RBI Policy Seeks to Reign in Inflation

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July 30 – India's central bank acted to clamp down on the country's soaring inflation yesterday by aggressively tightening key interest rates and bringing in curbs on lending.

It also lowered the projection for India's economic growth from 8.5 percent to around 8 percent.

The Reserve Bank of India increased its benchmark interest rate – the rate at which it makes short-term loans to commercial banks – half a point to 9 percent. This was a quarter more than analysts had expected and puts rates at a seven-year high.

At the same time it increased the so-called cash reserve ratio, or the share of deposits that banks must keep on hand, by 25 basis points, to 9 percent. Experts told The Independant that both steps can help lower inflation.

Inflation has quickly become a serious problem for India. Earlier this month it hit a 13-year high when it reached 11.89 per cent after a series of increases in the cost of petrol, cotton, rice and building materials.

"A realistic policy endeavour would be to bring down inflation from the current level of about 11-12 percent to a level close to 7 percent by March 31, 2009," said the bank's governor, Venugopal Reddy. "Inflation has emerged as the biggest risk to the global outlook, having risen to very high levels across the world, levels that have not been generally seen for a couple of decades."

Soaring costs have created political problems for the government headed by Prime Minister Manmohan Singh, whose term as India’s finance minister in the 1990s is credited with introducing many of the economic reforms responsible for the country's impressive growth.

The Indian industry also gave a thumbs down to the Reserve Bank's monetary policy aimed at reigning inflation saying it will dampen growth and dent business confidence as well as investments in the country.

The markets reacted sharply, tumbling over 540 points at mid-session, to the Reserve Bank's move to hike key short-term inter-bank lending rate and mandatory cash reserve requirement by 0.50 percent and 0.25 percent respectively. The BSE index closed the day at 13,791.54, down by 557.57 points.