India’s Steepest String of Interest Rate Cuts May End

April 22 (Bloomberg) -- India’s central bank may be coming to the end of its steepest string of interest-rate cuts on record after saying Asia’s third-largest economy is faring better than most in the global recession.

The Reserve Bank of India expects economic growth, which slowed to a six-year low of 5.3 percent in the December quarter, to pick up to as much as 6 percent over the next year. The bank yesterday reduced rates for the sixth time in as many months.

Governor Duvvuri Subbarao urged commercial lenders to follow the central bank’s lead and lower rates on loans for companies and consumers. India’s economy, which is less dependent on exports than its Asian neighbors, is this year likely to be the second-fastest growing in the region after China as record harvests boost rural incomes.

“The fiscal and monetary stimulus measures initiated coupled with lower commodity prices could cushion the downturn in the growth momentum” over 2009 to 2010, the central bank said yesterday. “Notwithstanding the contraction of global demand, growth prospects in India continue to remain favorable compared to most countries.”

The yield on India’s benchmark 10-year bonds fell three basis points to 6.15 percent at 9:30 a.m. in Mumbai today. The rupee strengthened 0.3 percent to 50.2950 against the dollar, while the benchmark stock index gained 0.9 percent to 10995.64.

End of Cycle

Before yesterday’s rate decision, the central bank had estimated its policy measures, along with increased government spending and tax cuts, were worth as much as $85 billion, or almost 7 percent of gross domestic product.

“The Reserve Bank is close to the end of the rate-cutting cycle,” said Sailesh Jha, an economist at Barclays Capital Plc in Singapore. “Growth has either bottomed out or is close to bottom. The monetary and fiscal loosening so far will start to kick in from the second half of this year.”

By September, the central bank will inject another 1.2 trillion rupees ($23.8 billion) 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 injection will be equivalent to a 3 percentage point reduction in the cash reserve ratio, the Reserve Bank said yesterday.

Part of Subbarao’s optimism stems from forecasts that this year’s monsoon rains will be normal. That will help sustain the unprecedented 4.3 percent average farm production recorded since 2005, boosting incomes for the three-fifths of India’s 1.2 billion people who depend on agriculture for their livelihood.

Less Vulnerable

India is also less vulnerable to the global economic slump than most of its neighbors as exports make up about a quarter of its $1.2 trillion economy, compared with about half of GDP for developing Asia as a whole.

A challenge to keep domestic demand buoyant will be to lower the cost of funds in the economy, the central bank said.

The Reserve Bank, which cut its reverse repurchase rate by a quarter point to 3.25 percent yesterday, has lowered the benchmark by 275 basis points since October. The repurchase rate has been reduced by 425 basis points over the same period.

Lenders haven’t fully passed on those rate cuts to their customers. ICICI Bank Ltd., India’s biggest non-state-owned financial institution, has reduced its lending rates by only 50 basis points in the past six months. State-run banks have lowered their borrowing costs by about 200 basis points after government prodding.

‘More Funds’

“I was not expecting much more from RBI,” said Sunirmal Talukdar, chief financial officer at Hindalco Industries Ltd., India’s biggest aluminum producer. “What needs to be done is to ensure that more funds are made available to companies as banks have artificially kept lending rates high.”

Lenders say state-run savings plans such as postal deposits, which compete with banks’ deposits, offer returns of as much as 8 percent and prevent them from cutting rates. The rates on these plans are set by the government and haven’t changed since the central bank started cutting borrowing costs to counter the global recession.

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.”