India’s Central Bank May Continue Cutting Rates to Spur Growth

March 5 (Bloomberg) -- India’s central bank indicated it may keep cutting interest rates after economic growth slowed to a five-year low last quarter.

The Reserve Bank of India yesterday reduced the benchmark repurchase rate to a record low of 5 percent from 5.5 percent and the reverse repurchase rate to 3.5 percent from 4 percent, adding it will “maintain ample liquidity in the banking system”.

Governor Duvvuri Subbarao is driving policy rates down to unprecedented lows to revive investment and spur consumption in Asia’s third-largest economy. The $1.2 trillion economy is slowing as exports decline and companies’ access to funds from overseas and from the stock market is cut off by the global recession.

“Credit availability in India is drying up and is the problem,” said Chetan Ahya, an economist at Morgan Stanley in Singapore. “We expect the RBI to cut the policy rate by another 50 basis points by the end of the second quarter of 2009.”

The deepening global recession and slumping share markets, including a 13 percent decline in India’s key stock index this year, have forced policy makers around the world to slash borrowing costs.

The U.S. Federal Reserve’s benchmark rate is near zero, the Bank of England’s is the lowest since its creation in 1694 and the European Central Bank today will probably trim its main rate to 1.5 percent, the lowest level in 10 years of setting policy, according to economists.

Slowing Inflation

Subbarao has room to slash rates because falling commodity prices have slowed inflation to a 14-month low of 3.36 percent from a 16-year peak of 12.91 percent in August.

India’s economy expanded 5.3 percent in the three months to Dec. 31 from a year earlier after a 7.6 percent gain in the previous quarter, the statistics agency said last week. That was less than the 6.1 percent predicted by economists.

India, which grew an average 9 percent in the past four years, is suffering from a slump in exports after trade as a percentage of GDP rose to 35 percent in the year ended March 31, 2008, from 21 percent in 1997-98.

The nation’s exports declined last quarter for the first time in seven years. Local demand has also been hit because commercial banks, laden with high-cost deposits, have been slow to reduce lending rates.

Prime Minister Manmohan Singh’s government has backed the monetary stimulus by lowering taxes and increasing spending on infrastructure.

Tax Cuts

Acting Finance Minister Pranab Mukherjee Feb. 16 lowered the excise duty to 8 percent from 10 percent and the service tax to 10 percent from 12 percent. He extended a 4 percentage-point cut in central value-added tax announced in December beyond March 31.

Before yesterday’s announcement, the combined stimulus from interest-rate cuts, increased government outlays and lower taxes totaled almost $80 billion, or 7 percent of India’s gross domestic product, according to the central bank.

Overseas borrowing and the sale of new shares on the stock market provided Indian industry with about 40 percent of total funding in the year ended March 31, 2008, according to Tehmina Khan, an economist at Capital Economics Ltd. in London.

Still, the spending is straining the budget deficit, which the finance ministry forecasts will widen to 6 percent of GDP in the year ending March 31 from a target of 2.5 percent. The government expects borrowing next year to increase to a record 3.62 trillion rupees ($72 billion). Indian government debt is the equivalent of 80 percent of the nation’s GDP.

Yields on India’s benchmark bonds due in 2018 have risen 1.19 percentage points to 6.44 percent this year because of deteriorating government finances.

Weighing on Confidence

“The massive public debt is weighing on investor confidence,” said Sherman Chan, a Sydney-based economist at Moody’s Economy.com. “There is an urgent need to clean up the government balance sheet after the global storm.”

The government, whose five-year term ends in May, wants to prop up growth and reduce unemployment as it prepares to face general elections.

Standard & Poor’s said Feb. 24 that the nation’s credit rating may be cut to junk as government debt reaches a level that’s “not sustainable.” S&P lowered India’s rating outlook to negative from stable.

Mukherjee said the rating company’s move was “not unexpected” and that the global decline requires “extraordinary steps from the government.”

Already, companies have cut about half a million jobs in the three months ended in December, according to the labor ministry.

Apollo Tyres Ltd., the Indian tiremaker partly owned by Michelin & Cie, said this month it plans to cut its workforce by 15 percent, or 1,500 employees. A survey of 50 textile companies by the Apparel Export Promotion Council of India found they reduced 14 percent of their workers in November.

“The mother-of-all monetary easing will continue,” said Rajeev Malik, regional economist at Macquarie Group Ltd. in Singapore. “There is no more room on the fiscal side and so the RBI will have to do the heavy lifting to support growth.”