(Refiles to fix typo in headline)
* India central bank holds rates, but sets tone for rate rise
* Begins exit from easy policy, ends some liquidity support
* C.bank raises inflation projection, holds growth projection
* Stocks fall; property shares hit especially hard
By Surojit Gupta and John Mair
MUMBAI, Oct 27 (Reuters) - India's central bank laid the groundwork on Tuesday for a rise in interest rates by tightening credit to the commercial property sector, lifting its inflation forecast and warning of the threat of asset price bubbles.
As expected, the Reserve Bank of India (RBI) left key interest rates on hold but surprised markets by removing emergency liquidity support measures that were implemented to protect Asia's third-largest economy from the global downturn.
Stocks <.BSESN> extended losses to 2.5 percent after the quarterly policy review and property shares <.BSEREAL> fell 7.3 percent as the RBI raised bank provisioning requirements for commercial real estate loans.
"This could be one way for them to signal rate hikes are imminent. It is tightening of course," said Ramya Suryanarayanan, economist at DBS in Singapore.
Despite the tightening, government bond yields fell after the central bank raised the amount of deposits banks are required to keep in government securities, soothing worries about the market's ability to digest this year's record borrowing.
The central bank, which has been under pressure from government officials to maintain its loose monetary policy, kept its growth forecast for the fiscal year ending in March 2010 at 6 percent with an upward bias.
India's economic growth slowed to 6.7 percent in the year through March after three years of growth at 9 percent or more.
However, the central bank raised its fiscal year-end projection of wholesale price inflation to 6.5 percent from 5 percent, with an upward bias, reinforcing market expectations that the central bank will start raising rates early next year. Some economists see inflation hitting about 8 percent by March, much above the central bank's comfort zone seen at about 5 percent.
"It may be appropriate to sequence the exit in a calibrated way so that while the recovery process is not hampered, inflation expectations remain anchored," the central bank said in its quarterly review.
"The 'exit' process can begin with closure of some special liquidity support measures," said the bank.
It also said there was a "critical need" for the government to borrow less and help sustain moderate interest rate levels.
So far, Australia is the only Group of 20 economy to raise rates amid signs of an easing in the global crisis, but India and South Korea are expected to follow its lead in months ahead.
All three share concern that keeping monetary reins loose for too long could fuel speculative bubbles in financial and property markets.
Indian stocks have risen about 74 percent since the start of the year and the central bank noted that property prices have risen "significantly" in major cities.
"They are saying, even though signs of recovery are incipient, the equity and commodity markets are running ahead of fundamentals," said Murthy Nagarajan, head of fixed income at Mirae Asset Management.
TIGHTENING LIQUIDITY
Effective immediately, the RBI ended a special repurchase facility for banks and another for the funding needs of non-bank financial companies, mutual funds and housing finance companies.
It also ended a foreign exchange swap facility for banks, and cut an export credit refinance facility to a pre-crisis level of 15 percent from 50 percent with immediate effect.
The central bank also raised the statutory liquidity ratio (SLR) of commercial banks to 25 percent from 24 percent effective Nov. 7, and said the collateralised borrowing and lending obligation liabilities of banks would be subject to cash reserve ratio requirements from Nov. 21.
Analysts said raising the liquidity ratio would make it
easier for the government to borrow and the bond market
welcomed the move with the benchmark 10-year government bond
The government plans to borrow a record 4.51 trillion rupees ($96.1 billion) this year to finance a fiscal deficit of 6.8 percent of GDP.
"Going forward, we will have a reasonably high fiscal deficit, but the rise in SLR would help the government borrow more without widening this deficit," said Abheek Barua, chief economist at HDFC Bank.
(For a graphic on Indian GDP, inflation and interest rates, click: http://graphics.thomsonreuters.com/109/IN_GDPINF1009.gif)
The central bank has cut its short-term lending rate
In the review, the RBI said bank credit remained sluggish and cut its forecast for adjusted non-food credit growth in 2009/10 to 18 percent from 20 percent.
"Banks are urged once again to step up their efforts towards credit expansion while preserving credit quality which is critical for revival of growth," it said. (For more India monetary policy coverage, click http://in.reuters.com/news/globalcoverage/policyreview) (Editing by Tony Munroe and Tomasz Janowski)