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RBI hints at rate hike on inflation surge
June, 16th 2010

Cbank dy gov says inflation more a concern than Europe crisis, also not in favour of shocking market; strong possibility of off-cycle rate hikes-analysts; bond yields rise on RBI comments.

Reserve Bank of India on Tuesday did not rule out an interest rate hike before a scheduled policy review in July and the government toned down earlier remarks to back the bank over taming accelerating inflation.

Indias headline inflation unexpectedly surged in May and bond yields shot up on the data, as expectations built that the Reserve Bank of India (RBI) would raise rates before its 27 July review.

Mays reading poses a fresh headache to the government which has held back crucial reforms, like freeing up retail fuel prices, due to worries over their impact ahead of eight state elections scheduled in 2010 and 2011.

Asked of the possibility of an off-cycle rate hike, K.C. Chakrabarty, a central bank deputy governor, said: The possibility is always for the rate rise ... For us inflation is a bigger concern than Europe.

But he said the timing would depend on the emerging situation and the RBI was not in favour of giving a shock to the market.

The comments from the central bank as well as the finance minister strongly suggest that an off-cycle rate hike could happen. said Brian Jackson, a Hong Kong-based senior emerging markets strategist for the Royal Bank of Canada.

Finance minister Pranab Mukherjee shifted from his earlier opposition to a near-term rate hike to back Chakrabarty.

Whatever appropriate steps are required to be taken to control inflation will be taken.

On Monday, Mukherjee had said inflationary pressures would ease by mid-July and he did not favour an immediate hike.

The 10-year benchmark bond yields rose to 7.69%t, off the days low of 7.59%, on Chakrabartys comments.

(The) last statement of relief has been taken away, so now yields are heading upwards, said Sandeep Bagla, a senior vice president at ICICI Securities Primary Dealership.

Yields had retreated on Tuesday on Mukherjees comments, which came after markets shut on Monday. They had ended Monday at a five-week high of 7.68%, with inflation data pushing yields up 7 basis points on the day.

The finance ministry exerts considerable influence upon the RBI and analysts say the banks independence has more to do with the personality of the governor.

Governors normally consult the finance minister before the quarterly review. The current incumbent Duvurri Subbarao was the finance ministrys top civil servant before he moved to the RBI.

A majority of economists polled by Reuters said there would be no rate hike till 27 July, but forecast a 50 basis point hike during the review.

Rains to cool prices

Mays inflation of 10.16%, driven by higher food and fuel prices, was the seventh straight monthly reading over 5%, the central banks perceived comfort level.

The RBI expects it to come down to 5.5% by end-March 2011, though the finance ministrys chief economic adviser Kaushik Basu said it could fall below 5% by then.

Analysts see these forecasts as optimistic as past utterances have often been off the mark. They predict it will stay in the high single digits during the fiscal year.

Policymakers are betting on good monsoon rains for a bountiful harvest and for food prices to cool. The rains have progressed normally so far since they hit the Indian coast a fortnight ago.

High prices have sparked off street protests and were blamed for the ruling Congress partys poor showing in local elections in the swing state of West Bengal. Opposition calls for firm action have often been matched by voices from Congress allies.

They have no measure left to take and they cannot remain quiet either, said D.H. Pai Panandikar, the head of think tank RPG Foundation.

The government, led by Prime Minister Manmohan Singh, also needs moderating prices before it can continue the process of dismantling socialist-era controls and accelerate economic growth to peer Chinas double-digit levels.

For instance, a decision to allow market pricing of fuel, need to improve public finances and yield profits to oil retailer, has been stalled on opposition from allies, would have to wait. Few expect any movement till inflation eases.

Singhs top economic adviser told Reuters in an interview any hike in fuel prices would be possible only when inflation has softened.

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