Economists hope India can cool inflation fight after fresh rate hike

With the RBI widely expected to raise interest rates for a third consecutive meeting

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on Wednesday, a key question is how much further it will take its battle against stubbornly-high inflation.

A Reuters poll showed 39 of 43 respondents expect the Reserve Bank of India (RBI) to lift the repo rate by a quarter percentage point to 8 percent, after raising it by the same amount at its reviews in September and October. No respondent predicted a 50 basis points hike.

Another rate increase could further establish the hawkish credentials of RBI Governor Raghuram Rajan since his appointment in September. And if it cools inflation, a hike could aid the embattled Congress party, which is facing general elections by May, and was pounded in recent state polls, in part due to high food prices.

But another rate hike will deepen concerns about the risk that India could grow even more slowly than the decade-low annual rate of 5 percent in the fiscal year that ended in March.

The hit to growth could make continued monetary tightening unsustainable, according to analysts, increasing expectations the RBI may raise rates on Wednesday but also signal a pause, especially as wholesalers say vegetable prices - the main driver of inflation - have eased this month.

Meanwhile the U.S. Federal Reserve will soon start withdrawing its monetary stimulus, raising concerns about a possible repeat of August, when fears of Fed action sparked outflows that made the rupee plunge to a record low.

"If CPI inflation, as expected, eases in December, the RBI might pause in January and till there is a credible drop in inflation, we would expect the RBI to hold on to rates," said Saugata Bhattacharya, chief economist at Axis Bank in Mumbai.

Bhattacharya expects the RBI to raise the repo rate by 25 basis points on Wednesday.

RAJAN'S CLEAR PRIORITY

A strong indication of the RBI's intentions will come from its statement and from Rajan during a news briefing around 11:15 a.m.

The Reuters poll showed 22 of 29 respondents expect the RBI to hold the rate at 8.00 percent until the end of the fiscal year in March.

In speeches over the past week, Rajan has made clear inflation is his priority. The most recent data showed consumer prices posted their biggest annual rise on record in November - 11.24 percent - while wholesale inflation hit a 14-month high last month.

Still, the inflation spike is being driven by a surge in prices of vegetables such as onions, which are largely impacted by India's lack of reliable ways to transport the produce and by traders suspected of hoarding supplies to raise prices.

These distribution problems are sparking debate about whether higher interest rates are the best response to high inflation, given that the previous two hikes have failed to quell it.

"There is a case for tightening rates to the core CPI level, but I don't see a need to rush to do so since growth is weak," said Gaurav Kapur, senior economist at Royal Bank of Scotland in Mumbai and one of the few analysts who expects the RBI to keep the repo rate unchanged on Wednesday.

VEGETABLE WOES

Surging vegetable prices hurt the poor and are a major headache for a government facing elections soon and already criticised for policy drift and corruption scandals.

Yet for businesses and investors in Asia's third-largest economy the priority remains getting the growth rate back up, helping India again attract investment and inflows which contain a current-account deficit that surged to a record high in the last fiscal year.

Rajan is betting India is in a better position to withstand any global volatility after measures to curb gold imports and help banks raise money overseas sharply narrowed the current-account deficit and boosted currency reserves to an eight-month high.

The RBI under Rajan has rolled back most of the emergency steps taken in July and August to prop up the rupee, which included a sharp hike in short-term interest rates that made borrowing money for short durations much more expensive.

Should the RBI raise the repo rate, it could also raise a key short-term rate, the emergency funding window called the marginal standing facility (MSF), to keep cash conditions tight and to increase the effectiveness of monetary policy.

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