April 18 (Bloomberg) -- India's central bank left its key interest rate unchanged after predicting economic growth will slow this year. Bonds rose and stocks extended gains as some economists had forecast a rate increase.

Reserve Bank of India Governor Yaga Venugopal Reddy today kept the overnight borrowing rate at 5.50 percent after quarter- point increases in October and January. Seven of 12 economists surveyed by Bloomberg News expected a rate rise.

Reddy faces pressure from the government to keep borrowing costs low to spur spending and investment in Asia's fourth- largest economy. The central bank expects growth in the $665 billion economy to slow to between 7.5 percent and 8 percent in the year starting April 1 from 8.1 percent a year earlier.

``Any further increase in rates would undermine economic growth,'' said Pyarelal Raghavan, an economist at the Federation of Indian Chambers of Commerce and Industry in New Delhi.

India's government bonds rallied, the biggest fluctuation of any government debt market today, after the release of the central bank statement.

The yield on the benchmark 7.59 percent bond due 2016 declined 14 basis points to 7.41 percent as of 5:30 p.m. in Mumbai, the biggest drop in nine months, according to data compiled by Bloomberg.

The Mumbai Stock Exchange's Sensitive Index rose 281.89, or 2.4 percent, to 11,821.57 at close of trading. The index gained 5 percent in two days, rebounding from its biggest two-day slide in almost six months last week.

Reduce Poverty

Prime Minister Manmohan Singh's government wants to accelerate economic growth to as much as 10 percent a year over the next decade from an average 6 percent between 1980 and 2005. That will help reduce poverty in a country where a third of the population of 1.1 billion people lives on less than $1 a day.

Growth in India's economy averaged 8 percent in the three years ended March 31, making it the second fastest growing major economy after China.

Keeping interest rates unchanged was ``a difficult decision to make,'' Reddy told reporters in Mumbai today, referring to rising interest rates globally. The central bank's next monetary policy move would be ``delicate, difficult,'' he added.

The U.S. Federal Reserve raised its key rate by a quarter- point to 4.75 percent, the 15th increase in a row, on March 29. The Bank of Japan on March 9 ended a five-year policy of fighting deflation, giving policy makers scope to raise borrowing costs later this year. The European Central Bank kept its benchmark rate unchanged at 2.5 percent on April 6 after increases in December and March.

Oil Prices

Reddy and his fellow policy makers raised the key rate by a quarter-point on Oct. 25 and Jan. 24, to keep inflation below the central bank's target of 5 percent to 5.5 percent by March 31. India's benchmark wholesale price inflation index fell to a seven-month low of 3.51 percent in the week ended April 1, the government said on April 13.

``Oil prices remain volatile with an upside bias,'' the central bank said in a statement today. ``The adverse consequences of further escalation of international crude prices are likely to be pervasive across economies including India.''

Oil, which Reddy told reporters was the most important factor for Indian inflation, traded near a record above $70 a barrel in after-hours electronic trading on the New York Mercantile Exchange today.

Policy Tool

Rising fuel costs contributed to inflationary pressure that prompted the Reserve Bank to increase the rate by 100 basis points since October 2004. The bank started using the measure as its main policy tool then after the banking system became swollen with surplus cash. A higher reverse repurchase rate encourages lenders to place more funds with the central bank, leaving them with less to lend.

``Inflationary expectations are building up and the central bank may raise rates at its next policy meeting in July,'' said Mahendra Jajoo, who manages the equivalent of $350 million in Indian debt at ABN Amro Asset Management Ltd. in Mumbai. ``If you look at global oil and commodity price increases, inflation will inch higher going forward.''

Copper prices in Shanghai rose to a record today after increasing 80 percent in the past year on demand for the metal in homes, cars and appliances. Gold prices rose to the highest in more than 25 years, gaining 43 percent from a year earlier. India is the world's biggest consumer of gold.

The Reserve Bank also today left its benchmark lending rate, or the bank rate, unchanged at 6 percent. Indian commercial banks take their cue to change lending rates from the bank rate, which has been held at 6 percent since April 2003, the lowest since May 1973.

To contact the reporter on this story: Cherian Thomas in Mumbai at cthomas1@bloomberg.net

Last Updated: April 18, 2006 09:23 EDT