A sliding rupee, the government's deteriorating finances and the persistence of a cheap money policy in the West may prompt Reserve Bank of India (RBI) governor Duvvuri Subbarao to toughen his stance against the call for a pause in raising interest rates on Tuesday, despite a dozen increases since March 2010.

The governor will raise the key repo rate - the rate at which the RBI lends to banks - by 25 basis points to 8.5% and probably cut economic growth forecast from the current 8%, when he places the quarterly monetary policy review on Tuesday. Indeed, there are chances of a possible upward revision of year-end inflation forecast of 7% due to little signs of price pressure easing, and missing it last year, an ET poll of 20 economists show.

"Whichever way one looks at it - headline, core, food, fuel - inflation is unacceptably high and remains a big concern," says Brinda Jagirdar, chief economist at the State Bank of India. "Besides, with the rupee weakening, imported inflation is another worry. Higher market borrowing by the centre and a potential fresh quantitative easing in developed economies could add to domestic liquidity, fuelling inflationary pressures," she adds.

Subbarao is torn between a central banker's commitment to rein in inflation and the demands of the business community to stop raising rates that is affecting profitability. The prolonged low rate of interest rates after the 2008 credit crisis had created such a strong demand momentum that even after the 12 hikes, bank loans are growing at an annualised pace of 20%, above the RBI's target of 19%.

Inflation - as measured by the Wholesale Price Index (WPI) - was at 9.72% in September, above the 8% mark for the 19th month in a row, defying expectations. This is despite the 'analytically bewildering' Index of Industrial Production (IIP) data that came in at 4.1% for August, showing slowing output. Although, car sales growth is slowing, other businesses such as motorcycles and televisions have been witnessing strong growth.

"We need to bring inflation down in order to bring interest rates down," Subbarao said recently in Jaipur. "When inflation is as high as 9.8% it is difficult to bring it down without compromising on growth. So, we are trying to trade off at this time on bringing down inflation, even if that means bringing down growth by a few basis points.''

But business climate is worsening with companies postponing new projects due to higher cost of funds and unpredictable raw material prices that make business forecasting difficult. L&T cut its full-year orders forecast two-third to 5%. Thermax, an electrical equipment manufacturer & Crompton Greaves, its competitor, also said that business is becoming difficult.

"There is zero demand for loans for new projects," said State Bank of India chairman Pratip Chaudhuri. On the contrary, HDFC Bank, Axis Bank and other lenders are reporting more than a quarter jump in their net profits with retail segment contributing the biggest growth. The macro numbers and micro developments are diverging substantially, creating a paradox for policy makers.

More than the inflation, it is the government finances that may be creating bigger trouble for policy makers in Mint Street. "We believe India's policy mix is worsening with a much tighter-than-expected monetary policy and looser-than-expected fiscal policy," says Tushar Poddar, chief India economist at Goldman Sachs.

"With market and consensus expectations of a rate hike on October 25, monetary policy is likely to tighten further. Along with this has come a worsening fiscal balances due to higher subsidies on oil and fertilisers but more importantly, a significant slowdown in revenues."

The treasury has said it will borrow 52,800 crore more than what it budgeted for in February. (Economic Times)