India’s Central Bank May Keep Benchmark Interest Rate Unchanged

April 21 (Bloomberg) -- India’s central bank may refrain from reducing its benchmark interest rate from a record low, giving time for three cuts since December to percolate through the economy.

The Reserve Bank of India will maintain its reverse repurchase rate at 3.5 percent, according to nine of 15 economists in a Bloomberg New survey. The rest expect a cut. The central bank will unveil its quarterly monetary policy at 11:15 a.m. today in Mumbai.

Governor Duvvuri Subbarao said April 6 he has done “everything” to fight the impact of the global recession and that commercial lenders have room to reduce borrowing costs further. The absence of a fiscal stimulus for the economy until at least June, when India’s new government takes office, may yet prompt him to lower rates.

“A rate cut now may not yield anything, because the full impact of past reductions hasn’t been transmitted through the economy,” said N. R. Bhanumurthy, an economist at the Institute of Economic Growth in New Delhi. “It could go either way.”

The central bank has cut its reverse repurchase rate by 250 basis points and its repurchase rate by 400 basis points since October. In response, non-state-owned ICICI Bank Ltd., India’s second-biggest, has lowered its lending rates by only 50 basis points. State-run banks cut their borrowing costs by about 200 basis points after government prodding.

Six-Month Lag

“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.”

Government-run savings plans such as postal deposits, which compete with banks’ deposits, offer interest rates at upwards of 8 percent. 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.

India’s $1.2 trillion economy expanded 7.1 percent in the year ended March 31, the slowest pace since 2003. The central bank will also unveil its growth forecast today for the year that started April 1.

‘Boost 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.

India started general elections April 16 to vote in a new parliament. The exercise will continue until May 13 and counting of ballots will 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 downturn in the economy has caused banks to park money with the central bank rather than lend to customers, out of fear of adding bad debts. Banks have placed over one trillion rupees ($20 billion) a day with the central bank in the past two weeks, according to Bloomberg data.

The yield on the benchmark 10-year government bond yields has declined 63 basis points to 6.38 percent this month, indicating there is enough cash in the banking system to soften borrowing costs in the economy.

Reluctant Banks

Reluctance by banks to lend and slash lending rates has prompted Subbarao in the past to say he may adopt unconventional methods to spur credit growth in the economy.

Banks’ loans growth to companies and consumers slowed to 17.3 percent in the week ended March 27 from a year earlier, the slowest in at least six years.

“There is a possibility of the RBI announcing a cap on the amount it borrows under the reverse repo auction,” said Rajeev Malik, a regional economist at Macquarie Group Ltd. in Singapore. “Such a move would prompt the banks to buy more government bonds and lend more.”

The government expects record borrowings of 3.62 trillion rupees this year to fund its fiscal stimulus plans. That forced the central bank in February to resume purchasing government bonds via auctions after a seven year break to prevent yields from rising.

Policy Tools

India’s central bank uses three main tools to conduct policy - the repurchase rate, the reverse repurchase rate and the cash reserve ratio. The bank uses the reverse repurchase rate, or the overnight borrowing rate, as the signaling rate when commercial lenders are flush with cash. It alters the cash reserve ratio, or the proportion of funds lenders need to keep aside with central bank, to control money supply in the economy.

Subbarao may also be cautious in cutting rates as the U.S. Federal Reserve says the world’s largest economy is taking a potential “first step” to recovery. A recovery in the global economy may push up commodity prices such as oil and flare inflation in resources-dependent nations like India.

“Further easing by India’s central bank is expected to be calibrated and gradual as inflation could pose a concern,” said Indranil Pan, an economist at Kotak Mahindra Bank Ltd. in Mumbai.

India’s Rate Forecasts