India Unexpectedly Tightens, Flags Cash Tools to Curb Prices

(Bloomberg) -- India unexpectedly raised the reverse repo rate while keeping the benchmark unchanged, effectively tightening policy to step up the fight against accelerating inflation. Bonds fell.

The reverse repo rate was raised to 6 percent from 5.75 percent while the benchmark repurchase rate was kept steady at 6.25 percent, the Reserve Bank of India said in a statement in Mumbai on Thursday, citing excess funds in the banking system after the government's clampdown on cash. No economist in Bloomberg surveys had predicted the move to shrink the corridor.

"Underlying inflation pressures persist, especially in prices of services," the RBI said in the statement, reiterating its neutral stance. "The future course of monetary policy will largely depend on incoming data on how macroeconomic conditions are evolving."

The move follows tightening by the U.S. Federal Reserve and continues a string of surprises at the RBI under Governor Urjit Patel that culminated in February with a shift to a neutral monetary stance from accommodative. Surplus funds in the banking system also risk intensifying price pressures and imperiling the RBI's 4 percent target.

Bonds fell and the rupee erased losses. The yield on the 6.97 percent government note due 2026 jumped 10 basis points to 6.75 percent as of 3:27 p.m. in Mumbai, set for the biggest increase in two months. The rupee was little changed at 64.8550 a dollar.

Key points from the statement

• Inflation to average 4.5 percent April-September and 5 percent in October-March, above the 4 percent midpoint of the central bank's target range
• Gross value added -- a key input of GDP -- is seen picking up to 7.4 percent in in the year started April 1 from 6.7 percent the previous year
• Banks have scope to further lower borrowing costs; "along with rebalancing liquidity conditions, it will be the Reserve Bank's endeavour to put the resolution of banks' stressed assets on a firm footing"
• While cash withdrawals will ease the surplus in the banking system, the RBI vowed to manage the rest with a mix of tools including reverse repo and open market auctions, market stabilization scheme bonds. It also said a proposed new deposit window -- Standing Deposit Facility -- would offer it greater flexibility

"This is a hawkish statement and it shows that they are concerned on the inflation front," said Anjali Verma, an economist at PhillipCapital. "They seem to be worried about the monsoon," the impact of a nationwide sales tax to be rolled out this year and higher salaries for government employees, she said.

Policy makers are grappling with an influx of deposits after the demonetization, which limits the RBI's ability to intervene in the foreign-currency market and rein in a rallying rupee. While a stronger currency lowers India's import bill and curbs inflation, runaway gains risk halting a recent export recovery.

All six members of the RBI's rate-setting panel voted in favor of the decision. Among economists surveyed by Bloomberg, all 52 had predicted a hold on the key repurchase rate; 43 of 45 saw no change in the reverse repo while the rest forecast a cut.

--With assistance from Manish Modi and Shikhar Balwani

To contact the reporter on this story: Anirban Nag in Mumbai at anag8@bloomberg.net.

To contact the editors responsible for this story: Ruth Pollard at rpollard2@bloomberg.net, Jeanette Rodrigues, Jacqueline Thorpe