The Reserve Bank of India (RBI) is likely to unveil Tuesday a slew of measures to tackle inflationary pressures and the economic slowdown in its annual monetary policy report for 2008-2009.
India's wholesale price index (WPI), the most widely watched indicator for gauging inflationary trends, was at 7.33 percent on April 12, almost 200 basis points higher than the 5 percent limit set by the central bank, due to higher food and fuel prices.
Most economists feel that the central bank will leave the bank rate and cash reserve ratio (CRR) untouched, but will raise the repo rate and reverse repo rate to suck liquidity from the banking system.
The central bank hiked the CRR by 50 basis points on April 17 to be implemented in two stages on April 26 and May 10, in order to drain about 185 billion rupees ($4.6 billion) of excess liquidity from the system. This increase will take the CRR to 8 percent on May 10 from 7.75 percent now.
Tushar Poddar, economist at Goldman Sachs said he expects the central bank to continue its tightening measures, given the huge political importance of inflation and continuing demand pressures.
'We expect a repo rate hike by the RBI in its policy meeting on April 29. We think that the RBI will go for a 25 basis points (bps) increase in repo rate. The guiding principle would be to arrest inflationary expectations and further slow demand. We expect the cash reserve ratio (CRR) hike will increase pressures on the domestic currency to appreciate as rupee liquidity will tighten,' he said in a note.
On the other hand, Lehman Brothers expressed doubts the RBI will raise rates in response to inflation caused by surging global commodity prices, especially when growth is slowing.
Lehman Brothers in a note said rather than hike rates it expects the policymakers to continue using trade and fiscal policies to contain inflation and allow moderate rupee appreciation.
'At present, the nature of inflation in the economy is supply side-driven. The monetary tightening measures by the regulator would rather hurt the other economic segments like real estate, consumer durables, automobiles,' said Venugopal N Dhoot, president, Associated Chambers of Commerce and Industry of India (Assocham).
The repo rate is a rate at which the central bank injects short-term liquidity into the system by buying government securities, while the reverse repo rate is the process of absorption of short-term liquidity from the system through the sale of government paper.
Dresdner Kleinwort, however, said measures such as a CRR hike are unlikely to have any material impact on the current inflation trend, as the trend is being driven by global prices. It expects inflation to peak during the first half and moderate during the latter part of the year, as the G7 economic downturn has an impact on world demand.
According to the advance estimates by the Central Statistical Organisation (CSO), the real GDP growth rate was 8.7 percent in 2007-08 as compared with 9.6 percent the previous year, reflecting moderation in growth in all three sectors -- agriculture and allied activities, industry and services.
Last week Crisil Ltd., a unit of Standard & Poor's, cut its GDP growth forecast for India to 8.1 percent for the fiscal year to March 31, 2009, from its earlier forecast of 8.5 percent, in view of rising inflation, interest rates and the global growth outlook.
Indian money supply has been growing by 20 percent for the past 16 months, significantly higher than the 17 to 17.5 percent envisaged by the central bank. On April 11, the broad money growth (M3) was 21.2 percent at 7.01 trillion rupees, according to the RBI data.
Edelweiss Securities Ltd. in a note said it expects a 25 bps hike in the repo rate, taking it to 8.0 percent. The reverse repo rate and CRR are likely to stay unchanged at 6.0 percent and 8 percent respectively, it said.
Smita Gupta, economist with Union Bank of India said he expects the RBI to maintain a neutral stance, thus keeping the repo and reverse repo rate at 7.75 percent and 6.00 percent respectively.
Dresdner Kleinwort in a research note said the commodity price increases have adversely affected India's trade balance, which is turning into a large deficit because of the rising import bill.
Food prices have had only a secondary impact on the Indian economy though, as the main impact has come from minerals, oil and other raw materials, Dresdner Kleinwort said. For this reason, inflation is spreading out to broader core categories, faster than in other countries.
Any significant reduction in inflation rates will be dependent on how effective the fiscal steps have been, and monetary policy will not have any immediate impact on the headline number but can soothe inflationary expectations, said V Vaidyanathan, executive director, ICICI Bank Ltd.
Goldman Sachs also warned that there is a significant threat of second-round effects from higher commodity prices being built into higher inflationary expectations, which could lead to even greater interest rate increases if these were to get embedded.
Sachidanand Shukla of Enam Securities in a note said the RBI may raise the reverse repo rate by 25 basis points, signalling its hawkish intent.
'A reverse repo hike will tighten liquidity in the short run and narrow the differential between the short-term lending and borrowing rates that stands at an unusually high 175 bps. Also, the hike may nudge inter-bank rates higher and yet avoid an outright tightening,' he added.