By Ira Dugal and Jaspreet Kalra
MUMBAI, May 22 (Reuters) - India's central bank does not see interest rate hikes as the best way to defend the embattled rupee, three sources said, a position at odds with markets, reinforcing that inflation - not the currency - will guide policy on borrowing costs.
The Reserve Bank of India has other levers it has yet to deploy, according to the sources familiar with the RBI's thinking, which Reuters reported earlier included options such as dollar deposit schemes for
non-resident Indians and tax tweaks for debt investors.
All options remain on the table and are under consideration in coordination with the government, one source added. "There doesn't seem to be an urgent need for the central bank to jump into rate hikes," the source said.
The stance puts policymakers at odds with market bets for tightening, even as the rupee slides to record lows on an energy-price shock linked to the Iran conflict. Inflation, however, remains subdued and officials fear rate hikes would do little to steady the currency while risking further damage to already slowing growth in Asia's third-biggest economy.
Indonesia and the Philippines have raised rates as inflation and currency depreciation risks rise.
India's rupee has fallen nearly 6% since the Iran war began late in February and slumped to a record low of nearly 96.96 per dollar on Thursday.
Interest rate swap markets are pricing in at least 40 basis points of rate hikes by the RBI over the next three months and more than 100 basis points over the next year.
A meaningful currency defence would require steep rate increases, another source said, warning that smaller moves would have little impact while crimping demand.
The RBI has historically avoided using interest rates as a primary tool to shore up the rupee, apart from a brief 2013 increase in the marginal standing facility rate. Officials continue to weigh measures to steady the currency, though not all options may be used, a fourth source said.
The central bank did not respond to an emailed request for comment.
The sources spoke on condition of anonymity due to the sensitivity of the topic.
The RBI's April forecast of 6.9% economic growth for the current financial year is likely to be revised lower, the first source said.
INFLATION WATCH
An oil price spike and a faltering rupee are poised to reignite inflation pressures in India's oil-import-dependent economy, overshooting the central bank's April forecast of 4.6 for the current year.
Consumer price index inflation is now trending higher towards 5% or a little above that, the second source said, which is still within the RBI’s tolerance band of 2-6% although higher than the 4% target. In April, CPI inflation was at 3.48%.
India’s wholesale inflation surged to 8.3% last month, but it has heavier oil weighting than the CPI basket, and the limited pass-through has softened the impact on consumers.
Policymakers are waiting to see how quickly pressures feed into core and headline consumer prices, all three sources said.
The central bank’s rate-setting panel will announce its next decision on June 5 and held consultations with economists on Thursday.
While it gave no signal, Governor Sanjay Malhotra asked whether policy lags could justify a pre-emptive rate hike, said two people familiar with the consultation, who requested anonymity to speak about private discussions.
A majority of economists do not expect a rate hike in June but some including the likes of Standard Chartered are wagering on a tightening.
(Reporting by Ira Dugal and Jaspreet Kalra in Mumbai;Editing by Shri Navaratnam)
