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India set for ninth rate hike to cool inflation

business Updated: May 01, 2011 10:06 IST

India, which has the highest inflation of any large Asian economy, looks set this week to hike interest rates for a ninth time despite mounting concern over the impact of monetary tightening.

The central bank has raised rates eight times since March 2010, albeit in gradual, quarter-point steps to minimise the impact on economic growth.

But inflation has remained high and some economists expect Reserve Bank of India (RBI) policymakers to move more aggressively when they meet on Tuesday.

"A 50-basis-point rate rise wouldn't surprise me -- inflation is proving stubbornly difficult to reduce," Deepak Lalwani, head of London-based India investment consultancy Lalcap, told AFP.

"It's time to step it up," agreed HSBC chief India economist Leif Eskesen.

Others bet the bank will stick to its "slowly, slowly approach" and only hike by a quarter point as it seeks to balance growth and inflation concerns.

The RBI meeting comes after data in April showed inflation had surged to nearly nine percent.

The Asian Development Bank has said controlling inflation must be the Asian region's top priority as strong growth, turmoil in the Middle East and Japan's nuclear crisis drive up food and oil prices.

Asian economies from South Korea, Indonesia, Taiwan to China are all battling inflationary pressures.

But some economists are concerned that India's central bank may push too hard on the brakes.

The benchmark repurchase, or repo rate, at which the bank lends to commercial banks, is 6.75% while the reverse repo, paid to banks for deposits, is 5.75%.

"The bottom line is the central bank needs to act but it should not go overboard," said CLSA economist Rajeev Malik. "It must avoid a repeat of the mid-1990s outcome of killing inflation by crippling growth."

The government has said it expects the economy to expand by nine percent in the current fiscal year, returning to levels it reached before the global financial crisis.

But there are already fears that Asia's third-largest economy will undershoot the target because of interest rate increases.

Investment house Goldman Sachs has already slashed its growth forecast for the year to March 2012 to 7.8% from 8.7%. Credit Suisse economist Robert Prior-Wandesforde has trimmed his expansion forecast to 7.5%.

The economy is already showing signs of slowing with an 18% year-on-year drop in capital goods output in February, trimming industrial production growth to 3.6%.

Inflation, fed by food and fuel price rises, has been one of the biggest headaches for the Congress-led government headed by Premier Manmohan Singh, whose coalition is also reeling from a string of corruption scandals.

Reducing prices is a political priority even as higher growth is seen as key to reducing crushing poverty in the nation of 1.2 billion.

Poorer households, the backbone of the party's support, have been especially hard hit by inflation, a traditional lightning rod for political discontent.

"Inflation is the most important short-term problem," said Montek Singh Ahluwalia, deputy head of India's influential economic Planning Commission, who has urged the central bank to use "all the flexibility" at its disposal.

Former central bank governor YV Reddy said the Reserve Bank cannot afford any let up in its anti-inflation fight -- even if it means slower growth.

"Tell me any single period when we have had higher growth and higher inflation. It just does not happen that way and it is a wrong policy. What we need is low inflation and if it demands low growth, so be it," Reddy said.