MUMBAI, Oct 26: The Reserve Bank of India on Tuesday raised its key repurchase agreement rate by a quarter percentage point to 4.75 per cent, its first such hike in more than four years, to check inflation that has hovered at multiyear highs in recent months.

In its biannual monetary and credit policy review statement the bank also lifted its projected inflation for this fiscal year, cut the economic growth forecast, and left the door open for more measures to contain the impact of high oil prices.

The cautious hike in the repo, which is the rate the central bank pays banks for overnight deposits, upset market consensus that the bank would hold rates to support a slowing economy. Government bond yields hit two-year highs in reaction. In afternoon trade, the benchmark 10-year bond yield spiked to 6.93 per cent, a level last tested in November 2002.

"This policy equally emphasizes growth and price stability," RBI Governor Y.V. Reddy told reporters after unveiling the policy paper.

Although the bank revised its inflation target for this fiscal year to 6.5 per cent from 5 per cent previously, it made no change to its other major monetary tools, acknowledging the need to protect growth.

It left the bank rate - the rate at which it lends to banks - and banks' cash reserve ratio unchanged at 6 per cent and 5 per cent respectively.

The central bank said its overall monetary policy stance will be to "pursue an interest rate environment that is conducive to macroeconomic and price stability, and maintaining the momentum of growth."

The bank said it would also emphasize "provision of appropriate liquidity to meet credit growth and support investment and export demand...while placing equal emphasis on price stability."

The RBI cut its estimate for India's gross domestic product growth to between 6 and 6.5 per cent from an earlier forecast of 6.5-7 per cent, citing poor monsoon rainfall and record high global oil prices.

The central bank noted that inflation in India, which hit a 3-1/2 year high of 8.33 per cent at the end of August, is mainly due to a supply shock caused by soaring global crude prices.

But the "full impact of oil price increases is yet to be absorbed in domestic prices," it said in a statement, and added that rising crude prices would likely "remain the most critical factor influencing domestic inflation in the medium term."

Kishlaya Pathak, an economist at Standard Chartered Bank in Mumbai, said Tuesday's repo rate hike is unlikely to hurt economic growth. The move "shows RBI's commitment to keeping price stability. It is a strong signal to the markets that the government is committed to dampen inflationary expectations," he said.

While central bank officials expressed concern over record crude prices hurting economic growth, they also noted the growth in non-food credit has been "larger-than-usual" and the ongoing investment recovery in the economy is "broad based."

Some analysts believe these statements suggest further monetary tightening is likely. Kotak Mahindra Bank Chief Economist Indranil Pan is penciling in another 25 basis point rise in the repo rate in December while JP Morgan Chase Bank's Rajeev Malik is forecasting an increase in early 2005.

Noting that the government's recent import and excise duty cuts on petroleum products had helped cushion the effect of high crude prices, the RBI indicated that the government could also consider more measures to fight inflation if necessary.

"It may not be inappropriate to assume that similar burden sharing will continue to enable moderation of the incidence of oil price shocks in future," it said. India is very sensitive to global crude price changes as it imports more than two-thirds of its annual energy needs.

Although India's trade deficit may widen due to higher oil prices, the RBI said the current account "may still show a marginal surplus" this fiscal year.

The strong growth in exports is likely to be maintained given the positive outlook for global trade, it said. Furthermore, other inflows, particularly of overseas remittances, "are expected to maintain the tempo on account of the rebound in global growth and expanding activity in oil-exporting Middle East countries."

The RBI said the country's foreign exchange reserves - currently just under $120 billion - are "comfortable and consistent with the rate of growth." It said capital inflows will likely moderate in the current fiscal year due to higher overseas interest rates, but added "the management of liquidity arising out of external flows will continue to be challenging."

However, the persistence of large-scale borrowing by the federal and state governments continues to be a matter of concern, the bank said.

The government is targeting a federal fiscal gap of 4.4 per cent of GDP in the current financial year, lower than the 4.8 per cent deficit in fiscal 2003-2004.- Dow Jone Newswires