Galloping prices leave RBI no choice on rate hike

All eyes are on the Reserve Bank of India's July 27 meeting for the quarterly monetary policy review. As the country's inflation rate galloped to 10.55 per cent in June, up from 10.16 per cent in May, a hike in interest rates is being widely expected.

All eyes are on the Reserve Bank of India's (RBI's) July 27 meeting for the quarterly monetary policy review.

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As the country's inflation rate galloped to 10.55 per cent in June, up from 10.16 per cent in May, a hike in interest rates is being widely expected.

So, expect EMIs to go up.

The higher inflation rate in June partly mirrors the increase in fuel prices that were deregulated three weeks ago, but economists said the full impact of the fuel price hike would be visible only in the July numbers.

Wholesale price-based inflation is hovering around 10.55 per cent, but is expected to go up as the secondary effects of the oil price hike kicks in across broader economic activities.

Former RBI governor and Prime Minister's Economic Advisory Council Chairman

C. Rangarajan has said the Reserve Bank of India (RBI) should take either strong monetary action or "baby steps" to arrest it.

"A bias towards (monetary) tightening is necessary," he said while presenting the council's economic outlook for 2010-11.

The council expects inflation to fall to 7-8 per cent by December before cooling to about 6.5 per cent by March 2011 as higher farm output buoyed by normal rains help enhance food supplies and pull down prices.

Economists however warned that rising demand could further fan prices of products and many expect the central bank to announce a another 0.25 percentage point hike in repo and reverse repo rates, which now stand at 5.5 per cent and 4 per cent respectively.

A higher repo rate—the rate at RBI lends to banks—would make it costlier for banks to borrow, prompting them to charge more from final home, consumer and corporate loan borrowers.

RBI uses the reverse repo rate—the rate at which RBI borrows from banks — to withdraw excess money from the system to counter demand.

It had raised both the rates by 0.25 percentage points earlier this month.

"We estimate that the fuel price hikes will add 1 percentage point to WPI inflation, prolonging the period of double-digit inflation until October," said Sonal Varma, Vice President, India Economist, Nomura Financial Advisory and Securities.