MUMBAI (REUTERS) - The Reserve Bank of India unexpectedly raised its policy interest rate on Tuesday by 25 basis points but said that if consumer price inflation eases as projected it does not foresee further near-term tightening.
The policy decision was driven by an expectation that consumer price index (CPI) inflation will remain high, an indication that the RBI is looking to adopt a recent proposal to base its policy rate decisions on a CPI target.
The RBI raised its policy repo rate by 25 basis points to 8.00 per cent.
Most economists in a Reuters poll conducted last week had expected no change in rates. However, expectations for a rate hike had increased after a central bank panel proposed to make CPI the main inflation benchmark.
Indian bonds, stocks and the rupee fell after the rate hike but soon recovered most losses on the back of the dovish statement. The benchmark 10-year bond yield which rose as much as 9 basis points following the hike, retreated entirely to continue trading down 5 bps on the day at 8.72 per cent.
"For now, this should mark the peak of the rate hike cycle, with the central bank's growth projections close to our conservative estimates at 4.8 per cent for FY14 and 5.3 per cent for FY15," said Radhika Rao, economist at DBS Bank in Singapore.
The CPI eased to a three-month low of 9.87 per cent in December but remains well above the central bank's policy repo rate of 7.75 per cent, and the RBI said on Tuesday that consumer inflation risks remain to the upside.
Last week, a central bank panel proposed revamping its monetary policy structure by setting a CPI inflation target of 4 per cent, plus or minus 2 per cent, over the long term, with a goal of trimming CPI to 8 per cent by January 2015 and 6 per cent by January 2016.
"An increase in the policy rate ... will set the economy securely on the recommended disinflationary path," the RBI said in a brief policy statement.
"If the disinflationary process evolves according to this baseline projection, further policy tightening in the near term is not anticipated at this juncture," it said.
The wholesale price index, long the RBI's main price barometer, slowed to 6.16 per cent in December.
"It seems like RBI has implicitly accepted the (panel) recommendations implying continued focus on CPI going ahead,"said Upasna Bhardwaj, economist at ING Vysya Bank, referring to the central bank panel on revamping monetary policy.
Mr Rajan faces the daunting challenge of reviving an economy growing at a decade low of around 5 per cent while battling persistently rising prices, much of which has been fuelled by supply-side shortages beyond the control of monetary policy.
The RBI said CPI inflation is likely to stay above 9 per cent during the final quarter of the fiscal year that ends in March, ranging between 7.5 per cent and 8.5 per cent for the quarter that ends in March 2015, "with the balance of risks tilted on the upside." It also said Indian economic growth is likely to fall short of its earlier projection of 5 per cent this fiscal year, improving to 5-6 per cent in the year that starts in April.