India rate hike will not stem outflows, leaving central bank in a bind

According to Business Recorder, the Reserve Bank of India raised its policy rate by 25 basis points on Wednesday, its first increase in four years. Analysts believe the modest move will not halt heavy capital outflows or ease pressure on the rupee, which sits near its weakest level ever against the dollar. The central bank is caught between a falling currency and inflation running above its 4% target.

Overseas investors have withdrawn $30 billion, a record, from Indian shares this year, while debt inflows have turned negative since early September. The rupee has slid 7% so far, and the price of insuring against further falls has surged since the RBI move. Yield gaps on India's 10-year bond versus US Treasuries and German Bunds have narrowed to levels last seen in 2004 and 2009 respectively.

Economists broadly see the move as fitting domestic conditions in India. Soumya Kanti Ghosh of State Bank of India, however, said a 50 basis point increase could be needed in December, and he also favours raising the marginal standing facility rate. The RBI argued that the second-round effect of higher food and fuel costs has so far been modest.