India central bank surprises by keeping rates steady

Was rupee's stabilization behind RBI's decision?

The Reserve Bank of India (RBI) has kept interest rates unchanged at 7.75 percent on Wednesday, defying expectations of a hike and triggering speculation that the RBI's rate hike cycle may be over.

Analysts had been expecting the central bank to raise the benchmark repo rate by 25 basis points after inflation in November accelerated 7.5 percent, versus analysts' forecast of 7 percent, sparking fears of stagflation.

(Read more: India inflation speeds up to 14-month high of 7.52%)

But the inaction could mean that the central bank's focus remains on economic growth.

"Going forward, we expect rates to remain on hold for some time...the economy is still yet to feel the effects of rate hikes implemented in earlier months," Daniel Martin, Asia economist at Capital Economics wrote in a note.

Reserve Bank of India entrance in Mumbai, India
Kuni Takahashi | Bloomberg | Getty Images

"Given that the economic recovery still very fragile, we think the RBI will be patient with inflation. As long as it starts to come down at the start of next year, more rate hikes are unlikely," he said.

(Read more: India market euphoria could end in disappointment)

Stabilization in the rupee and falling global commodity prices should temper import price inflation, Martin said. While, this year's good monsoon will likely help to bring down food price inflation.

Despite holding fire, the RBI said it would remain vigilant on inflation and will be ready to act if necessary. "The policy decision is a close one. Current inflation is too high," the RBI said in a statement.

The central bank added that it will monitor the financial impact of any decision by the U.S. Federal Reserve to scale back on its massive bond buying program. The U.S. central bank will announce its rate decision tonight.

India's benchmark Sensex index shot up over 1 percent following the decision, while the rupee rose 0.3 percent to 61.8 per dollar following the news.

According to Robert Prior-Wandesforde, director of Asian economics research at Credit Suisse, the central bank is likely delaying the inevitable and another rate increase is only a matter of time.

"With the Fed set to announce its tapering decision tonight, the bank could be forced into a quick intra-meeting move if the rupee were to take a renewed battering as a result," he said.

Prior-Wandesforde's base case is for a 25 basis point rate hike at the RBI's next policy meeting next month.