The Reserve Bank of India has a tough choice between an across-the-board tightening or sector-specific curbs, as it meets on Tuesday for a mid-term review of the 2006-07 monetary policy.
The central bank is expected to do a fine balancing act between supporting the higher-than-expected economic growth and ensuring price stability through curbs on rising inflationary expectations.
"In his April review, RBI Governor YV Reddy opted for growth and refrained from any price hike, though in June he had to go for a hike outside the policy review. One hopes that he does not repeat the same act this time as it disturbs all corporate plans," said the chief financial officer of a large manufacturing company.
The magnitude of credit offtake during the last ten quarters is extraordinary, with the total outstanding credit doubling to Rs 16,55,000 crore (Rs 16550 billion) at present, from Rs 8,40,000 crore (Rs 8400 billion) in March 2004.
The banking community is vertically divided on whether the RBI needs to effect another 25 basis point hike in the reverse repo rate, the rate at which banks park excess money with the central bank.
While a section feels that Reddy should bite the bullet to dampen inflationary expectations, those against it say an across-the-board tightening will hurt the unprecedented buoyancy in the economy.
The RBI has hiked the reverse repo rate by 150 basis points since October 2004. One basis point is one hundredth of a percentage point.
"Whether the current credit growth can be labelled as a bubble is a matter of semantics. Nonetheless, the situation deserves a strong regulatory response and a hike in interest rates will act as a signal for the banking sector," an IDBI Capital Markets' commentary on monetary policy expectations said.
Inflation is on the rise, driven by demand-pull pressures leading to rising core inflation, pressure from prices of primary articles and an erosion of the base effect.
Inflation for the week ended October 14 rose to 5.26 per cent from 5.16 in the previous week, which is still within the RBI's target of 5-5.5 per cent. But the tolerance level for inflation has dropped to 4 per cent, as stated by Finance Minister P Chidambaram recently.
Analysts expect inflation to rise to 6-7 per cent in the fourth quarter of 2006-07 if the significantly high inflationary expectations go unchecked.