In a Surprise Move, India Lowers Key Interest Rate for the First Time in Four Years

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

India's central bank yesterday (Monday) unexpectedly lowered its base lending rate for the first time since 2004 – a move that signals that India Reserve Bank Governor Duvvuri Subbarao sees weaker growth and the credit crisis as bigger threats than inflation in Asia's third-largest economy.

The Reserve Bank of India cut its overnight lending rate from 9% to 8%, according to a government statement issued in Mumbai yesterday. The “surprise move” that came days before a regularly scheduled meeting of its policy board came after India’s central bank reduced the cash reserve ratio by 2.5 percentage points to 6.5% – retroactive to Oct. 11, Bloomberg News and both reported.

The so-called “repurchase rate” is the discount rate at which India’s central bank lends money to commercial banks to infuse liquidity into the market. India’s rupee weakened while bonds reversed losses after the central bank's announcement. The Bombay Stock Exchange rose 2.5% for the day – closing at 10,223.09 – although it jumped as high as 5.6%, BBC News reported. On Friday, India’s key stock index fell to its lowest close since June 2006.

In late May 2007, the Bombay exchange became the third emerging stock market after China and Russia to surpass $1 trillion in market value – a surge that was helped at the time by the nation’s fastest economic growth in six decades, a flood of foreign investment and a strengthening rupee, Bloomberg reported at the time. On the day it achieved that milestone, the 30-stock Sensitive Index, or Sensex, closed at 14,508.21 – 1% below its then-record high.

Clear Fears

India today clearly fears that the ongoing turmoil in the worldwide credit markets remains a threat to drop much of the global economy into a planet-wide recession. China's economic growth slumped to a five-year low last quarter and Vietnam reduced borrowing costs yesterday, as JPMorgan Chase & Co. (JPM) and UBS AG (UBS) said the world economy is sliding into its first recession since 2001.

“A 100-basis-point cut is an indirect admission that not all is ‘hunky dory’ with the India growth story,” Nandkumar Surti, chief financial officer at JPMorgan Asset Management India Pvt. Bank in Mumbai, told Bloomberg. “One way to look at it is that the global problem has begun to affect us.”

The near-collapse of the banking systems in both the United States and Europe this month prompted the International Monetary Fund (IMF) to throttle its worldwide growth forecast for 2009 from an earlier estimate of 3.9% all the way back to 3.0% -- a point the IMF itself has labeled as the dividing line between global expansion and a global recession.

After growing at an estimated rate of 9.3% in 2007, the IMF says the growth rate of the Indian economy may slow to 7.9% this year and all the way down to 6.9% next year.

Subbarao, India’s 22nd central bank governor – and who took office just last month – is scheduled to release his first quarterly monetary policy statement on Friday. He can likely afford to reverse four years of tighter credit as declining commodities prices ease inflationary pressures.

India's key wholesale price inflation number slowed more than economists expected to 11.44% in the week through to Oct. 4 – a four-month low. Crude oil prices have been cut in half since their peak in July – a reality that’s actually forcing the Organization of the Petroleum Exporting Countries (OPEC) to hold an emergency meeting on Friday, Money Morning reported yesterday. U.S. oil prices, which hit a record of $147.27 a barrel in July, have since plunged by more than 50%, actually hitting a 16-month low of $68.57 last week. The Reuters/Jefferies CRB Index of 19 commodities dropped to its lowest in four years on Oct. 17.

“We expect a further reduction in wholesale price inflation in the next two months,” Prime Minister Manmohan Singh told lawmakers in parliament yesterday. “Nevertheless, we must be prepared for a temporary slowdown in the Indian economy. Increased public expenditure is an important part of the solution.”

Singh had been under mounting pressure to speak publicly about the issues facing India's financial markets. And with good reason: India’s stock market has lost more than half its value this year, the rupee has fallen to new lows and cash flow problems have crippled banks – leading to jitters among investors, The BBC reported.

India's commerce minister, Kamal Nath, said he was confident India could remain a strong force on the economic stage and told The BBC that the country’s growth rate was “not as yet” under threat: Foreign-direct investment remains strong, and export growth soared 31% in September.

Also key: Unlike in the United States, none of India's banks had gone bust due to the Asian country's “stricter norms,” Nath told Britain’s well-known global broadcaster.

Finance Minister Palaniappan Chidambaram asked India’s parliament for approval to spend an additional $49 billion (2.4 trillion rupees) on rural jobs, food and oil subsidies in the year ending March 31 to boost the economy, which has advanced at a record 8.8% annual clip since 2004, according to Bloomberg.

India’s leadership “must have been worried about global growth, big economies and [the fact that other key economies in] the region [are] slowing,” Sailesh Jha, senior regional economist at Barclays Capital (ADR: BCS) in Singapore, told Bloomberg yesterday, referring to gross domestic product (GDP) report for China.

Hit “The BRICs” for Superior Profits?

Although central banks in the United States and Europe have pared interest rates in an attempt to avoid a worldwide recession, only India and China among the so-called “BRIC” economies of Brazil, Russia, India and China have joined global policymakers in that battle. Russia lowered its reserve requirement for the second time in a month, while Brazil reduced the measure Oct. 13 for the fourth time in three weeks.

Back on Oct. 8, easing inflationary pressures in China enabled that nation’s central bank to pare interest rates for the second time in three weeks. It reduced the one-year lending rate from 7.2% to 6.93% on the same day that the U.S. Federal Reserve, European Central Bank (ECB) and three others lowered rates in an unprecedented coordinated worldwide action. China also reduced the proportion of deposits that lenders must set aside as reserves by 0.5 percentage points.

China's economy, the biggest contributor to global growth, zoomed along at a 9% clip in the third quarter, that country’s statistics bureau announced yesterday.

In a report released last week, the Macquarie Research unit of Macquarie Group Ltd. said that Indian real-estate developers are facing a shortage of funds, which may slow demand for steel, cement and transportation products and services.

“The capital crunch has hit the real estate sector very hard,” Macquarie analysts Unmesh Sharma and Bharat Rathi said. “We believe the tightness will continue for a few more months, given the difficulty in raising capital through bank debt, equity markets and (more recently) private equity.”

The decline in demand is already showing in India. The nation's output at factories, utilities and mines rose 1.3% in August from a year earlier, after a revised 7.4% gain in July, as rising borrowing costs have dampened demand from consumers.

Rajeev Malik, a regional economist with the Macquarie Group in Singapore, recently said that the “downside risks to India's growth have increased, while the upside risks to inflation have receded. We expect inflation to continue improving, thereby facilitating a shift in the RBI's monetary stance.”

[Editor’s Note: For investors interested in reading more about potential profit plays in the India market, check out these two recent Money Morning investment research reports by contributing editor and global investing expert Martin Hutchinson. The first report focuses on both India and China – which make up the third and fourth letters in the “BRIC” acronym – while the second report compares and contrasts those two countries, with Hutchinson concluding that India offered the slightly better opportunity. The reports are both free of charge.]

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.

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