India raises interest rates over capital outflow fears

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."