Mumbai, March 19: The Reserve Bank of India (RBI) has left the door open for another bout of monetary tightening as it flagged inflation as its biggest worry amid clear signs of a rapidly reviving economy.

“The Reserve Bank will continue to monitor macroeconomic conditions, particularly the price situation, and take further action as warranted,” the central bank said in a note that spelt out its rationale for today’s 25-basis-point increase in both the repo and the reverse repo rates.

In January, the RBI had raised the cash reserve ratio (CRR) — which is the portion of deposits that the banks must maintain with the central bank — by 75 basis points to 5.75 per cent.

The reverse repo is the rate at which the central bank absorbs liquidity against government securities. The repo is the rate at which the central bank lends cash to banks in exchange for gilts.

Explaining the rationale for the hike in the two key short-term rates, the central bank said there had been major macro-economic developments since the presentation of the third-quarter review of monetary policy in January.

While the recovery in the Indian economy has been consolidating, the manufacturing sector, in particular, has recorded robust growth.

“The sharp acceleration in the growth of the capital goods sector points to the revival of investment activity. After contracting for 13 straight months, exports have expanded since November 2009. That the recovery is gaining momentum is also evident from the sustained increase in bank credit and the resources raised by the commercial sector from non-bank sources,” the RBI said.

According to the central bank, inflation was a source of growing concern. Though food prices are moderating, they are still at elevated levels. Moreover, consumer price inflation has accentuated further.

It observed that the rise in the prices of non-food manufactured goods and fuel items had been worrying.

“Anchoring inflation expectations and containing overall inflation have become imperative. Headline inflation on a year-on-year basis at 9.9 per cent in February has exceeded our baseline projection of 8.5 per cent for end-March 2010 set out in the third quarter review,” the RBI said.

It said that increasing capacity utilisation by manufacturing companies and rising commodity and energy prices were exerting pressure on overall inflation. “All these factors heighten the risks of supply-side pressures translating into a generalised inflationary process,” it added.

The central bank expected today’s rate hikes to “anchor inflationary expectations”.

“The RBI's move reflects the growing confidence in the recovery of growth in the Indian economy and is in line with its stated objective of anchoring inflation expectations,” ICICI Bank CEO Chanda Kochhar.

“There is ample liquidity in the market. We need to wait and see the credit offtake and assess the medium-term impact on lending and borrowing rates,” she added.

Harihar Krishnamurthy, treasurer at FirstRand Ltd, the South African financial services company, said the 25-basis-point hike was a good move. He said it would enable the central bank to tame inflation without jeopardising economic growth.

“It is a nice, tempered move and since it is a small hike, banks are unlikely to raise their prime lending rates at least immediately,” he told The Telegraph.

Debabrata Sinha of the United Bank of India also felt that there was little chance of a rate hike by banks in March though the RBI action would raise the cost of funds.

A bond market dealer said there could be a knee-jerk reaction when the markets resumed trading on Monday.

According to him, the Reserve Bank is likely to wait for more data on inflation before taking any action on April 20.

“At this juncture, another hike in the reverse repo and the repo on April 20 seems unlikely,” he added.