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RBI expected to hike rates, CRR

india Updated: Apr 20, 2010 11:19 IST

Reuters
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The Reserve Bank of India is expected to raise interest rates for the second time in a month on Tuesday and drain more liquidity from the banking system to contain rising inflationary pressures.

While most economists expect the Reserve Bank of India (RBI) to continue tightening monetary policy at a gradual pace, some expect that it will grow more aggressive given strong price rises.

Headline wholesale price index (WPI) inflation reached 9.9 percent for March, slightly less than expected but the biggest rise since October 2008.

A Reuters poll of 20 economists showed that two-thirds of them expect the RBI to raise rates by 25 bps next week and the rest by 50 bps.

Fourteen economists also expect the RBI to raise the cash reserve ratio, of which nine see a 25 bps rise and five predict a 50 bps increase.

Bond and swap markets have priced in a 25 bps rate increase, though more market watchers are now leaning towards a 50 bps rise. Accordingly, bond yields have touched an 18-½ month high as many dealers cut their long positions.

The RBI raised the CRR by a more-than-expected 75 bps in January and followed it with a between-meeting surprise 25 bps point increase in the repo and reverse repo rates in March.

Here are possible outcomes of the April 20 annual policy.

25 bps hike in both rates and CRR

After the tightening steps earlier this year, most analysts say a moderate, 25 bps increase would be the most appropriate to both contain inflation and keep the country's nascent economic recovery on track.

Inflationary pressures have strengthened, with food prices remaining stubbornly high.

India's food price index rose 17.22 percent in the 12 months to April 3, while the wholesale price index rise in March was its fastest in 17 months, driven by higher fuel prices.

* Probability: Most likely

* Market impact: The benchmark bond yield , now just above 8 percent, may come down to 7.90-7.95 percent on a relief rally.

However, the fall in bond yields is not likely to be sustained as a quarter percentage point rate increase may be considered too timid a response to surging prices pressures.

Concerns of a mid-cycle rate hike may push the benchmark bond yield to 8.15 percent thereafter.

50 bps hike in both rates, 25 bps hike in CRR

The RBI could get more aggressive as it looks to tamp down price pressures and avoid any surprise, inter-meeting policy action that could rattle financial markets

Hikes in both rates and the CRR may allow the RBI to combat inflation more effectively, while keeping enough liquidity in the system for a smooth government borrowing programme and credit growth.

However, while the government sounds concerned over the relentless rise in prices, it appears wary of stronger policy responses which could choke off economic growth.

* Probability: Less likely

* Market impact: Benchmark 10-year bond yield may rise to 8.25 percent as a reaction to the unexpectedly hawkish moves, but they may not rise further as uncertainty about mid-policy action will be ruled out.

50 bps hike in both rates and CRR

This would be considered a very hawkish stance by the central bank and is likely to take many analysts and investors by surprise.

The cumulative impact of recent policy tightening moves and such strong follow-up action may impede bank loans to more productive sectors of the economy, curbing economic growth.