By Saikat Chatterjee and Tony Munroe
MUMBAI, July 24 (Reuters) - India's central bank is widely expected to leave interest rates steady at a quarterly policy review on Tuesday and will try to avoid agitating a bond market already under pressure from huge government debt supply.
For a poll on rates, please see [ID:nBOM221365].
The central bank has cut its main lending rate by 425 basis points to 4.75 percent in six steps since October, so higher bond market yields would undermine monetary policy.
Here are some scenarios on what will happen at the Reserve Bank of India's meeting on July 28:
CENTRAL BANK TO AVOID TALK OF EXIT STRATEGY, EMPHASISE GROWTH
This is likely. Such comments would repeat what it said at its last meeting in April and have been priced in by financial markets alongside no changes in rates.
The central bank is well aware that bond markets are agitated over record government borrowing in 2009/10 of 4.51 trillion rupees to support its biggest fiscal deficit in 16 years, which forced the one-year to 10-year spread out to a record 318 basis points on Wednesday. <0#INBMK=>
Short-term inflation pressures are emerging and there are signs the economy is on the road to recovery. But the central bank will not want to fuel the rise in bond yields by talking about the potential for withdrawing economic stimulus.
Instead, it will emphasise that nurturing growth is its main priority. It may say its massive monetary easing in recent months must be viewed as temporary, but it is unlikely to go further, such as by drawing up a timeline for withdrawing excess cash from money markets.
Its message on the economic outlook will be cautiously optimistic, reflecting recent comments from Governor Duvvuri Subbarao, and it is unlikely to revise up its growth forecast of 6 percent for 2009/10. [ID:nBOM497825].
For a graphic on a rebound in some sectors in the economy:
http://graphics.thomsonreuters.com/079/IN_CRSLPMI0709.jpg
Wholesale prices are falling from a year earlier, reflecting deflation seen in other parts of the world owing to high year-earlier oil prices.
That gives the central bank room to maintain an accommodative policy stance. But the wholesale price index has been rising sequentially since March as food and oil prices pick up. In addition, consumer price inflation hovers near 8 percent, so most analyst say a rate cut is unlikely.
EMPHASISE CONTINUED SUPPORT FOR BOND MARKET
This is likely. The central bank will probably say managing the government's record borrowing plan without unsettling the bond market poses a major challenge.
Since the budget, the central bank has tried to assure the debt market it will continue with its bond buy-back programme to ensure the market has ample liquidity.
It is likely to repeat that message on Tuesday to try to put a floor under the market. Yields on 10-year bonds have risen 175 basis points in 2009 to around 7 percent and the central bank is widely seen as trying to keep yields below 7.50 percent.
For a graphic on monthly borrowing and yield trends:
http://graphics.thomsonreuters.com/079/IN_GVBDBRR0709.jpg.
Although some analysts expect the central bank to cut rates on Tuesday, most argue that a cut would give only a brief respite before market yields rose again.
TALK TOUGH ON BANKS
This is likely and would repeat the tone of April's central bank statement. At that time the RBI said commercial banks weren't doing enough to pass on its rate cuts and so spur lending.
Banks have argued their hands are tied. High interest rates on federal tax-free savings schemes, high-cost deposits from previous years and distorted lending to priority sectors are forcing banks to keep lending rates high.
Loan growth
State-run banks have reduced rates by only 150-200 basis points, less than half the cuts made by the central bank.
Pointing to excess liquidity in the banking system of 1.4 trillion rupees ($29 billion), the central bank is likely to tell banks they have more room to cut rates. (Editing by Neil Fullick) (US$=48.5 rupees)