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India leaves interest rates on hold

India’s central bank left interest rates and the cash reserve ratio for banks unchanged on Monday, defying widespread expectations for a rate cut as it warned that doing so could worsen inflation, disappointing markets.

The Reserve Bank of India kept its policy repo rate unchanged at 8 percent and left the cash reserve ratio for banks at 4.75 percent.

“Further reduction in the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressures,” the RBI wrote in its mid-quarter policy review.

Indian bond prices and stocks dropped while the rupee weakened against the dollar after the RBI’s unexpected decision to hold rates steady.

The benchmark 10-year bond yield rose 9 basis points to 8.43 percent from levels before the announcement, while the new 10-year bond yield rose about 7 basis points. The main BSE index erased gains to fall 0.6 percent from before the decision.

“The Reserve Bank of India’s action is clearly disappointing,” said Sujan Hajra, chief economist at Anand Rathi Securities in Mumbai.

“Inflation remains a concern, but the slowing growth needed at least a 50-basis-point rate cut. The RBI will have to ease sooner or later, otherwise there will be further challenges to growth,” he said.

After cutting its policy rate by 50 basis points in April, the Reserve Bank of India had been widely expected to leave rates unchanged in June. But global and domestic economic conditions have deteriorated sharply since then, driving expectations for a cut in both interest rates and the cash reserve ratio.

India’s March quarter economic growth of 5.3 percent was far worse than expected and the weakest annual pace in nine years. The data sparked calls from industry for immediate action to lift an economy that Standard & Poor’s says could be the first BRIC nation to lose its investment-level credit rating.

April industrial output figures last week suggested little pickup in economic growth heading into the current quarter.

The government is politically hamstrung, so is unable to drive reform and its deep fiscal deficit leaves it no room to provide stimulus spending at a time when the euro area debt crisis is weighing on the global economy, a factor set to dominate a G20 meeting in Mexico on Monday and Tuesday.

However, RBI Governor Duvvuri Subbarao had less room for maneuver after May benchmark inflation rose to 7.55 percent, the highest among industrialised countries and the BRIC group of Brazil, Russia, India and China.

Investors and companies have long called for India to implement pro-growth policies that would spur investment and help remove bottlenecks in the economy blamed both for restricting growth and keeping inflation high.