India surprisingly raised interest rates yesterday to dampen inflation, saying it was now better prepared to deal with the risk of major capital outflows roiling emerging economies. The Reserve Bank of India (RBI), however, said that if retail inflation eased as projected, it did not foresee further near-term monetary policy tightening. India's rupee sank 11 per cent against the US dollar last year as emerging markets sold off sharply after the US central bank announced it would taper an aggressive bond-buying programme that had fuelled global demand for risk assets. India's 25 basis point rate increase was driven by expectations of high but moderating inflation, an indication that the central bank intends to adopt a recent proposal to base its rate decisions on a consumer price index (CPI) target. RBI governor Raghuram Rajan faces the daunting challenge of reviving an economy growing at its slowest pace in a decade while battling stubbornly rising prices, especially for food, fuelled by supply-side shortages beyond the control of monetary policy. HSBC economist Leif Eskesen said he expected more rate increases from the RBI. "This was the right decision, but it does not constitute the end to the tightening cycle, in our view," he said. "If RBI wants to knock out core inflation, the policy rate will likely have to be hiked further." The RBI raised its policy repo rate to 8 per cent amid market worries over slowing growth in China and the prospect of further tapering of US stimulus. "We have injected some medicine, 75 bps in rate hikes since September, and we have to watch to see how that medicine works along with, again, the weak state of the economy as well as the stabilisation of the rupee," Rajan said. Lifting rates lends support to an Indian currency which strengthened slightly yesterday. The Indian economy, which not long ago aspired to double-digit growth, has been weakened by sluggish investment and persistent inflation in recent years. Most economists polled last week had expected no change in rates. However, expectations for a rate rise had increased after a central bank panel proposed to make CPI the main inflation benchmark. "For now, this should mark the peak of the rate hike cycle, with the central bank's growth projections close to our conservative estimates," said Radhika Rao, an economist at DBS Bank. The RBI said economic growth was likely to fall short of its earlier projection of 5 per cent this fiscal year and improve to 5 to 6 per cent in the year that starts in April. The CPI eased to a three-month low of 9.87 per cent last month, well above the wholesale price index (WPI), long the RBI's main price barometer, which slowed to 6.16 per cent.