India's central bank may have picked the rock over the hard place on Tuesday, hiking interest rates to control inflation despite slowing economic growth, but economists don't expect prices to react any time soon.
"India has had a structural inflation problem for some time now. Some of the pricing mechanisms in this economy have broken down. Policy needs to be kept relatively firm for an extended period to bring down inflation expectations," Glenn Maguire, chief economist for Asia-Pacific at ANZ, said in a phone interview with CNBC.
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The RBI raised the benchmark repo rate by 25 basis points to 7.75 percent Tuesday, in line with expectations, after hiking the rate by 25 basis points in September.
India's economic growth has slowed sharply from around 8 percent annually between 2002 and 2012 to about 5 percent for 2012-13, compared to the U.S. economy which grew at a 2.5 percent annual rate from April through June, while China's gross domestic product climbed 7.8 percent in the third quarter.
Meanwhile, India's wholesale price index for September rose to a seven-month high of 6.46 percent, while the consumer price index grew at 9.84 percent, its fastest pace in three months, driven in part by higher food prices, including a 322 percent jump in onion prices.
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"It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth," Raghuram Rajan, who took the helm as Reserve Bank of India (RBI) governor in early September, said in a RBI statement Tuesday.
"Curbing mounting inflationary pressures and managing inflation expectations will help strengthen the environment for growth by fostering macroeconomic and financial stability."
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But economists expect India's growth and inflation outlook will only transition slowly.
While the central bank expects economic growth to pick up in the second half of the current fiscal year, "the RBI is overestimating the size and underestimating the time it takes for interest rate moves to impact price increases," said Robert Prior-Wandesforde, an economist at Credit Suisse, in a note.
He expects it will take 12-18 months for monetary tightening to affect real economic activity. Credit Suisse forecasts India's gross domestic product to grow 5.4 percent for the current fiscal year, before climbing to 6.5 percent in the 2014-15 fiscal year.
Analysts say Rajan has a tough task on his hands. On the one hand, the central bank wants to reassure markets that it will do all it can to keep inflation under control, but there is also some concern that raising rates too high could put further pressure on a slowing economy.
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