The Reserve Bank of India (RBI) is expected to raise rates for a third time since June on Friday to combat inflationary pressures as it grapples with a weakening rupee, surging oil prices and market instability sparked by a major non-bank finance firm`s defaults. Anticipation of a rate hike has increased in the past month as oil prices climbed, the rupee`s slide accelerated and concerns on liquidity emerged.

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Rising U.S. interest rates, capital outflows from emerging markets and India`s weakening balance of payments and current account deficit are also expected to make the central bank act. A rate hike should make domestic yields on debt more attractive for foreign investors and contain inflationary pressures from high crude prices as India imports more than two-thirds of its oil needs.

The monetary policy committee will hike interest rates by 25 basis points to battle inflation risks from costly crude oil and the weak rupee as well as "provide assurance about durable liquidity," predicted A. Prasanna, chief economist at ICICI Securities Primary Dealership.

"You cannot wish away the depreciation in the rupee if you are a current account deficit country," he said, adding that another reason to hike is so India does not "fall behind the curve in terms of interest rate differential given that central banks globally are raising interest rates."

A 25 basis point repo rate hike to 6.75 percent would mean a 75 basis point rise since June, the steepest increase since the last tightening cycle, between September 2013 and January 2014, when India faced its worst currency crisis since the 1990s. A Sept. 19-25 Reuters poll showed 35 of 64 respondents expect a rate hike on Friday. In a July poll, only 11 of 56 projected the rate to be 6.75 percent by December.

While a majority of analysts expect a quarter-point raise, some analysts said they would not be surprised if there`s a 50 bps increase, given surging oil prices and the rupee`s battering. The rupee, which inched towards 74 to the dollar on Thursday, has fallen 13.5 percent in 2018, making it Asia`s worst-performing currency.

Emerging market central banks including Indonesia, Argentina, Philippines and Turkey have raised rates to contain inflation pressures and currency weakness with the U.S. Federal Reserve set to keep raising rates. MARKETS ON EDGE The RBI is also expected to assure markets that adequate funds are available after investors panicked when a series of debt defaults by Infrastructure Leasing & Financial Services (IL&FS) led to redemption pressure at other companies in the shadow banking sector.

India`s inflation rate was 3.69 percent in August and is expected to go above the RBI`s projected 5 percent by June 2019 on higher fuel prices, the weak rupee and strong consumer spending. The 10-year benchmark bond yield has risen by 50 basis points to 8.20 percent since the last policy-making meeting in August. DBS economist Radhika Rao expects a rate hike, along with the RBI shifting its stance to "hawkish" from "neutral".

"For bond markets, a 25 bps hike accompanied by a hawkish stance could trigger the 10-year bond yield to rise to 8.25 percent," Rao told Reuters after yields surged on Thursday. BALANCING ACT The IL&FS debt problems have pushed up short-term interest rates sharply with one-year commercial paper rising by nearly 70 basis points to 9.20 percent since early August, while the one-year treasury bill rate is up 50 bps to 7.73 percent.

One underlying concern is that the RBI`s selling of dollars to stem the slide in the rupee has drained 1.5 trillion rupees from the banks since April. Analysts ruled out chances of a cut in the central bank`s cash reserve ratio (CRR) on Friday. To alleviate cash crunch fears, the RBI has unexpectedly outlined a large bond purchase programme worth 340 billion rupees ($4.61 billion) for October on top of 200 billion rupees of purchases last month.

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"The RBI is ready to keep real rates high because the policy mandate is to anchor inflation," said Anindya Banerjee, deputy vice president, currency derivatives at Kotak Securities. "The biggest policy anchor for rupee is high real rates. Raising the repo rate will increase the real interest rates and help in attracting fresh foreign inflows which will help in containing the rupee."