India's central bank raised benchmark interest rates by a more-than-estimated 0.5 percentage point after forecasting inflation will stay at an "elevated level" until at least September. Stocks fell the most since February.
The Reserve Bank of India lifted the repurchase rate to 7.25 percent from 6.75 percent, according to a statement in Mumbai today. Only seven of 25 economists in a Bloomberg News survey had predicted the move, while the rest expected a quarter-point increase. The central bank boosted the reverse repurchase rate to 6.25 percent from 5.75 percent.
Inflation in India is the highest after Russia among the so-called BRICS economies and if left unchecked could rekindle public protests and undermine Prime Minister Manmohan Singh's government. Rising borrowing costs will slow India's economic growth this year and help ease inflation to 6 percent "with an upward bias" by March 31, 2012, Governor Duvvuri Subbarao said.
"We aren't going to see any reprieve from inflation in the coming quarters," said Sonal Varma, a Mumbai-based economist at Nomura Holdings Inc. "Elevated levels of inflation mean the rate-hike cycle will be prolonged further."
Indian stocks dropped the most among major indexes in the world, with the Bombay Stock Exchange's Sensitive Index losing 2.4 percent, the biggest decline since Feb. 24. The Indian rupee weakened 0.4 percent to 44.5175 per dollar, a one-week low.
David Fuller's view India's central
bank may feel that it had few choices other than to raise interest rates sharply,
if only to show intent and to deter an inflationary psychology from becoming
more entrenched. However, a tighter monetary policy is a blunt weapon for what
is mainly commodity price inflation, not least due to global food shortages
and higher energy costs.
The rate hike is not without repercussions for India's stock market. The Sensex Index (weekly & daily) has backed away from the psychological 20,000 level once again, falling back beneath the 200-day moving average in the process. A move above that level, breaking the progression of lower rally highs, is required to indicate that demand is regaining the upper hand once again. However, we are likely to see a further test of this year's lows before that occurs. The leading Bankex Index (weekly & daily) also weakened sharply today and the year's earlier lows need to hold if a more substantial correction is to be avoided.
India remains one of my favourite stock markets for the very long term. Consequently, it has been an overweight position in my personal investment portfolio since May 2003. I do not feel under pressure to lighten this position because I can ride out inevitable setbacks and I expect to see much higher levels over the longer term. If India weakens further, which it easily could before the central bank begins to lower rates once again, I would be tempted to increase my position.
I have previously mentioned that subscribers who are interested in India should only consider accumulating positions on weakness. That is still my view. (See also Robin Griffiths' comments on India, in his WIS report posted last Thursday.)