* Focus turn more to inflation than economic growth
* RBI raises policy repo rate by 25 bps to 7.50 pct
* RBI cuts marginal standing facility rate by 75 bps to 9.50
* Bonds, rupee, stocks all weaken after policy rate hike
By Tony Munroe and Suvashree Dey Choudhury
MUMBAI, Sept 20 Reserve Bank of India 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 put in place
to support the ailing rupee.
Rajan, who took office early this month amid India's worst
economic crisis since 1991, increased the RBI's policy repo rate
by 25 basis points (bps) to 7.50 percent, defying
widespread 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 but was non-committal about the direction of the next
policy rate move and said he intends to withdraw liquidity
tightening steps that had been implemented to stabilise the
currency as soon as market conditions allow.
Despite an economy that grew at just 4.4 percent in the June
quarter, its weakest in four years, Rajan opted to increase
India's 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
India's 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 his policy statement.
"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 sensitive to interest
rate changes than some other countries, Indian voters are very
sensitive to inflation, and there are several important state
elections over coming months and a general election due by May.
Indian federal bonds, the rupee and stocks all extended
losses after the RBI decision.
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 U.S. Federal
Reserve to begin scaling back its massive stimulus programme.
It has recovered some of those losses since Rajan took over
at the RBI amid high expectations on Sept. 4, gaining about 9
percent through Thursday, helped by the Fed's unexpected
decision this week to hold off on tapering its bond purchases.
"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.
ROLLING BACK RUPEE SUPPORT
The Fed's surprise move to forge ahead with its current easy
money policy gave Rajan an extra cushion 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
The RBI on Friday reduced the marginal standing facility
(MSF) rate by 75 bps to 9.50 percent, which makes borrowing
cheaper for banks. It had raised the MSF rate to 10.25 percent
in mid-July to tighten market liquidity and bolster the rupee,
and the MSF had been widely regarded as the effective policy
Rajan said he wanted the repo rate to resume its place as
the operational policy rate as the 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.
Also on Friday, the RBI partially scaled back the minimum
cash balance requirement that banks must keep with the central
bank on a daily basis.
"The hike in repo rate has partially dented the positive
impact of the reduction in MSF rate by 75 bps and relaxation in
CRR (cash reserve ratio) maintenance requirement," Standard
Chartered's Sahay said.