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RBI likely to take more steps on prices

India's central bank is likely to tighten monetary policy soon, after the finance ministry said on Saturday it expected the monetary authority to take action to cool inflation.

business Updated: Jun 22, 2008 00:02 IST

India's central bank is likely to tighten monetary policy soon, after the finance ministry said on Saturday it expected the monetary authority to take action to cool inflation, now at a 13-year high above 11 per cent.

Annual inflation unexpectedly jumped to 11.05 per cent early this month from 8.75 percent in late May, due mostly to a rise in government-set fuel prices at the start of June. The rate has doubled since February largely on costlier oil, metals and food.

The price data, released on Friday, is a political headache for the ruling Congress party ahead of state and national elections in coming months and sparked hurried meetings between the prime minister, finance minister and central bank governor.

Finance Minister Palaniappan Chidambaram vowed on Saturday to take further fiscal steps to quell inflation but he and his ministry cautioned second-round inflation effects were now in play and inflation would remain high for some months.

Economists said the central bank could now to raise its key lending rate, the repo rate, as early as the coming week after a surprise 25 basis point increase to 8.0 percent on June 11, the first rate rise in more than a year.

"I think by next week the central bank will act. They will move on the repo and reverse repo by 50 basis points," said A. Prasanna, economist at ICICI Primary dealership.

The reverse repo is the rate at which the Reserve Bank of India (RBI) drains cash from the banking system. It is at 6.0 percent and has remained steady for two years.

For the past year until this month's rate rise, the central bank used banks' reserve requirements to reduce excess cash in the system but Prasanna said the cash reserve ratio (CRR) was unlikely to rise this week because market liquidity was tight.

"Anything on CRR they would wait until the policy (review) in July," he said. The next scheduled review is on July 29.

Meetings in New Delhi

In an unusual move, the finance ministry said in a statement Chidambaram had called on Prime Minister Manmohan Singh on Friday evening and had a long discussion with him. Chidambaram then invited RBI Governor Yaga Venugopal Reddy, whose headquarters are in Mumbai, to meet him on Saturday to review the situation.

"We expect the central bank to take some more action," Finance Secretary D. Subbarao told a news conference, while reading out the statement. "It is for the RBI to take a decision and to take a decision on when it is appropriate."

He said demand management had to be part of the solution. "In this regard the first line of defence is monetary policy action."

In the statement, Chidambaram said he would take on board a suggestion from the main opposition party for "deeper cuts in taxes" to calm prices but added giving up revenues and borrowing in the market to finance expenditure would be inflationary.

"Given the difficult circumstances, government will take appropriate measures in order to contain and moderate inflation," Chidambaram was quoted as saying.

In recent months the government has cut a series of import duties and raised some export duties to keep prices down and supplies up and Chidambaram said the food situation was comfortable, with no cause for worry on staples wheat and rice.

"We will provide adequate wheat and rice to the public distribution service and we will use our stocks to moderate prices in the open market," he was quoted as saying.

(Additional reporting by Devidutta Tripathy; Writing by Charlotte Cooper; Editing by Chris Pizzey)