Equity investors in India will keep their eyes on the central bank for direction this week, with the possibility of aggressive monetary tightening being a big concern for the market.
Quarterly earnings from big companies will also set the trend.
The Reserve Bank of India (RBI) is widely expected to raise its benchmark lending and borrowing rates by a quarter of a percentage point on Tuesday when it announces policy to dampen inflationary pressures that are spreading from food to manufacturing.
It would be the second increase in two months after the RBI lifted rates unexpectedly in March, citing rising prices and stronger economic growth, after keeping them at record lows for more than a year.
"The market has discounted a 25 basis point rise," said equity trader Rajesh Shah. "Anything more could upset the apple cart."
The blue-chip 30-share Sensex, which is a barometer of the stock market, posted its first weekly fall in 10 when it shed 1.9 per cent last week to 17,591.18, its lowest close in April.
The widely tracked index had risen 11 per cent over the previous nine weeks in its longest run of gains in almost a year.
Like all central banks, the RBI is wary of inflation and the consequences it could cause while the government is focused on growth.
Some economists have predicted the RBI may raise rates by 50 basis points and increase the percentage of deposits that banks must keep with the central bank in reserve, or CRR, by a quarter point.
The RBI had hiked the CRR by 25 basis points in March.
On Friday, after RBI Governor D. Subbarao met Finance Minister Pranab Mukherjee ahead of the policy review, government officials indicated only a small rate rise was needed as inflation was set to start cooling.
"I think actually we've peaked. Inflation's still got to remain high for a while but on a downward trajectory from now on," Kaushik Basu, the chief economic adviser to the finance ministry, told reporters.
Annual wholesale price inflation in March was 9.9 per cent, the strongest since October 2008, but below economists' estimates of above 10 per cent. The data seemed to back Basu's point that inflation was likely to moderate in the coming months.
Samiran Chakraborty and Anubhuti Sahay, economists at Standard Chartered Bank, said the RBI would likely adopt a gradual and calibrated tightening as the economy was still too early in the recovery cycle.
They predicted the RBI would raise the repo and reverse repo rate by 25 basis points each and the CRR by 50 basis points. "We believe that would be appropriate to demonstrate the RBI's resolve to counter inflation," they wrote in a report.
The bank expects wholesale price inflation to average 6.75 per cent in 2010-11 and ease to five per cent in 2011-12. There is also an opinion the central bank should hold its fire for the time being, especially because of the action in March.
"As the RBI moved barely a few weeks ago, the best policy would be to wait and watch," the Indian Express wrote in an editorial yesterday.
"The difficulties in the transmission mechanism of monetary policy mean that it's not clear how much and how long it would take for higher policy rates to get transmitted to higher bank lending rates."
So, will the RBI tone down its aggressive stance?
"While these developments are unlikely to stop the RBI from hiking rates again at next Tuesday's quarterly policy meeting, they increase the chances the move will be 25 bps rather than 50 bps," said Robert Prior-Wandesforde, senior Asian economist at HSBC.
Investors will also be watching quarterly earnings from companies. Some of the top results due this week include: Reliance Industries, Tata Consultancy Services, Wipro, Hero Honda Motors, ACC, Ambuja Cements and UltraTech.
The writer is a journalist based in India.
