Rajan keeps policy rate on hold at last RBI review

The decision had been expected after retail inflation rose to 5.77% in June, near the top of the RBI's 2-6% range, and above its target of 5% by March next year

Reserve Bank of India governor Raghuram Rajan on Tuesday kept the repo rate unchanged at 6.50% at his final policy review after inflation hit a nearly two-year high, but said the policy stance remains "accommodative."

The decision had been widely expected after consumer inflation accelerated to 5.77% in June, near the top of the RBI's 2-6% range, and above its target of 5% by March next year.

The much admired former International Monetary Fund chief economist is due to step down on September 4 after a three-year term to return to academia and family living in the United States. The government has still to pick a successor.

Rajan said he expected "upside" risks to his March inflation target, citing a hike this year in the salaries of millions of government employees and sticky core inflation, which excludes food and fuel.

"It is appropriate for the Reserve Bank to keep the policy repo rate unchanged at this juncture, while awaiting space for policy action," Rajan said in a statement.

"The stance of monetary policy remains accommodative and will continue to emphasise the adequate provisions of liquidity."

India's benchmark 10-year bond fell 2 basis points to 7.15 percent from levels before the decision after the RBI also announced an open market bond purchase.

The broader NSE Nifty was down 0.3%, while the rupee was slightly weaker.

Rajan has lowered rates by 150 bps since January last year to their lowest in more than five years, but economists doubt whether the current easing cycle has much further to run, and expect the next RBI governor to provide at most another 25 bps cut by the end of the year.

Rains have been better than average, suggesting food prices that shot up before the monsoon arrived will moderate. But they are stubbornly high in rural areas suffering from the previous two years of drought.

Rajan will leave behind a revamped central bank from the one he inherited in September 2013 when India was mired in its worst currency crisis in more than two decades and inflation was running at a double-digit pace.

The government last week formally adopted Rajan consumer price inflation target of 4 percent with a plus or minus 2 percent band - a strategy he believes will anchor policy in a country with a history of volatile prices.

Rajan has also persuaded the government to form a monetary policy committee, with three members from the RBI and three chosen by the government to decide interest rate changes. The RBI Governor will cast the deciding vote in case of a tie.

In contrast to most economists, bond markets are betting the next RBI governor might take a more relaxed view on timelines to meet the 4 inflation target. Ten-year bond yields have slumped 33 bps since Rajan unexpectedly announced his departure.

Whoever takes over will also have to follow through on a campaign to clean-up banks' high levels of bad debt, leaving bankers worried over profit margins and reluctant to lower lending rates.