The Reserve Bank of India (RBI) said on Monday it was ready to act against "unacceptably" high inflation if necessary but any steps needed careful thought.

Following the statement from Governor Yaga Venugopal Reddy, analysts said a tightening of cash conditions may be on the cards.

"We are in full readiness to take appropriate action if and when we make a judgement that any action is needed," Reddy told reporters after markets closed.

Annual inflation, as measured by wholesale prices, hit a 14-month high of 6.68 per cent in mid-March, largely driven by food and manufactured product prices, and economists expect pressures to remain elevated for a few months.

Inflation is now well above the central bank's goal of around 5 per cent for the fiscal year which ends on Monday and has caused concern in the government, which faces a series of state elections this year and a national election due by 2009.

But at the same time economic growth has slowed due to an interest rate-raising campaign in 2006 and 2007.

"Any decision to act has to carefully assess this extremely complex situation," Reddy said.

Analysts said the RBI was more likely to keep control on funds in circulation by lifting its cash reserve ratio (CRR) than raise rates outright.

"I don't really think he will touch the rates, but CRR is certainly a possibility," A. Prasanna, analyst with ICICI Securities said.

"If they don't do it now, they will do it in (April)."

The central bank lifted interest rates five times between June 2006 and March 2007 but has now left its key lending rate on hold at 7.75 per cent for a year. It holds its next policy review on April 29, but can and does make unscheduled rate moves.

In tandem with the cycle of rate increases, it pushed up the CRR, the proportion of funds banks must keep with it on deposit, in a series of steps to 7.50 per cent as a way of absorbing inflation-fuelling spare cash from the banking system.

The last CRR increase was in November.

"Full Readiness"

Bond yields have risen in the past two trading sessions as the surge in inflation stoked expectations the central bank would have to respond. The benchmark 10-year bond yield closed at 7.94 per cent on Monday, its highest level since October.

Abheek Barua, chief economist at HDFC Bank, did not rule out a rise in the key lending rate, known as the repo. "I would not be surprised if they do a combination of repo rate and CRR increase," Barua said.

Reddy said the RBI had expected some price pressure at its last review in January, when it held rates steady. "Inflation is unacceptably high," he said.

But the recent pressures came from food, fuel and metals, as well a delayed adjustment in some prices, and inflation had turned out to be more than anticipated, "in fact much more than anticipated", he said.

The central bank had a range of instruments to manage the level of cash circulating in the system, he said, adding: "We would not hesitate to use them. Liquidity management has to be consistent with overall monetary management."

The government has taken a series of fiscal measures in recent weeks to take the sting out prices and ministers were due to meet late on Monday to discuss further steps.

India has cut import duty on palm and other edible oils, banned exports of edible oils, scrapped tax refund schemes for exports of steel and cement, and made rice imports cheaper by cutting import duties as well as severely curbing exports.

Reddy noted the government was taking supply-side initiatives. "That would certainly be very helpful in containing inflationary pressures," he said.

(Reuters)