India hikes rates as onions bring tears to investors’ eyes

NEW DELHI — Reserve Bank of India (RBI) Governor Raghuram Rajan surprised markets in his maiden policy review yesterday by raising interest rates to ward off rising inflation as surging onion prices reduced investors to tears.

The new Governor raised the RBI’s policy repo rate by 25 basis points to 7.5 per cent, defying widespread forecasts that he would leave it unchanged to bolster a sluggish economy, as he struck a hawkish tone.

“The need to anchor inflation and inflation expectations has to be set against the fragile state of the industrial sector and urban demand … The Reserve Bank will closely and continuously monitor the evolving growth-inflation dynamics with a readiness to act pre-emptively as necessary,” he said in his first policy statement after taking office on Sept 4.

The decision rocked markets: The Mumbai Sensex fell 1.9 per cent, with banking counters leading losses. Bonds slipped, the yield on government 10-year notes rising 24 bps to 8.4 per cent, while the rupee dropped 0.4 per cent to 62.0425 per United States dollar.

Headline inflation, measured by the wholesale price index, shot to a six-month high of 6.1 per cent last month, while consumer prices rose 9.5 per cent, hardening the case for the central bank to keep interest rates firm.

Of particular concern was the massive 18.2 per cent jump in food prices, with onion costs surging 245 per cent, official data showed earlier this week.

Political parties have won and lost elections in India over the cost of onions, the key ingredient used to make spicy masala that goes into dishes from curries to briyani.

The RBI yesterday also rolled back some of the steps that had been imposed to support a currency that had fallen as much as 20 per cent to a record low late last month, reducing the marginal standing facility (MSF) rate by 75 bps to 9.5 per cent.

The central bank lifted the MSF rate to 10.25 per cent in mid-July to tighten market liquidity and stabilise the rupee and the MSF has since been treated by the market as the effective policy rate.

Mr Rajan said he wanted the repo rate to resume its place as the operational policy rate as the rupee support measures were unwound. AGENCIES