India's central bank raises interest rates and hints at possible further increases

The increase in the key repo rate by 25 basis points to 6.5% was in line with expectations

A scaffolding at a construction site in Mumbai. The increase in India's repo rate is expected to affect house prices. Reuters

India's central bank raised its key interest rate by 25 basis points and indicated that it is open to the possibility of further rate increases, as core inflation stays elevated.

The increase in the key repo rate by 25 basis points to 6.5 per cent on Wednesday was in line with expectations.

But remarks by the governor of the Reserve Bank of India, Shaktikanta Das, which pointed to potential further tightening, surprised markets.

“We need to see a decisive moderation in inflation,” Mr Das said. “We have to remain unwavering in our commitment to bring down inflation.”

The RBI forecast inflation at 6.5 per cent in the April 2022 to March 2023 financial year, coming down to 5.3 per cent in the next financial year.

“Considerable uncertainties remain on the likely trajectory of global commodity prices, including [the] price of crude oil,” Mr Das said.

Despite this, he was upbeat about India's economy, saying that it was resilient.

The RBI is projecting gross domestic product growth of 6.4 per cent in the current financial year.

High inflation became a pressing issue last year in India, partly due to the effect on commodity prices of Russia's war in Ukraine.

Food prices also rose as crops were destroyed by extreme weather in parts of India.

To tackle high prices the RBI has raised interest rates six times, by a total of 250 bps, since May last year.

“The continued rate hikes by the Bank of England, the ECB [European Central Bank] and the US Federal Reserve and the implications of these in the foreign exchange market influenced the decision of the Reserve Bank of India to go for another rate hike,” said Sujan Hajra, chief economist and executive director at Anand Rathi Shares and Stock Brokers in Mumbai.

But its latest rate increase was smaller than previous increases, as inflation in India eased recently.

Retail inflation came down to a one-year low of 5.72 per cent in December on softening food prices.

This is within the RBI's target of keeping inflation between 2 per cent and 6 per cent.

Assuming that inflation remains under control, some economists expect Wednesday's rate increase to be the last change in the current cycle, despite the RBI's hints that it is open to further rate increases.

“Unless there is an unexpected flare in inflation, we would expect the Reserve Bank of India to maintain an unchanged policy rate for the remainder of 2023,” Mr Hajra said.

“This would be positive both for the debt and equity markets.”

But others believe there is scope for another small raise.

“Inflection points are always difficult to call, but I think that the rate hiking cycle of the RBI may not yet be over,” said Indranil Pan, chief economist at Indian private lender Yes Bank.

“We remain open to another 25 basis-point increase in the repo rate in April or even later and [the move] will critically depend on the inflation prints in the months ahead."

The latest rate increase will further raise the cost of borrowing as it gets passed on to consumers and businesses taking out loans.

“There is no denying the fact that the increase in the repo rate would definitely [affect] housing affordability,” said Ramani Sastri, chairman and managing director of Sterling Developers.

“The repeated rate hikes may have a short-term impact on overall housing demand. This comes at a time when the real estate sector had shown recovery.”

The benchmark S&P BSE Sensex gave up some of its earlier gains following the RBI's rate announcement, but it remained in positive territory in morning trade.

The India rupee was flat at about 82.6 against the US dollar.

But some analysts expect the rupee to weaken. It “now looks poised to see 83 or even 83.4”, said Anand James, chief market strategist at Geojit Financial Services.

A weaker rupee enables Indians working in the UAE and other GCC states to send more money home.

“Remittance growth for India in the first half [of the current financial year] was around 26 per cent, more than twice the World Bank’s projection for the year,” said the RBI's Mr Das.

“This is likely to remain robust owing to better growth prospects of the Gulf countries.”