RBI seen raising rates again by 25 bps

Last Updated: Mar 12, 2011, 13:11 PM IST

Bureau Report

Mumbai: The Reserve Bank of India is expected to continue its rate tightening cycle and raise policy rates by a quarter percentage point on Thursday, for the eighth time in about a year, to tame inflation amid strong growth momentum.

Besides supply bottlenecks and the prospect that global oil prices could remain high, concerns over robust credit growth and elevated levels of non-food manufacturing inflation are likely to prompt central bank action to curb demand-led inflation.

The Reserve Bank of India (RBI) has raised its lending rate, known as the repo rate, seven times by a total of 175 basis points and its borrowing rate, or reverse repo rate, by 225 basis points since last March to contain inflationary pressures.

India`s annual food inflation eased to a three-month low of 9.52 percent in late February, as prices of vegetables, potatoes and rice declined, data showed on Thursday.

Annual headline inflation in January was at 8.23 percent, well above the RBI`s perceived comfort zone of 4-5 percent and compared with its end-March target of 7 percent.

Following are potential scenarios for RBI action on March 17:

RAISE REPO, REVERSE REPO RATES BY 25 BASIS POINTS EACH

Most analysts and market participants expect the RBI to raise rates by 25 basis points, continuing with its stance of gradual policy tightening.

A quarter percentage point rate hike would signal the central bank`s discomfort over inflation as well as its intention not to hurt growth momentum. With that outcome already factored in by markets, the accompanying statement will be closely watched by bond and money market investors.

Many dealers expect a dovish statement from RBI Governor Duvvuri Subbarao given that inflation is easing and certain downside risks to growth are also emerging.

Brokerages Morgan Stanley and Bank of America-Merrill Lynch this week lowered their growth forecasts for India`s GDP to 7.7 percent and 8.2 percent, respectively, for the 2011/12 fiscal year starting in April.

The government, in its annual budget last week, said it expects India to grow at 9 percent, plus or minus 0.25 percent in the next fiscal year.

PROBABILITY: MOST LIKELY

Market Reaction: The rate moves may not have much impact on bond and swap rates, but if the accompanying statement is dovish, bond yields may ease by 2-3 basis points and swaps by 5-7 basis points across the curve, with similar movement on the upside if the statement is hawkish on inflation and liquidity.

NO CHANGE IN RATES

A handful of market participants expect the RBI to pause next week, with inflation easing and downside risks to growth escalating following a spate of corruption scandals, political uncertainty ahead of five state elections this year, and a pullout of foreign funds from Indian equities.

Such expectations have been reflected in bond and swap rates, which fell sharply this week. Swap rates touched a two-month low on Thursday after reaching a 28-month peak in early February, when inflation worries were at the fore.

Also, bankers fear that after raising lending rates by nearly 150 basis points since July, further rate hikes may slow credit growth and interrupt momentum in the economic recovery.

PROBABILITY: LESS LIKELY

Market Reaction: Leaving rates unchanged could send bond yields down 8-10 basis points and swap rates down 12-15 basis points.

However, the market could soon give up such a rally and the swap curve could steepen with rate hike and supply worries at the beginning of the next fiscal year, pushing up the long-end and improved liquidity conditions protecting the shorter end.

REPO, REVERSE REPO RATES RAISED 50 BASIS POINTS EACH

Very few analysts expect the central bank to act so aggressively. But, the RBI might justify the move if it expects inflation to remain above its projected 7 percent level for March end and longer and is confident about robust growth momentum.

PROBABILITY: LEAST LIKELY

Market Reaction: Bonds yields could surge by 10-12 basis points and swap rates by 15-20 basis points if rates are raised aggressively.

The swap curve would steepen as the sharp increase in short-term policy rates would impact the shorter end more than the long end. Also, such a move would reduce the possibility for further sharp rate hikes in the near future.

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