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NEW DELHI (Reuters) - India's industrial output grew at its fastest pace in two years in November, strengthening the case for the Reserve Bank of India (RBI) to tighten policy later this month to temper inflation expectations.
The RBI, which reviews its quarterly policy on Jan. 29, is expected raise banks' cash reserve ratio, the level of deposits that banks must keep in cash.
Analysts are divided over when the RBI will start raising policy rates, and after market hours one of the deputy governors of the RBI said food prices are plateauing.
Some central banks in Asia have started to drain liquidity from the market as the economic recovery gathers pace.
China on Tuesday raised the reserve requirement ratio, the proportion of deposits that banks must hold in reserve, by 0.5 percentage point. The measure will take effect on Jan. 18.
India's industrial output grew at faster-than-expected 11.7 percent in November from a year earlier, data showed on Tuesday.
"This number combined with an expected 7.3 percent WPI inflation for December, would strengthen the case for monetary tightening by the RBI," said Gaurav Kapur, senior economist at ABN Amro Bank, referring to wholesale price data due on Thursday.
The benchmark 10-year bond yield revisited a near 15-month high of 7.81 percent hit last Friday, after the data.
The one-year overnight indexed swaps rose to 4.95/98 percent, from Monday's 4.92/95 percent.
The partially convertible rupee ended at 45.71/72 per dollar, about 0.8 percent weaker than its previous close of 45.34/35. It rose to 45.2850 on Monday, its strongest since Sept. 22, 2008.
The December inflation data, due on Jan. 14, will be the last important data for the RBI to gauge price pressures before its policy review on Jan. 29.
A Reuters poll of 22 economists showed annual inflation jumping to 7.31 percent in December from 4.78 percent last month.
"Inflationary pressures seem to be plateauing on the food front," Subir Gokarn, one of RBI's deputy governors, said at a banking conference.
"Inflationary pressures are relatively concentrated on food and very clearly as (the) economy starts to grow start to utilise whatever slack capacity there is, the risk of food inflation spilling over to wider surge increases," he added.
India and South Korea are expected to be among the first Group of 20 nations to follow Australia and raise rates.
"The number is extremely strong. Now a 25 basis points rate hike (in policy rates) in January is all but certain." said Ramya Suryanarayanan, an economist at DBS, Singapore.
But other economists think the RBI will hold off from hiking rates, as the bank credit remains below the central bank's forecast. Bank loans grew an annual 11.3 percent as of Dec. 18 compared with the RBI's forecast of 18 percent for the current fiscal year that ends in March.
"So far as the RBI policy action is concerned, they will go for a strong liquidity withdrawal signal than hike policy rates as credit still remains subdued," said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.
Last month, RBI Deputy Governor Shyamala Gopinath said the focus of monetary policy was shifting to managing recovery and containing inflation from fostering growth after the global downturn.
But there have also been signs that government officials are wary of any sharp monetary tightening, worried it could choke off economic recovery. Any government pressure could influence the RBI.
The finance secretary was quoted as saying on Monday the ministry backs administrative steps to tame inflation and wants hike in policy rates only if food inflation escalates into general inflation.
Factory output in November, which had expanded 10.3 percent in October from a year earlier, is riding a revival in consumer demand following aggressive rate cuts by the central bank and stimulus through tax breaks after the global downturn.
Back pay of about 180 billion rupees ($3.96 billion) to federal government workers in October, the second instalment of a wage pact agreed in 2008, has also helped shore up consumers' purchasing power.
A private survey found last week the December purchasing managers' index showed the pace of manufacturing activity jumped to its highest since May on sharp rises in new work and output, while car sales in December rose an annual 40.3 percent.
Montek Singh Ahluwalia, the deputy chairman of Planning Commission, said the industrial growth for the full 2009/10 would be well above last year's level, but inflation could moderate in the coming months.
India's economy grew an annual 7.9 percent in the quarter through September, its fastest in 18 months, prompting the finance minister to raise the growth forecast for the current fiscal year to end-March to around 8 percent from 7.0 percent.
While government officials said the industrial output growth highlighted recovery was on course, RBI's Gokarn said the recovery is somewhat uneven.
(Additional reporting by Suvashree Dey Choudhury and Neha D'silva in MUMBAI)
(Editing by Malini Menon )