RBI unexpectedly raises rates; trims rupee support steps

By Tony Munroe and Suvashree Dey Choudhury

MUMBAI (Reuters) - Reserve Bank of India (RBI) Governor Raghuram Rajan surprised markets in his maiden policy review on Friday by raising interest rates to ward off rising inflation, while scaling back some of the emergency measures recently put in place to support the ailing rupee.

Rajan, who took office early this month amid worst economic crisis since 1991, increased the RBI's policy repo rate by 25 basis points (bps) to 7.50 percent, defying most forecasts that he would leave the rate on hold to bolster a sluggish economy.

As expected, the former IMF chief economist struck a hawkish tone on price pressures in Asia's third-largest economy.

He was non-committal about the direction of the next policy rate move but said he intends to continue withdrawing liquidity tightening steps that had been implemented to stabilise the currency as market conditions allow.

While raising the traditional policy rate, Rajan freed up market liquidity with a three-quarter point cut in an overnight borrowing rate that the central bank had temporarily raised by 200 bps in July to support the rupee.

"In our view, the RBI has risked sending a confused signal to markets, and the withdrawal of tightening measures may be premature," Goldman Sachs economist Tushar Poddar wrote, adding that he expects the rupee to remain under pressure.

However, several traders said they expected the rupee to soon to resume its recent recovery from a record low on August 28, propelled by the U.S. Federal Reserve's decision not begin tapering its stimulus, as well as the Indian rate hike.

On Friday, the rupee fell, while stocks and bonds also weakened.

Despite an economy that grew at just 4.4 percent in the June quarter, its weakest in four years, Rajan opted to increase policy interest rate for the first time in nearly two years, following similar moves by Indonesia and Brazil, whose currencies have also been hit by heavy capital outflows in recent months.

The wholesale price index (WPI) inflation rose to a six-month high of 6.1 percent in August, with consumer price inflation (CPI) at 9.52 percent.

"In the absence of an appropriate policy response, WPI inflation will be higher than initially projected over the rest of the year," Rajan, 50, said in a policy statement that reaffirmed his penchant for surprise.

In his first day on the job, Rajan unexpectedly outlined an action plan to revive the rupee and bolster financial markets and the banking system.

"What is equally worrisome is that inflation at the retail level, measured by the CPI, has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence," he said.

While Indian growth rates are less responsive to interest rate changes than in some countries, Indian voters are highly sensitive to inflation. Several states hold elections in coming months, with the general election due by May.

"What's clear now is that Rajan is very focused on containing inflation and the currency, and that means high interest rates until we see prices coming down and a greater fiscal discipline," said Aneesh Srivastava, Chief Investment Officer, of IDBI Federal Life Insurance.

For full coverage on the RBI review, click http://in.reuters.com/subjects/rbi-policy-review

ROLLING BACK RUPEE SUPPORT

The rupee fell as much as 20 percent this year to a record low in late August as investors pulled money from emerging markets ahead of an expected move by the Fed to begin scaling back its massive stimulus.

It has recovered some of those losses since Rajan took over at the RBI amid high expectations on September 4, gaining about 9 percent through Thursday.

"The statement clearly has a strong hawkish bias as it states that with a relatively more stable exchange rate, monetary policy formulation will be determined once again by internal determinants viz inflation and fiscal deficit," said Anubhuti Sahay, economist at Standard Chartered in Mumbai.

The Fed's surprise move to forge ahead with its easy money policy gave Rajan extra space to roll back some of the steps imposed to bolster a currency that had been the worst performer in Asia, dragged down by investor worries over the country's record current account deficit.

Rajan, who famously forecast the global financial crisis, said on Friday that domestic drivers of the rupee now take precedence: "The focus has turned to internal determinants of the value of the rupee, primarily the fiscal deficit and domestic inflation.

The RBI on Friday reduced the marginal standing facility (MSF) rate to 9.50 percent, which makes borrowing cheaper for banks. Since mid-July, the MSF has been widely been viewed as India's effective policy rate.

Rajan said on Friday he wants the repo rate to resume its place as the operational policy rate as temporary rupee support measures are unwound, returning the gap between the repo rate and the MSF rate to its customary 100 basis points.

"It could be that we walk (move) more on the MSF side, but it could be that the repo rate will do some of the walking. I want to be at this point entirely neutral on what the next step would be. It would be dependent on economic conditions," he told a media briefing.

(Additional reporting by Neha Dasgupta, swati Bhat, Subhadip Sircar, Archana Narayanan, Aradhana Aravindan and Himank Sharma; Editing by Kim Coghill)

Matches

MORE TOP STORIES TODAY

Srinivasan named in fixing report: SC

Srinivasan named in fixing report: SC

The court emphasised that the tainted administrator can no longer work for the BCCI. More »

On-field action set to divert from off-field drama

On-field action set to divert from off-field drama

The Preview — Defending champions Mumbai Indians take on Kolkata Knight Riders More »

Why I'm not looking forward to the IPL

Why I'm not looking forward to the IPL

Welcome to another season of a league that many watch but few trust. More »

'If you do the wrong thing it will be found out'

'If you do the wrong thing it will be found out'

'Everyone knows what is right and what is wrong and if you do the wrong thing it will be found out' More »

Mitchell Johnson may quit T20s for Test cricket

Mitchell Johnson may quit T20s for Test cricket

Australia's Mitchell Johnson may quit limited-overs cricket to prolong his test career with an eye on the 2015 Ashes series in England, the fast bowler… More »

There's a lot going on: Fleming

There's a lot going on: Fleming

He experienced anxious moments in the lead-up to the tournament as the courts decided on whether to suspend the franchise, he said, but stressed that the… More »

Latif couldn’t work with tainted players

Latif couldn’t work with tainted players

Former Pakistan cricket captain Rashid Latif said Tuesday he turned down the job of national chief selector because he could not work with ex-players tainted… More »

We are not over-confident: Bailey

We are not over-confident: Bailey

Indian Premier League — George Bailey-led Kings XI Punjab will face Chennai Super Kings on Friday. More »

Taxing issue — BCCI hits roadblock

Taxing issue — BCCI hits roadblock

MoU between BCCI & its units to avoid double taxation delayed after a few decline to share details. More »

Big runs expected, with bat and ball

Big runs expected, with bat and ball

Royal Challengers Bangalore: Their main concern, once again, is the fast bowling More »

Srinivasan appeals to court to allow BCCI comeback

Srinivasan appeals to court to allow BCCI comeback

He was aggrieved by the allegations against him during the hearing. More »

Black Caps pick rookie duo for West Indies

Black Caps pick rookie duo for West Indies

New Zealand selectors included two new caps in a 15-man Test squad named Tuesday to tour the West Indies, with injury-hit spinner Dan Vettori's future… More »

India: cricket's Brazil

India: cricket's Brazil

They are tough to beat with a big talent base exposed to good facilities. (CYCSPL) More »

Delhi Daredevils say no to gifts

Delhi Daredevils say no to gifts

Franchises are doing their bit to refurbish the image of the tainted league. More »

Klinger on his exit from South Australia

Klinger on his exit from South Australia

Michael Klinger has revealed he felt compelled to leave South Australia after being told he would be only a fringe part of the Redbacks' plans for next season, and disputed the suggestion that he left… More »

India-Pakistan Test series likely in 2015

India-Pakistan Test series likely in 2015

The revival of Indo-Pak Test ties could take place in UAE. More »

Kohli hopes to end RCB trophy drought

Kohli hopes to end RCB trophy drought

'This time around we will hope to go few more steps ahead and actually get that trophy' More »

Gavaskar can help IPL regain glory

Gavaskar can help IPL regain glory

Apart from the foreign players a lot of behind-the-scene activity has taken place in selecting the Indian domestic players. More »

Tendulkar, Ganguly to promote soccer

Tendulkar, Ganguly to promote soccer

Leading Spanish club Atletico Madrid and former cricketers Sachin Tendulkar and Sourav Ganguly are among the owners of eight franchises of a new Indian… More »

This isn’t my first trip to India: Neesham

This isn’t my first trip to India: Neesham

Kiwi all-rounder wants to utilise the India leg to explore the country’s tourist attractions. More »

Ishant wanted to quit ODIs

Ishant wanted to quit ODIs

Says his mother made him change his mind. More »

Supreme Court says no to BCCI’s request

Supreme Court says no to BCCI’s request

Bench refuses to grant access to recordings of Srini and Dhoni’s depositions before Mudgal committee. More »

Pietersen’s ‘little’ secret is out

Pietersen’s ‘little’ secret is out

A fractured little finger could now throw the Delhi Daredevils captain out of action at the start of this season. More »

SMA Trophy gets short-changed

SMA Trophy gets short-changed

Key players are away preparing for the IPL, taking the shine off the other domestic T20 fixture. (CYCSPL) More »