Indian interest rates rise to 9%

Inflation is eroding the value of the rupee

India's central bank has increased its key interest rate to 9% from 8.5% in a bid to dampen surging inflation.

It is the third time in two months that Indian interest rates have risen and more rate rises are expected.

Inflation is running at a 13-year high, driven by the soaring cost of food and fuel which is biting into the spending power of India's poor.

Many Asian countries are facing the same problem, threatening to curb rapid economic growth.

In an attempt to discourage lending, the Indian Reserve Bank also raised the level of minimum cash reserves banks must hold in relation to customer deposits.

India's main stock index, the Sensex, tumbled after the rate rise on worries that car and home loans will become more expensive, slowing consumer spending.

It closed down 557.6 points, or 3.9%, at 13,791.54 - a one-week low.

"The hikes were above consensus. We expect lending and deposit rates to rise further and growth to slow significantly," said Macquarie Securities analyst Seshadri Sen.

But Reserve Bank Governor Y. Venugopal Reddy said that compared with the rest of the world, the drop in growth rates would be marginal.

Main priority

The Indian economy has been growing by more than 8% a year so far in 2008.

Capital investment, rising incomes and availability of credit have helped to fuel this expansion, but this has also fed into higher domestic prices.

The high prices of crude oil - India imports two-thirds of its oil requirements - and steel products have also been blamed for stoking inflation.

To help combat this, the government has cut duties on these products.

In addition, the government has also cut exports of rice to try to keep domestic prices down.

Wider problem

The governing party is keen to ease inflation pressures as it prepares to fight an election scheduled for the first half of next year.

But interest rates are still expected to go higher, even if growth suffers as a result.

"Bringing down inflation from the current high levels and stabilising inflation expectations assumes the highest priority in the stance of monetary policy," the Indian Reserve Bank said in a statement.

Pakistan is also dealing with similar problems.

Its benchmark share index also fell after the country's central bank raised its main interest rate to 13% from 12% in an attempt to bring inflation back to target levels.