Bond players say 50:50 chances of a repo hike

Bond market players are a divided lot on the prospects of the Reserve Bank of India hiking the interest rate to counter inflationary pressures.

After the central bank announced a 50-basis point hike in banks' cash reserve ratio Saturday, 14 players polled by CRISIL MarketWire Monday indicated a fifty-fifty chance of a repo rate hike.

Barely a month after Finance Minister P. Chidambaram announced a blend of fiscal and monetary measures to fight inflationary pressures, the RBI announced a 2-stage hike in cash reserve ratio to tighten money supply.

The CMW poll showed that traders were mixed on the course of action the central bank will take if the inflation""at 8.33 per cent in week ended August 28 ""doesn't ease quickly.

Most dealers, who don't expect the RBI to hike interest rates, said that as explained by central bank itself, the rise in inflation was mostly due to cost-push factors led mainly by high oil prices.

In the absence of demand-pull factors playing a role in the rise in the inflation rate, monetary tightening through a CRR hike or a repo rate hike will offer little help in easing inflationary pressures.

However, those who expect a repo rate hike said the factors that prompted a CRR hike will eventually lead to the central bank hiking repo rate also.

They said the central bank could take one step after another, starting with liquidity tightening through a combination of a CRR hike and bond sales under the market stabilisation scheme.

"The conditions are building up for a repo rate hike by the RBI," said an analyst at a primary dealership firm. "Inflation figures are not showing signs of tapering off."

Dealers expecting a repo rate hike justify their view on the following grounds:

""Interest rates must rise to adjust to inflation, so that real interest rates are not negative.

""Interest rates must move with global trends and keep pace with hike in rate by the U.S. Federal Reserve and other central banks, so that India remains attractive for investments.

""CRR hike may not be fully effective in suppressing demand-pull factors as liquidity is abundant.

Those expecting a status quo say:

""Hike in CRR was a measure to only contain liquidity and not a rate signal.

""RBI may analyse the impact of the CRR hike before announcing the hike in the repo rate. Hence a repo rate hike appears unlikely soon.

""A repo rate hike may also be inflationary as it may lead to higher cost of capital.

""A hike in the repo rate may also affect the GDP growth as demand in the economy will be curbed.