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Mumbai: India's central bank jolted financial markets with a double strike against inflation yesterday and lowered the country's economic growth projection to around 8 per cent from 8.5 per cent, sending the stock market into a downward spiral.
Analysts said it was clearly prepared to sacrifice some growth for tamer prices, with more tightening expected.
The Reserve Bank of India (RBI) raised its benchmark lending rate by 50 basis points to nine per cent, its highest in seven years and the third increase in two months as it battles annual inflation close to 12 per cent.
It is also increasing the proportion of funds banks must keep on deposit with it by 25 basis points to nine per cent to absorb surplus cash in the banking system as it seeks to quell demand and quash knock-on price hikes from higher fuel prices.
"Every time a medicine is given people find it bitter, but in the end everybody wants to be healthy," RBI Governor Yaga Venugopal Reddy told a news conference after the decision.
The move shocked the stock market, which closed down nearly four per cent. Bank stocks were particularly hard hit on worries higher borrowing costs would hurt loan growth and margins, while auto makers fell on concerns about sales.
Losses in shares helped knock the rupee lower against the dollar. It closed 0.2 per cent weaker at 42.64/65.
Government bond yields jumped to just short of a recent seven-year high of 9.55 per cent before ending 33 basis points up at 9.40 per cent as the prospect of tight cash conditions indicated limited funds available to invest in debt.
"These are big strides taken to cool down the economy by reducing demand pressures," said Indranil Pan, chief economist at Kotak Mahindra Bank.
Eight out of 10 analysts polled by Reuters after the decision expected the central bank to raise the lending rate by another 25 to 50 basis points by the end of the current fiscal year in March 2009. Three of them expected the next rate rise by October.
All 10 expected the central bank to raise the cash reserve ratio by 25 to 100 basis points by next March, with half seeing the next increase possibly by the next review in October.
Neighbouring Pakistan's central bank also hiked its key discount rate by one percentage point to 13.0 percent on Tuesday to reinforce its fight against inflation of more than 21 per cent and widening fiscal and current account deficits.
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