Indian stocks eased and bond yields rose to 18-month high on Monday as investors braced for further interest rate rises after the central bank unexpectedly lifted rates for the first time since the global crisis.
Analysts had expected the bank to raise key rates by 50 basis points at its policy review on April 20, and many now see it carrying out the remaining 25 basis points rate hike in April following the 25 basis points tightening late on Friday.
The Reserve Bank of India (RBI) cited intensifying inflationary pressures and a steady economic recovery as reasons for its action, but on Monday a central bank deputy governor and top government adviser said they expect inflation to ease in coming months.
"The RBI's rate hike shows that it expects inflation to get worse before it gets better, though the baby steps show that it is probably not as sanguine about growth as it would like to seem," said Sujan Hajra, chief economist at Anand Rathi Securities in Mumbai.
"In India double-digit inflation always has a political connotation and this move was designed to show that the RBI is acting upon inflation," he added.
The RBI has consistently been behind the curve regarding inflation projections, analysts note, with a broad expectation for at least 150 basis points tightening in the fiscal year to March 2011 if growth numbers are in line with projections.
However, Anand Rathi's Hajra said the RBI is unlikely to tighten policy by more than 100 basis points in 2010/11 as inflation is likely to ease and growth numbers could disappoint.
India's headline inflation topped expectations and came within touching distance of double digits in February, compared with the RBI's projection of 8.5 per cent at end-March.
BOND YIELDS UP
The yield on the benchmark 10-year bond rose 10 basis points to 7.93 per cent after briefly surging to 8.03 per cent, its highest since Oct. 8, 2008.
The main stock index fell as much as 1.4 per cent, led by financials, before cutting most of its losses.
"The market was getting complacent that the RBI was unlikely to act in between policy reviews," said B. Prasanna, CEO of ICICI Securities Primary Dealership.
A central bank deputy governor had ruled out any inter-meeting rate action.
"Since that has happened I think some kind of a re-rating will happen because of that, so yields will be headed higher as we go into the borrowing programme and the next policy and it will be a slow grind upwards," Prasanna added.
Markets are looking ahead to a central bank and finance ministry officials' meeting on March 29, where they will decide on the borrowing calendar for the first half of fiscal year 2010/11.
India is budgeted to borrow a record gross 4.57 trillion rupees ($100 billion) in the fiscal year starting April 1, and a majority of this is expected to be borrowed in the first half of the year.
The partially convertible rupee tracked local shares, and was at 45.490/495 per dollar, off a low of 45.54, and marginally above its previous close of 45.50/51 as stocks pared losses.
