RBI likely to lift rates by 25 bps next week

The RBI has raised rates three times this year by 25 basis points each,most recently in an unexpected move on July 2.

“My sense is unless we see a strong pick up in domestic demand both for credit,investment and for the economic activity in general,we might see a little bit of a softer approach towards policy tightening than initially thought,” said Saugata Bhattacharya,an economist with Axis Bank in Mumbai.

Most economists have not changed their expectations from a Reuters poll on July 5 that the RBI would raise the repo rate,at which it lends to banks,by another 50 basis points to 6.0 per cent by end of December.

They expect the RBI to raise the reverse repo rate,at which it absorbs excess cash from the banking system,by 50 basis points by end-December.

Tight liquidity since early June has led economists to expect no change in the cash reserve ratio (CRR),the per centage of cash banks must keep in reserve with the RBI by end-December,compared with a 50 basis point rise expected in the July 5 poll.

Of 12 economists in the new survey who were also part of the previous poll,two have lowered their expectations on rate increases for the rest of the year,while three expect the RBI to tighten more aggressively than earlier forecast.

Twelve economists said the RBI’s policy tightening in recent quarters was appropriate,while four said the RBI should tighten more aggressively.

Most economists polled expect the repo rate to remain the RBI’s operative rate by the end of September,a sign that they expect tight cash conditions to persist. The RBI has allowed cash conditions to remain tight in recent weeks,which helps dampen inflation expectations.

Economists were almost evenly split on whether the repo or reverse repo would be the operative rate by the end of December.

REPO:

Seventeen of 20 economists expect the RBI to raise the repo rate in the July 27 policy review by a quarter-point to 5.75 per cent. By the end of December,10 economists expect a total of 50 basis points in increases in the repo rate and five expect 75 basis points of increase.

By the end of the fiscal year in March,nine economists predict a 75 basis point rise in the repo rate,five expect a 100 basis point increase,two expect 50 basis points and one expects 150 basis points of increase.

REVERSE REPO:

Eighteen of 20 economists expect the RBI to raise the reverse repo rate on July 27,with a median forecast of 4.25 per cent,in line with the July 5 poll,from 4 per cent. Ten economists expect the rate to be 4.50 per cent at the end of December,and five expect the rate to reach 4.75 per cent at the end of 2010.

By the end of the fiscal year in March 2011,nine respondents see a 75 basis point increase in the reverse repo rate,and five see a 100 basis point rise.

CASH RESERVE RATIO:

None of the 17 economists foresee a change in the CRR in the July 27 review,in line with the last poll.

The median forecast for the end of December is 6.0 per cent,the same level it has held since April 24,compared with 6.5 per cent in the July 5 poll. However,none of those who participated in both surveys changed their forecast.

By the end of March,nine economists expects no change in CRR,and three expect a 50 basis point rise.

FACTORS TO WATCH:

— Wholesale prices in June rose 10.55 per cent from a year earlier,marginally below the median forecast for a 10.8 per cent rise in a Reuters survey and compared with May’s pace of 10.16 per cent.

— The fuel price index rose 14.27 per cent in the year to July 3,compared with the previous week’s 18.02 per cent,while food price index rose an annual 12.81 per cent,from 12.63 per cent reading in the previous week.

— Industrial output in May grew at a slower-than-expected 11.5 per cent from a year earlier,helped by robust domestic consumer demand,expanding exports,and higher infrastructure spending.

MARKET IMPACT: Traders have discounted a 25 basis point increase in interest rates by the RBI in the July review,but traders said a 50 basis point rise could see the benchmark 10-year bond rise to 7.80 per cent,from 7.65 per cent now.

A half per centage point increase in policy rates may also push up the one-year overnight indexed swap to 6.20 per cent,from 5.86 per cent now.