Mumbai: The Reserve Bank of India (RBI) raised interest rates, probably signalling the start of another rate tightening cycle over the next four quarters. That always calls for adjustments of portfolios and allocations to asset classes.

Bright outlook: Morgan Stanley managing director Ridham Desai.

“Rising inflation is a key concern and this move by central bank suggests that they are conscious of it," said Morgan Stanley managing director Ridham Desai, who expects $25-30 billion of capital inflows in 2010. Edited excerpts:

How do you think stock markets will negotiate this rate tightening cycle?

I think this is quite similar to 2004. So the key concern is that inflation is rising or is likely to rise, and I am not referring to the headline inflation number that we see every month; it’s core inflation pricing power. So it is important for the central bank to peg inflation expectations to anchor them. I think this is the first move to suggest to the market that they are conscious of the inflation pressures, enabling it to take actions to peg them.

I think the important thing about this rate hike was the fact that the central bank raised the repo rate more than the reverse repo, so that’s a clear signal to the markets. I think the markets will like it. In ’04 market multiples in short-term yields were positively correlated after the first rate hike and I expect a similar scenario now. So unless we get some global crises or some global event, I think the rest of the year should be pretty nice for the equity markets with the central bank raising rates probably every quarter and short-term yields rising, and multiples remaining positively correlated.

How prolonged or steep tightening cycle do you expect compared with 2004 this time?

I think at least this year we should see about 100 bps (basis points) rise in the repo rate. There are three more meetings, so probably another 25 bps in each of those three meetings. (One basis point is one-hundredth of a percentage point.)

Beyond that?

Beyond that, maybe, another 100 bps next year; I think that is possible.

So you are saying that the stock market now continues to move along higher even as interest rates move higher over the next four quarters?

I think that is what we will get because growth is pretty strong and if the central bank successfully convinces the market that it has pegged inflation expectations for which it needs to continue to act, this one action is not enough. So it needs to continue to act. If that happens then I think on its own India should be okay.

On capital flows front, how much capital do you think will be raised by the time we hit another air pocket in the global markets?

We are expecting around $25-30 billion (Rs1.13-1.35 trillion) as total issuances in this year, which includes the $9-10 billion that the government targets.