India's central bank kept its policy rate on hold on Wednesday and unexpectedly signaled an end to its longest easing cycle since the global financial crisis, saying inflation poses a bigger threat to the economy than a crackdown on "black money."
After keeping the repo rate on hold at 6.25 percent for a second meeting in a row, the RBI also changed its stance to "neutral" from "accommodative", stunning bond investors who had bet the RBI would ease by 25 basis points, either this week or at its next policy review in April.
The new stance could effectively mark an end to a period in which the RBI cut interest rates by a total of 175 bps from January 2015 to October 2016, starting with previous Governor Raghuram Rajan and continuing under Urjit Patel.
The vote by the monetary policy committee to hold rates steady was 6-0, marking its third straight unanimous decision since being established in September.
It is a decision that differs sharply with some private forecasters, who believe the RBI is under-estimating the impact of the cash crackdown.
"It's quite disappointing that RBI has come out with a strongly hawkish policy at a time when growth slowdown has become very acute in the aftermath of demonetization," said Rupa Rege Nitsure, group chief economist at L&T Financial.
A Reuters poll last week showed 28 of 46 participants had expected the RBI to cut the rate by 25 bps to its lowest since November 2010. Analysts had warned it could be a close call but the change in stance jolted investors.
Benchmark 10-year bond yields rose by as much as 34 bps, the biggest single-day rise since September 2013.
Many analysts were expecting a rate cut from the RBI by April given inflation fell to a two-year low of 3.41 percent in December, below the central bank's medium-term target of 4 percent.
But the RBI dashed those hopes, saying on Wednesday the fall was largely on the back of a decline in volatile food prices, and warned core inflation had been "unyielding" at 4.9 percent since September.
The RBI also said it wanted more time to gauge the impact of global risks on the rupee, which fell more than 2 percent against the dollar last year as expectations of higher U.S. interest rates triggered a flood of capital outflows from emerging markets.
In holding the line, the RBI's monetary policy committee is seeking to establish its inflation-fighting credentials.
Under changes pushed by Rajan, a former chief economist at the International Monetary Fund, and his then deputy Governor Patel, India last year formally adopted an inflation target and set up a six-member panel to set interest rates in a bid to tame the country's historically volatile prices.
"The decision of the MPC is consistent with a neutral stance of monetary policy," the RBI said in its statement, adding it would allow it to achieve an inflation target of 4 percent in the medium term "while supporting growth."
But analysts warn the RBI risks under-estimating the impact of Prime Minister Narendra Modi's crackdown on unaccounted cash, or "black money."
Announced in November, it sparked a severe shortage of money that sent shockwaves through the cash-reliant economy, though the situation has improved in recent weeks.
The RBI lowered its gross-value added, a measure of growth it prefers, to 6.9 percent from 7.1 percent for the year ending in March, but then forecast the economy would "recover sharply" - a view that is not shared by some economists.
"It's a big surprise to us," said Anjali Verma, an economist for Phillipcapital India.
"The commentary is in line with the decision they have taken but it is probably not in sync with the reality."