The Reserve Bank of India (RBI) is expected to resume its rate hike cycle at its quarterly monetary policy review next week as soaring inflation stalks Asia's third-largest economy.

The vast majority of analysts surveyed by Reuters expect the RBI to raise key lending and borrowing rates by only 25 basis points (bps) on Jan. 25 despite persistent price pressures, as a slump in industrial production growth suggests some risks to economic momentum still exist.

The RBI raised its main lending rate or the repo rate Repo rate by 150 bps to 6.25 percent and its main borrowing rate by 200 bps to 5.25 percent through six rate increases in 2010.

Some market watchers, however, are pricing in a more aggressive increase.

The wide spreads between quotes on the one-month Overnight Indexed Swap (OIS) suggests that the view in the market is diverse and there are some who expect a 50 bps hike.

The bid/ask spread on the one month OIS was 6.60/90 percent.

The wholesale price index (WPI), India's main inflation gauge, rose 8.43 percent in the year to December, well above the RBI's comfort zone of 5.5 percent.

A Reuters poll showed WPI is expected to rise by an average 8.8 percent for the fiscal year ending March 2011, higher than 8.3 percent seen in the previous survey in October.

Here are the possible outcomes of the Jan 25 monetary policy:


This is the most widely expected policy action by the RBI to contain price pressures without sapping the economy's momentum. It would be in line with what it says is its calibrated or gradual approach to tightening, which is perceived as a 25 bps rate hike by the market.

With November industrial output data at an 18-month low, a 25-basis-point rate hike could be the least disruptive yet send an anti-inflationary signal.

The central government may also not oppose this move as spiralling food and fuel prices have damaged voter confidence in the government, causing a headache for the multi-party ruling coalition ahead of key state elections.

* Probability: Most likely

* Market impact: This scenario has been mostly priced in and therefore initially swap rate and bond yields could ease. The overnight indexed swap curve may bull steepen immediately led by a sharper fall in the front-end. However, going ahead, swap rates may inch up across the curve on expectations of accelerated rate increases.


The RBI could get more aggressive as it looks to clamp down on stubborn inflationary pressures after the country battled double-digit food inflation through most of 2010, the highest rate of any major Asian economy.

However, analysts say such an aggressive move may curb economic growth.

* Probability: Less Likely

* Market impact: Swap and bond yields may rise as the action could be construed as an aggressive stance. The short-end swap rates would rise sharply, thereby squeezing the spread between the 1-and 5-year OIS to 50 basis points from 58 basis points now. However, if the statement is less strongly worded, then swap rates can come off.


This could be interpreted as a less aggressive stance by the central bank. Raising the reverse repo rate, or the rate at which it borrows liquidity from banks, by more than the repo rate, its key lending rate, would indicate the RBI's intention to keep adequate liquidity in the system to ensure smooth bank lending and support the government's borrowing programme.

This would be in contrast to the RBI's current stance of keeping liquidity in the negative zone to contain inflation.

* Probability: Less likely

* Market impact: While the rate action should pull down OIS rates marginally, the overall impact on the curve would depend on the tone of the statement. If the RBI indicates a pause in the March policy then the swap curve would steepen as short-end would fall faster and if it uses a hawkish tone, then the curve would flatten.


This is a very unlikely scenario. However, if it keeps rates unchanged to protect growth and waits for its past policy actions to be effective, it may still impose sector-specific measures to contain prices.

Analysts expect sectors like real estate, and food related sectors to attract some credit control measures.

However, this would be seen as dovish stance in the backdrop of soaring prices.

* Probability: Least likely

* Market impact: Bond yields and swap rates will fall briefly but will soon reverse as traders will expect aggressive action from the RBI going ahead