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India cuts interest rates for third time in two months

Section: Daily Dispatches

By Cherian Thomas and Anoop Agrawal
Bloomberg News
Saturday, December 6, 2008

MUMBAI -- India's central bank cut interest rates for the third time in less than two months after last week's terror attacks shook investor confidence in an economy already weakened by a global recession.

The Reserve Bank of India reduced its repurchase rate to 6.5 percent from 7.5 percent, Governor Duvvuri Subbarao told reporters in Mumbai. The bank also cut the reverse repurchase rate at which it borrows overnight to 5 percent from 6 percent. The cut in the reverse repurchase rate was the first since 2003.

Companies including Merck KGaA, Daiichi Sankyo Co., GlaxoSmithKline Plc, and Sanofi-Aventis SA have halted business trips to India after terrorists attacked luxury hotels in the financial capital of Mumbai on Nov. 26 and killed 163 people. The tragedy came as India's economy faces its weakest economic expansion in six years, dragged down by the global recession.

"The downside risks to growth have increased after the terror attacks," said N.R. Bhanumurthy, an economist at the Institute of Economic Growth in New Delhi. "We expect the central bank to loosen monetary policy further."

The government will also announce a fiscal stimulus package to support industries, Commerce Minister Kamal Nath said yesterday. India may unveil a 750 billion rupee ($15 billion) plan to boost growth, the Economic Times reported Dec. 4, without saying where it got the information. The announcement may be made tomorrow, according to the Press Trust of India.

... Industry Funding

Lower interest rates will allow Indian companies to turn to local banks for funding rather than rely on lenders in the U.S. and Europe, where a credit crunch has dried up money. Forty percent of Indian industry's funding in the year ended March 31 came from borrowings from abroad and the sale of new shares in the stock market, according to Tehmina Khan, international economist at Capital Economics Ltd. in London.

India's financial markets are closed today. Bonds gained for a fourth week at the end of trading yesterday, pushing yields to 6.76 percent, the lowest level since April 2005, on speculation slowing inflation will prompt the central bank to reduce borrowing costs.

Today's move by Subbarao was made easier after the government reduced fuel prices yesterday by as much as 10 percent, which may further drive down inflation from the current seven-month low of 8.40 percent.

"We think much will depend on the government's approach in dealing with terrorism" to remove the negative business sentiment, said Rajeev Malik, regional economist at Macquarie Group Ltd. in Singapore.

... Tackling Terrorism

Prime Minister Manmohan Singh this week moved Palaniappan Chidambaram, one of his most able ministers, who oversaw record average economic growth of 8.9 percent since 2004, to the home portfolio from the finance ministry to tackle the threat of terrorism.

Singh, who opened up India to foreign investors as finance minister in the early 1990s, has taken charge of the finance portfolio. He said Nov. 30 that India will establish four more hubs for its elite National Security Guards to be stationed in various metropolitan cities and frame laws to set up a federal investigative agency.

Singh's government, which hasn't revised its growth forecast since last month's Mumbai assault, expects the economy to slow to as much as 7 percent in the year to March 31, the weakest pace since 2003. Subbarao said today that the "moderation in growth will be more than anticipated."

He said the central bank will provide 70 billion rupees of refinance credit to small and medium industries and is working on a 40 billion rupee refinance plan for mortgage companies.

... Growth, Inflation

India's economic expansion is slowing due to a decline in exports and investments from abroad, as well as interest-rate increases earlier this year to control inflation that accelerated to a 16-year high in August.

The government wants lower borrowing costs to push growth back up to around 9 percent, a pace it says needs to be sustained to reduce poverty. The World Bank estimates 76 percent of India’s 1.2 billion people live on less than $2 a day.

Governor Subbarao presided over India's first rate reduction in four years on Oct. 20, reversing the tight policy stance the central bank had followed since 2004, as he prioritized growth over fighting inflation.

Today's move by the central bank came after non-state lenders including ICICI Bank Ltd. said they wanted a looser monetary policy before they start to cut their lending rates. Only state-run banks, which control half the assets in India's banking sector, have lowered their prime lending rates following the reduction in central bank rates so far.

... Stocks, Vehicle Sales

India's consumers, who account for 60 percent of the economy, are also spending less in response to a declining stock market. The benchmark Sensitive Index has dropped 56 percent this year as overseas investors sold a record $13.5 billion of equities. Foreign lenders are shying from emerging markets like India as the U.S., Japan and Europe succumb to recession.

Industrial production, which makes up a quarter of India's $1.2 trillion economy, may drop in October for the first time in at least 14 years. Motor vehicle sales sank 14 percent in October. The industrial output data will be announced on Dec. 12.

"Historically, there has been a close relationship between the output of consumer durables and motor vehicle sales," said Robert Prior-Wandesforde, senior Asian economist at HSBC Group Plc in Singapore. "The case for further policy rate cuts is building up strongly."

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