FACTBOX-What India's central bank could do to calm prices

June 24 (Reuters) - India's central bank is expected to
tighten monetary policy soon, although governor Y.V. Reddy has
indicated a tightening will be a carefully considered step,
calming concerns of swift and aggressive action.

Annual inflation rate unexpectedly jumped to 11.05 percent
early this month from 8.75 percent in late May, due mostly to a
rise in government-set fuel prices at the start of June.

The rate has doubled since February largely on costlier
oil, metals and food.

Following are some of the instruments available to the
Reserve Bank of India (RBI) and possible scenarios.
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INSTRUMENTS

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REPO RATE: The short-term rate at which the RBI lends cash
to banks. The rate was last raised on June 11 by 25 basis
points to 8.00 percent. This was the first increase since March
2007.

REVERSE REPO RATE: The short-term rate at which the central
bank absorbs cash from the market. It has remained steady since
July 2006 when it was raised to 6.00 percent.

CASH RESERVE RATIO (CRR): The CRR is the percentage of
banks' deposits which they must keep with the central bank. It
was last raised by 25 basis points to 8.25 percent on May 24.

BANK RATE: Banks use this to price long-term loans to firms
and individuals. It has been steady at 6.00 percent since 2003.

POSSIBLE SCENARIOS

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1 - RAISE REPO RATE AND CRR: A slim majority of the 13
economists polled by Reuters after an increase in the RBI's key
lending rate on June 11 expected the repo rate to rise by 25
basis points again in 2008. But some economists have since said
more might be needed and some expect the CRR to rise as well.
Money market conditions are tight at the moment so the RBI
could announce a CRR increase at a future date.

ADVANTAGES: Using the two instruments together would be a
potent combination as it would raise the cost of funds for
banks and in turn lending rates. It may temper inflation
expectations and reduce demand in the economy -- a way to try
to dampen potential second-round effects from the recent fuel
prices hike.

DISADVANTAGES: It may drastically slow growth in months
ahead, hurt consumer sentiment and dent investment. This could
reduce government revenues and push up its borrowing costs when
funds are needed for the next pay round for government
employees and to compensate banks for a farm loan waiver.

2 - RAISE REPO RATE, LEAVE ALL OTHER RATES UNCHANGED:

ADVANTAGES: Strong signal to banks to raise lending rates
to curb demand pressures in the economy.

DISADVANTAGES: Unlikely to work effectively if cash
conditions improve as this can lower money market rates. More
government spending is expected and banks are likely to be
compensated by the government for waiving farmers' loans soon.

3 - RAISE CRR, LEAVE OTHER RATES UNCHANGED:

Cash conditions are tight in the money markets at the
moment with advance tax payments last week and bond sales,
making a CRR hike more tricky unless the RBI announces it for a
date in the future.

ADVANTAGES: Could help reduce cash in circulation in the
system, with M3 money supply well above the RBI's comfort
level. Restricting liquidity was the central bank's most
favoured option in the past year, until the June 11 rate hike,
and the CRR has risen by 275 basis points since the beginning
of 2007.

DISADVANTAGES: May reduce demand for government bonds and
hurt banks' profitability.

4 - RAISE REPO AND REVERSE REPO RATES, OTHERS UNCHANGED:

ADVANTAGES: Overnight cash rates usually hover between
these two rates. An increase in reverse repo would prompt banks
to raise deposit rates, pushing up lending rates in turn.

DISADVANTAGES: Pushing up money market rates will increase
borrowing costs for companies, which in turn could impact
investment and dent growth. Higher reverse repo rate could
reduce the central bank's income and in turn lower government
revenues.

5 - RAISE REVERSE REPO RATE, LEAVE OTHERS UNCHANGED:

Similar effect to option 4. Only difference is that by
leaving the repo steady, it might be read as less aggressive.
Effectiveness of measure depends on day-to-day market
liquidity.

6 - INTERVENTION TO PUSH UP RUPEE, LEAVE ALL RATES STEADY:

Rupee is holding just above 43.00 per dollar, a level it
has only crossed once, briefly in late May, since last year.
Traders suspect the central bank has sold dollars and bought
rupees to stop it weakening beyond this level and importing
inflation.

ADVANTAGE: Rupee has depreciated about 8 percent in 2008
after a 12 percent rise in 2007. Selling dollars to push it up
could reduce the price of imported commodities, particularly
crude oil, which is India's largest import.

DISADVANTAGE: Hard to push against the market with a
widening trade gap and foreign investor selling. Furthermore
exports might suffer and software industry, already bearing
brunt of the U.S. economic uncertainty, could be hurt.

BACKGROUND:

- Annual wholesale price inflation has held above 5.5
percent, the RBI's target for the fiscal year end, for 17
consecutive weeks.

- GDP has expanded at an average 8.8 percent over the past
five fiscal years. The central bank estimates growth at 8.0-8.5
percent in the 2008/09 fiscal year that began in April.

- The monsoon is forecast to be near normal this year.
Farming contributes less than a fifth to GDP but good farm
output pushes up rural incomes and triggers all-round demand.

- The government plans to issue 960 billion rupees ($22
billon) of bonds in April-September, and a gross total of 1.45
trillion rupees in 2008/09.

- M3 money supply growth was at annual 21.4 percent in the
two weeks to June 6, above the RBI's 2008/09 forecast of
16.5-17 percent.

- Bank loans rose 25.9 percent year-on-year in the two
weeks to June 6.

- Foreigners have sold a net $6.1 billion worth of shares
so far this year. In 2007, they bought a record net $17.4
billion.
(Compiled by V. Ramakrishnan; Editing by Charlotte Cooper)