India's central bank increased the benchmark interest rate to a two-year high and signaled further gains in borrowing costs after raising its inflation forecast. Governor Duvvuri Subbarao lifted the repurchase rate to 6.5 percent from 6.25 percent, according to a statement from the Reserve Bank of India in Mumbai today. The decision was forecast by 21 of 22 economists in a Bloomberg News survey. One expected a half-point advance. Subbarao increased the reverse repurchase rate to 5.5 percent from 5.25 percent. India joins South Korea and Thailand in raising rates this month after boosting them six times in 2010, the most by any central bank in Asia. The move will buttress government efforts to cool inflation after Prime Minister Manmohan Singh unveiled plans to reduce food prices by importing onions from Pakistan and keeping a ban on exports of lentils and edible oils. ``Borrowing costs in India need to go up further to keep inflation under check,'' Sonal Varma, a Mumbai-based economist at Nomura Holdings Inc., said before the decision. ``Inflation may remain stubbornly high this year.'' The RBI expects inflation at 7 percent by March 31, more than its earlier prediction of 5.5 percent, Subbarao said today. The growth projection for the current financial year has been kept at 8.5 percent with an ``upward bias,'' he said. ``Current growth and inflation trends warrant persistence with the anti-inflationary monetary stance,'' Subbarao said in the statement. ``The current growth-inflation dynamics in the last few weeks suggest that the balance of risk has tilted toward intensification of inflation.'' Rate Swaps Deutsche Bank AG forecast this month that rates on India's 2016 interest-rate swaps, already twice as high as the 4.15 percent for the similar gauge in China, will advance further as investors use the contracts to guard against higher debt costs. Inflation concerns have sent India's benchmark nine-year government bonds toward the first monthly loss since October, pushing yields close to the highest level since the notes were issued in May. The Bombay Stock Exchange's Sensitive Index has declined more than 6 percent since Jan. 1. The rupee weakened 1.9 percent in the period. ``While the current spike in food prices is expected to be transitory, structural demand-supply mismatches in several non- cereal food items such as pulses, oilseeds, eggs, fish, meat and milk are likely to keep food inflation high,'' Subbarao said. Voted Out India's key wholesale-price inflation rate climbed to 8.43 percent in December, led by higher food costs. The government on Jan. 13 blamed the late arrival of rains for the disruption in supplies of fruits and vegetables including onions, a staple in the local cuisine. It said prices of milk, eggs, meat and fish have gained because of consumer demand, strengthened by rising incomes generated by economic growth. In the past 15 years, Indians have voted out at least two national governments after inflation eroded the spending power of the poor. The World Bank estimates 828 million Indians live on less than $2 a day. Inflation of more than 6 percent between 1994 and 1996 helped oust Prime Minister P.V. Narasimha Rao. His Congress party-led government lost to the Bharatiya Janata Party, or BJP, which was voted out in May 2004 after prices rose in eight of the 12 months that preceded the poll. The BJP started a monthlong nationwide campaign on Jan. 20 against the government, alleging corruption and failure to control prices. Cabinet Reshuffle Singh changed his food minister in a cabinet reshuffle on Jan. 19 to overhaul the government's image. He put K.V. Thomas in charge of the ministry for food and consumer affairs, a portfolio previously held by Agriculture Minister Sharad Pawar. He also turned to neighboring rival Pakistan to help boost onion supplies. India is third after Brazil and China among the so-called BRIC nations to tighten policy this month, and investors expect Russia to follow as emerging economies move to curb price gains. In China, the central bank boosted rates twice in the fourth quarter of last year and on Jan. 14 told banks to set aside more deposits as reserves for the fourth time in just over two months to cool inflation. Brazil increased its benchmark on Jan. 19 for the first time since July, to 11.25 percent. In Russia, inflationary pressures are becoming more pronounced and price-growth may accelerate this quarter, Bank Rossii First Deputy Chairman Alexei Ulyukayev said in a Jan. 20 interview with Bloomberg News, prompting investors to speculate the central bank may raise the key refinancing rate for the first time since 2008. `Spillover Effects' ``The rise in food inflation in India has not only persisted for more than two years now, the increase has been rather sharp in the recent period,'' Subbarao said. ``This cannot but have some spillover effects on generalized inflation.'' Companies including Larsen & Toubro Ltd., India's biggest engineering company, and Godrej Consumer Products Ltd., the nation's second-largest maker of bath soap, said this month that higher input costs are reducing their profit. Inflation forced Hero Honda Motors Ltd., maker of about half the motorcycles sold in India, to raise wages, Chief Finance Officer Ravi Sud said in a Jan. 19 interview without providing details. ``Food inflation puts pressure on wages as a large section of the population spends most of their income on food,'' Ramya Suryanarayanan, an economist at DBS Group Holdings Ltd. in Singapore, said before the release. ``There is a risk of inflation becoming entrenched.'' She expects the RBI to raise rates by 1.25 percentage points in 2011. To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net; To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

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