India Cuts Bank Cash Ratio for First Time in 5 Years

By Kartik Goyal and Anoop Agrawal

Oct. 6 (Bloomberg) -- India allowed banks to set aside smaller reserves for the first time in five years to boost cash in the financial system and calm markets after the collapse of Lehman Brothers Holdings Inc. and the sale of Merrill Lynch & Co.

The Reserve Bank of India reduced its so-called cash reserve ratio to 8.5 percent from 9 percent effective Oct. 11, according to a statement in Mumbai. The cut will add 200 billion rupees ($4.2 billion) to the financial system, the bank said.

The move is the first policy action by Duvvuri Subbarao since he took over as governor last month, paring back increases of 4 percentage points since Dec. 2006 by his predecessor Y.V. Reddy. Central banks around the globe have injected billions of dollars into the financial system to spur lending and prevent the world from slipping into recession.

``Investor sentiment will improve because liquidity had been tight in the domestic market long enough and was probably on the verge of creating undesired results,'' said Parthasarathi Mukherjee, president of treasury at Axis Bank Ltd. ``Global liquidity tightness made such a move necessary.''

Money-market rates have climbed worldwide as banks hoarded cash on speculation the seizure in credit markets is deepening and may prompt more financial institutions to collapse. The U.S. Federal Reserve today said it will double its auctions of cash to banks to as much as $900 billion and is considering further steps to unfreeze short-term lending markets.

`Right Direction'

``The rate cut is in the right direction; the impact has to be felt and understood before RBI takes further measures,'' Koushik Chatterjee, chief financial officer of Tata Steel Ltd., said by telephone. ``There was a liquidity crunch in the market, and interbank rates had soared.''

The rate at which Indian banks lend to each other climbed to an 18-month high of 15.125 percent on Sept. 19, following the failure of Lehman and the U.S. government takeover of American International Group. The rate declined to 11.50 percent today, according to data compiled by Bloomberg.

The Reserve Bank is monitoring the level of cash in the financial system and will take steps when required, Deputy Governor Shyamala Gopinath said in an interview in Mumbai.

The London interbank offered rate, or Libor, that banks charge each other for overnight dollar loans rose 37 basis points to 2.37 percent today, the British Bankers' Association said. The three-month rate stayed near the highest level since January.

India's finance ministry last month allowed companies building roads, ports, utilities and other infrastructure projects to borrow more overseas, giving them access to cheaper funds. The central bank on Sept. 16 also announced measures to boost cash in India's financial system.

Liquidity Crunch

``Especially for smaller companies it is very good, as liquidity crunch hurts the smaller companies more,'' said Sachit Jain, executive director of Vardhman Textiles Ltd., India's largest exporter of cotton yarn. He spoke in a telephone interview from Ludhiana, in the northern Punjab state, where the company is based. ``The overall confidence will go up, though I would have expected a deeper cut.''

In addition to raising the cash ratio, Reddy had lifted the central bank's key repurchase rate by 300 basis points to 9 percent since 2004 to tackle inflation and prevent the world's fastest growing major economy after China from overheating.

Cooling prices have given Subbarao room to start easing policy. India's inflation held near a five-week low of 12.14 percent in the week to Sept. 13 from a year earlier, matching the previous week's gain, data released on Sept. 25 showed.

Rupee Plunges

The rupee plunged to a 5 1/2 year low today and is the second-worst performer this year among the ten most-active Asian currencies excluding the yen. The rupee fell as the credit-market turmoil in the U.S. prompted overseas funds to pull out money from Indian stocks.

India's capital markets regulator today lifted curbs on overseas investors imposed a year ago, in a bid to stem record sales by offshore funds that have triggered a 42 percent slide in the benchmark index this year.

Foreign investors, who bought a record $17.2 billion of Indian stocks last year, are now fleeing an economy which grew last quarter at the slowest pace since 2004. Overseas investors have pulled out $9.2 billion since January.

To contact the reporter on this story: Kartik Goyal in New Delhi at cthomas1@bloomberg.net; Anoop Agrawal in Mumbai at aagrawal8@bloomberg.net.