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BW Businessworld

Further Tightening Likely

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Concerned over high inflation, the Reserve Bank on Friday raised key interest rates by 25 basis points, its 12th such hike since March, 2010, making auto, home and other loans more expensive. RBI also said it will persist with its anti-inflationary policy stance, even as growth slows in Asia's third-largest economy.

The apex bank is now expected to raise interest rates one more time in 2011. Earlier it was predicted that a Friday increase would be the last of the year.

Finance Minister Pranab Mukherjee said the 25 basis points rate hike by the Reserve Bank will help in moderating inflation to a comfortable level without hurting growth. But finance secretary R.S. Gujral said the government is concerned about high inflation and slowing growth.

Corporate India, meanwhile, has become increasingly gloomy as rate increases continue and growth slows.

"There seems to be no other alternative for RBI ... but I think government has got to look at alternatives now," said Sunil Sikka, president of Havells India, which makes electronic equipment.

"Increasing the repo every now and then is a demand dampener," he said. "The cost in any case is passed on to the consumer. I don't know how it is going to help, so far it has not."

FM Supports Move
"I am hopeful that measures taken (by RBI) would get us back to a more comfortable inflation situation earlier rather than later... while (leaving)
scope for growth to pick up in the second half of the year," Mukherjee told reporters in New Delhi.

The RBI lifted its policy lending rate, the repo rate, by 25 basis points to 8.25 percent, in line with expectations, as it persisted in a thus far largely futile fight to curb inflation.

The RBI's hawkishness, which saw it raise rates by an unexpectedly steep 50 basis points in late July, increasingly jars with dovish talk from central bankers worried about the health of the global economy, with both the United States and euro zone weighed down by debt problems.

It also sets India apart from its Asian neighbours, which have recently rolled back rate hike campaigns.

The central bank said it was too soon to ease back from its anti-inflationary bias.

"A premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions. It is,  therefore, imperative to persist with the current anti-inflationary stance,"  it said in a statement.

Inflation Up, Growth Down
Headline inflation for August rose to 9.78 percent, data on Wednesday showed,  its highest level in more than a year.

India's economic growth has cooled and demand crimped following the cumulative impact of earlier rate increases and rising prices.

"RBI is still viewing rising inflationary expectation as a key risk after a series of 12 rate hikes. This, according to me, is a real worry so far as
rate outlook is concerned," said Nitesh Ranjan, chief economist at Union Bank in Mumbai.

The benchmark 10-year bond yield rose 4 basis points after the RBI kept up its hawkish tone, while the one-year swap rate surged 11 basis points. Shares too trimmed gains to be up just about 0.4 percent from 1.4 percent before the announcement.

While inflation in India was initially driven by food and fuel prices, both largely beyond the scope of monetary policy, it has spread to the core
non-food manufacturing sector and remains far above the central bank's perceived comfort zone of 4 to 4.5 per cent.

Most economists in a poll released on Monday expected the central bank to raise rates on Friday and then pause in a tightening cycle that has made RBI Gov. Duvvuri Subbarao one of the most aggressive central bankers anywhere over the past two years.

Industrial output in July was the weakest in nearly two years, while India's June-quarter economic growth of 7.7 percent was the slowest in six quarters.

The rupee, which plunged to a near two-year low against the US dollar on Wednesday, may further weaken on the rate rise, hitting India's import bill.

Industry Unhappy

JSW Steel CEO Vonod Nowal said: "When growth is taking place, inflation takes place. When people have the capacity to pay, RBI need to balance it; they should not always use this tool of rate hike. Interest rates are already high, if they are further going to increase them, then it will further affect the business environment."

"This will definitely create a problem for liquidity, somewhere it will slowdown the infrastructure investment as well as manufacturing growth. It is
going to further impact already sagging capital expenditure by the industry."

Crompton Greaves CFO Madhav Acharya said:  "I am not sure if 25 bps rate hike is going to help RBI to contain the situation too much. So my understanding is that the interest rate hike will continue for some bit of time. For the slowdown in growth, may be RBI does not have much of a choice there. With more interest hikes to come there will be some more effect on the capex."

Sulajja Firodia Motwani, Joint MD, Kinetic Engg, said: "The inflation that we are experiencing is more to do with commodities like food... and increasing interest rates is not going to address that issue but instead it is going to slow down the investment, reduce demand for products."

(With input from agencies)