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What will the RBI say?

Today is the annual policy review by the Reserve Bank of India. Predictions abound but no one can say for sure what's going to happen

Today, the Reserve Bank of India (RBI) will announce its annual policy review. Basically, it will present an analysis of the macro developments and present an appropriate response to it. Given the dilemma between inflation and economic growth, the RBI does have a tough call on hand.

Navneet Munot, Executive Director, Morgan Stanley Investment Management feels that there is a high probability that the RBI will choose to raise policy rates. According to him, the current policy rates (6% - reverse repo / 7.75% - repo) can be termed as accommodative if consensus expectations of GDP growth is above 7.5% and inflation is likely to average above 6.5% in FY 09. "The fiscal situation is deteriorating due to mounting subsidies, proposed loan waiver and wage hikes. A rate hike at current juncture would indeed have negative implications for growth outlook. However, macro economic stability warrants a renewed focus on price stability by RBI," he says.

A credit policy preview by Enam Securities shows that they too believe that the RBI may raise the reverse repo rate by 25 bps in tune with its hawkish intent. But they also admit that a repo rate hike will force banks to raise lending and borrowing rates and dampen inflationary pressures. However, it would have a long lag and may do nothing to curb inflation in the short term. Moreover, it may aggravate demand slowdown as it impacts long term rates.

Enam Securities expects a hawkish stand by the central bank. According to them, the RBI may lower its 2008-09 GDP forecast to 8% from 8.5%. The also are of the opinion that the focus will remain on liquidity management and the RBI may up risk weights and margins selectively in the backdrop of the forex derivative fiasco.

Munot feels that the RBI is unlikely to use exchange rate as a major tool to fight inflation. "It can't afford a sizeable appreciation that could have a meaningful impact on import prices. Exports, particularly employment intensive industries, are already under tremendous pressure. The current account could deteriorate further while capital flows are already slowing down," he says.

In a few hours we shall know what the RBI has to say.