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The Indian central bank is likely to raise its short term borrowing rate in its rate-setting session later this week, DBS Bank said on Monday.
The Reserve Bank of India is likely to raise the reverse repo, the rate at which it borrows from banks, by 25 basis points to 4.75%, DBS said in a note. The central bank is expected to retain the repo rate at 5.75% during its forthcoming meeting on September 16.
The RBI had hiked the rates four times this year to reign in the surging inflation. During its previous meeting in July, the central bank made a 50 basis points hike in the reverse repo rate and 25 basis point increase in repo rate. This narrowed the interest rate corridor by 25 basis points.
Expectations for a rate hike are supported by a surge in industrial output in July. As per the latest official data, industrial production grew 13.8% year-on-year in July, nearly doubling June's 7% growth. This may once again fuel concerns of overheating in the economy, DBS said.
However, according to DBS, the Indian economy was not overheating, but was growing at a temporarily strong pace from July 2009-March 2010, when the economy, especially the industrial sector, grew at a scorching pace, offsetting the earlier weakness.
A slow-down in production in the April to June quarter largely reflected a "normalization" in demand, DBS said and sees chances for an "undershoot". The bank said the surge in production in July strengthens the view.
DBS analysts also noted that a 50 basis point hike in the repo, the rate at which the central bank lends, is more unlikely as the headline inflation rate is expected to ease going forward, though core inflation pressures are forecast to rise along with the renewed growth momentum. The bank feels that such a situation demands a normalization of monetary policy.
Although there has been considerable upward pressure on prices in the recent quarters, DBS forecast inflation to ease below 5% by March 2011, even as core inflation picks up. "Therefore, we think the central bank doesn't have to press the panic button and lift rates more sharply at this juncture," the bank said.
India's annual rate of inflation, based on the monthly wholesale price index, rose to 9.97% in July, but slower than a 10.55% growth in the previous month. In the second quarter, India's economy logged the fastest growth in more than two years, fueled by buoyant manufacturing and mining. The economy expanded 8.8% on an annual basis during April to June.
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