Chetan Ahya, MD, Morgan Stanley, said the Reserve Bank would not touch the Repo rate. "It is not necessary to conclude that rates must be hiked as the situation is dynamic. The central bank may take some other measures to curb inflation. However, a rate hike will slow down investment demand and growth outlook. Domestic demand is slowing, so the right decision will be to hold back for now. Alternatively, RBI can wait for a Fed move before taking decisions on rates."

According to Ahya, the US futures market is discounting a Fed tightening by 2.9%. "The market is beginning to discount a more hawkish stance by the Fed. The US regulator will give an indication that tightening will come soon.

The government's move will show up in next week's inflation numbers, he said. "However, one needs to watch global commodity prices and its impact on the rupee."

Excerpts from CNBC-TV18’s exclusive interview with Chetan Ahya:

Q: What are your expectations from RBI next week?

A: At this point in time, we are expecting that they will not touch the repo rate. However, things are changing very quickly. The Fed futures in the last few days are now beginning to discount a possibility of a rate hike by the Fed in October and there has been a huge swing in the last trading session.

Now, the Fed Futures are discounting the Fed rate going up to 2.9% in July 2009, which just a month back was discounting 2%. So, there has been a 90 basis points swing in the Fed futures expectations for July 2009 and that reflects that the Fed could start tightening. This will play on the central banks mind as well. Considering the fact that they have already tightened in India ahead of time and cooled down the domestic demand at this point if time, the central bank could hold the repo rate unchanged.

They could take some other measures which would still convey that the commitment is still on in terms of controlling inflation and inflationary expectations. We would want to see that they don’t do anything which tighten the lending rates further because that would slow down the investment demand which in any case is likely to slow considering the macro environment. Further throttling of investment demand will pull down our medium-term growth outlook as well. So, they will probably just hold back the repo rate for the moment.

Q: If there is a repo rate hike for whatever reasons, do you think it would tantamount or workout to a policy mistake and would bond and equity markets react sharply to that?

A: The situation is dynamic and it would probably be a little bit early to take a call. Circumstances may prove that decision to be more correct one, if commodity prices continue to rise significantly and the Fed changes its view dramatically on April 30 saying that they would hike rates. The market has begun to discount it earlier, even October has priced it in right now. Obviously, the central bank’s decision may appear to be the right one by moving on with a rate hike ahead of time.

At this point of time, it is not necessary to conclude there is a need to hike the policy rate. The situation is dynamic, so watch out what happens on commodity prices and the Fed policy and then take a call of a domestic rate hike rather than doing it right now on April 29 when RBI meets.