Pranab Mukherjee expects more rate increases

NEW DELHI: Further Indian interest rate increases are likely, the finance minister said on Wednesday and pledged support for the central bank's battle against inflation a day after a surprisingly sharp rate rise.

The Reserve Bank of India on Tuesday shocked markets by lifting interest rates by 50 basis points, double what was expected, and kept up its hawkish stance.

"I don't think we have reached the end of tunnel," Finance Minister Pranab Mukherjee told reporters on Wednesday, referring to the central bank's rate tightening cycle.

The Reserve Bank of India has raised rates 11 times since March 2010 to fight nearly double-digit inflation which has been fuelled in part by bottlenecks in the economy, government spending and borrowing.

The central bank's rate increases over the past year make it the most aggressive inflation fighter anywhere. Headline inflation in India was 9.44 percent in June and is expected to remain high in coming months.

Tuesday's rate rise sent bond yields and swap rates surging, battered stocks, drew criticism from companies worried about higher borrowing costs and prompted economists to cut their growth outlooks for Asia's third-largest economy.

On Wednesday, India's benchmark 10-year bond yield hit its highest level in almost three years after having risen 15 basis points on Tuesday, following the hefty rate increase. Indian stocks continued their slide, losing nearly 0.5 percent, and are down 10 percent in 2011.

Whereas officials in New Delhi once spoke of a return to double-digit growth, the government of Prime Minister Manmohan Singh appears to have become resigned to the need to control rising prices, which threaten to derail longer term growth.

"Appropriate measures will be taken," Mukherjee said, referring to government support of the central bank's policy action, without giving specifics.

A Reuters poll after Tuesday's rate rise found analysts expect another 50 basis points in rate rises by the end of 2011, which would put the repo rate at 8.50 percent, or half a point higher than had been expected last week.

Still, there is plenty of disagreement over the RBI's next moves, with Goldman Sachs among those predicting that the central bank will probably refrain from further near-term rate increases, a view supported by the inverted curve on Indian swap rates.

"The market is getting over the shock and trying to sense if there's more coming. Base case would be another 25 basis point hike, and then the assumption has to be that we are at the end of this cycle," said Hitendra Dave, head of global markets at HSBC India.

Standard Chartered cut its India GDP growth forecast for the fiscal year that ends in March to 7.7 percent from 8.1 percent following the rate hike. Kotak cut its growth forecast for the current fiscal year to 7.3 percent from 7.7 percent, among the lowest expectations in the market.

Copyright Reuters, 2011