not a ‘take no prisoners’ kind of stance,” he told reporters in India’s financial hub Mumbai after yesterday’s meeting.
“The priorities of the central bank have always been inflation and growth. The emphasis on each varies with conditions.”
The Sensex recovered marginally to close down 1.85 percent at 20,263.71 points after Rajan explained the rationale for the cut.
Huge expectations have been riding on the former International Monetary Fund chief economist, who famously predicted the 2008 global financial crisis and has been lionised by India’s media.
After taking over the job, he immediately announced a string of measures to liberalise financial markets and support the currency.
Rajan’s efforts to swell foreign exchange coffers have helped the rupee rebound to reach around 62 to the dollar, from 67 when he took charge.