India Cuts Interest Rates on Slower Growth Estimate
India’s central bank reduced interest rates for the sixth time in as many months to a record low after forecasting the economy will expand at the slowest pace since 2003.
The Reserve Bank of India cut the reverse repurchase rate to 3.25 percent from 3.5 percent, according to a statement in Mumbai today. Economic growth may ease to 6 percent in the year that started April 1 from 7.1 percent in the previous 12 months, the central bank said.
Governor Duvvuri Subbarao’s efforts to stimulate growth in Asia’s third-largest economy are being hampered by the reluctance of commercial lenders to pass on rate cuts and the government’s inability to increase spending during an election. Bond yields fell to the lowest in six weeks.
“The worst is yet to come for India as signs of weakness are still growing,” said Sherman Chan, a Sydney-based economist at Moody’s Economy.com. “The RBI needs to facilitate credit growth to support the economy.”
Bonds extended gains after the central bank decision, with the yield on benchmark 10-year government bonds declining to 6.21 percent from 6.34 percent before the announcement. The rupee traded little changed at 50.44 a dollar. Only six of 15 analysts in a Bloomberg News survey expected the rate to be cut.
India’s industrial production dropped 1.2 percent in February from a year earlier, the most in more than 14 years. Exports plunged by a record in March, extending the longest declining streak in a decade.
‘Further Action’
The Reserve Bank also cut the repurchase rate by a quarter- point to 4.75 percent and kept the cash reserve ratio unchanged at 5 percent, today’s statement said.
“Banks have been slow in reducing their lending rates,” Subbarao said in the statement. “Further action on policy rates is now being taken to reinforce this process.”
The central bank had lowered the reverse repurchase rate by 275 basis points and its repurchase rate by 425 basis points since October. In response, non-state-owned ICICI Bank Ltd., India’s second-biggest, has reduced its lending rates by only 50 basis points. State-run banks cut their borrowing costs by about 200 basis points after government prodding.
“There is typically a six-month time lag for the central bank’s rate cut to filter through the economy,” said Arun Kaul, New Delhi-based treasurer at state-owned Punjab National Bank. “Commercial rates will come down, but not substantially because government savings instruments are offering higher rates.”
Deposit Rates
Government-run savings plans such as postal deposits, which compete with banks’ deposits, offer interest rates at upwards of 8 percent faxless payday loans. The rates on these plans are set by the government and haven’t been changed since the central bank started cutting borrowing costs to counter the global downturn.
Kaul said banks are also holding high-cost term deposits because the central bank’s key rates were double current levels until October 2008 after inflation touched a 16-year high of 12.91 percent in August.
Inflation has subsequently slowed to 0.18 percent in the week ended April 4. The central bank expects inflation to accelerate to about 4 percent by the end of March.
“Inflation risks have clearly abated,” Subbarao said. “Banks should not be overly apprehensive about reducing deposit rates for fear of competition from small savings, especially as the overall systemic liquidity remains highly comfortable. There is scope for the overall interest rate structure to move down.”
Cash Injection
Between April and September, the central bank will inject 1.2 trillion rupees ($23.8 billion) of cash into the banking system by purchasing government bonds via auctions and buying back market stabilization bonds, which were sold in the past four years to drain money from the economy. The cash injected will be equivalent to a 3 percentage point reduction in the cash reserve ratio, the central bank said.
Subbarao said the central bank’s efforts are aimed at creating consumer demand and spurring growth, which he expects will remain favorable compared with most countries as normal rains boost farm production.
“However, any upturn in the growth momentum is unlikely in view of the projected contraction in global demand during 2009, particularly in trade,” Subbarao said.
The rate cut came in the middle of elections in India, which started on April 16 and will continue until May 13, with counting of ballots due to be held on May 16. Most opinion polls say Prime Minister Manmohan Singh’s Congress party may emerge with most seats, though it may have to rope in new allies to secure a majority in the legislature.
The central bank said it will use “a combination of monetary and debt-management tools” to ensure there is enough money in the economy and prevent the government’s record 4.35 trillion rupees of borrowings this year from disrupting growth.
“With no further fiscal stimulus likely until after the election, the onus is on the monetary policy to boost growth,” said Sonal Varma, an economist at Nomura Securities Ltd. in Mumbai.