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Updated Wednesday, July 28, 2010 12:21 am TWN, By Erika Kinetz, AP

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India hikes key interest rates more than expected

The bank said it is concerned that a faltering global economy could crimp trade, hitting India's manufacturing and service sectors. A bigger worry, however, is that growing risk aversion would keep foreign investors out of India, slowing capital inflows needed to fund the nation's widening current account deficit.

The bank has hiked policy rates by three quarters of a percentage point this year, but still has a way to go before getting back to pre-crisis levels. To stave off the Great Recession, the Reserve Bank of India cut the reverse repo rate by 2.75 percentage points, to 3.25 percent, and the repo rate by 4.25 percentage points, to 4.75 percent.

“It's a thin line which the RBI is making,” said Shishir Bajpai, a senior vice president in private wealth management at Mumbai's IIFL Capital. “On one side, the government doesn't want to dilute high GDP growth. On the other, it is very concerned about high inflation.”

The bank, he said, came down heavily on inflation and may raise rates further in September if food prices don't ease. But there is only so much monetary policy can do to curtail spiraling prices, which have been driven by rains, global commodities markets and supply side constraints.

“There are parts of inflation that can't be contained,” Bajpai said. “There's a lot of supply side problems and huge demand growth. Just increasing the rate — as RBI also knows— won't itself curtail inflation. But it has to do what it can.”

The bank said the government's recent decision to partially deregulate oil and gas prices will add one percentage point to headline inflation. Higher minimum payments to farmers will further fuel price rises.

The bank also said that given the rapidly evolving economic situation, it would conduct policy reviews every six weeks, instead of every quarter.

Investors took the news in stride. The benchmark Sensex index ticked up 0.4 percent after the bank's announcement, before settling back to 18,075.7 points, up 0.3 percent in midday trade on the Bombay Stock Exchange.

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