Raghuram Rajan expected to hike rates to fight inflation; EMIs may rise

Reserve Bank Governor Raghuram Rajan is on course to hike interest rates for a third straight time to rein in India's stubbornly-high inflation, economists say. A Reuters poll showed 39 of 43 respondents expect Dr Rajan to lift the repo rate by a quarter percentage point to 8 per cent.

The repo rate is the rate at which banks borrow short term money from the RBI. When it goes up, lenders' cost of funds goes up and invariably the hike is passed on to consumers. Consequently, equated monthly installments (EMI) on home loans will go up and new loans would become costlier.

This would further pressure domestic budgets at a time when headline inflation is at a 14-month high and food prices are rising every month.

Controlling inflation is the biggest priority of the central bank, Dr Rajan has said. Another rate increase could further establish his hawkish credentials since his appointment in September.

If inflation cools, it could aid the Congress party, which was pounded in recent state polls, in part due to high food prices.

However, it's not as easy as it sounds. Most of India's inflation is structural or related to infrastructure bottlenecks, analysts say.

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

As a result, higher interest rates may not be the best response to high inflation. In fact, the previous two hikes have failed to control price rise.

Moreover, another rate hike will further weigh on growth at a time when India's GDP has slowed to the slowest pace in a decade. India may grow at less than 5 per cent this fiscal, when it needs to clock 8 per cent growth to reduce poverty and provide jobs for its burgeoning young population.

"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.

When Dr Rajan took over as the governor in September, India was on the verge of a currency crisis. His deft maneuvering of policies has helped the rupee make a spectacular recovery from near 69 per dollar to 62 per dollar.

Now, he faces an equally tough and challenging task.

(With inputs from Reuters)