Dealers expect RBI to bite the bullet

Market presages 25-basis point hike.

Bond dealers are expecting a 25-basis point hike in the reverse repo rate by the Reserve Bank of India (RBI) in its quarterly monetary policy review meeting on July 25.

The hike is expected against the backdrop of the 25 basis points hike in the US Fed rate to 5.25 per cent "� the 17th rate hike since June 2004 when the rate was 1 per cent.

One basis point is one hundredth of a percentage point.

The RBI hiked the reverse repo rate early this month by 25 basis points to 5.75 per cent, within hours of the rate hike by the European Central Bank. It may bite the bullet again to contain inflationary fears.

The annual inflation in terms of wholesale price index increased to 5.4 per cent in the week ended June 17 from 5.24 per cent a week earlier.

Besides, the difference between the benchmark rates in the US and India has narrowed down to 50 basis points following the latest rate hike by the Fed.

The reverse repo rate is now 5.75 per cent. The rate differential was as much as 3.5 percentage points in May 2004, when the US Federal Reserve began its secular rate increases.

The yield on the benchmark 10-year government bond rose to 8.11 per cent from 8.09 per cent just before the weekly inflation data was released. The benchmark yield today closed at 8.13.

"The RBI needs to hike the domestic rate to prevent capital outflow," said a senior banker.

Rajeev Malik, Singapore-based Asia economist with JP Morgan, said the RBI would probably revise its inflation forecast range upwards to 5.5-6.0 per cent from 5.0-5.5 per cent in its first quarter annual policy review on July 25.

JP Morgan expects the RBI to hike the reverse repo rate by 25 basis points at the meeting and, given the still high pace of credit expansion, consider a hike in the cash reserve ratio in the next few months from the current 5 per cent.

"We expect inflation to remain a major concern in this fiscal year. Further, the differential between domestic and US interest rates is just 50 basis points. This spread is extremely narrow by historical standards. All these factors are likely to result in two or three more rate hikes this year. We certainly expect a 25-basis point rate hike in July," said S P Prabhu, head - fixed income, IDBI Capital.