India Lowers Key Rate for the First Time Since 2004

By Cherian Thomas

Oct. 20 (Bloomberg) -- India's central bank unexpectedly lowered its key repurchase rate for the first time since 2004 as global credit-market turmoil threatens to plunge the world economy into recession.

The Reserve Bank of India cut its overnight lending rate to 8 percent from 9 percent, according to a statement in Mumbai today. The action came after the bank reduced the cash reserve ratio by 2.5 percentage points to 6.5 percent since Oct. 11.

The move signaled Governor Duvvuri Subbarao sees weaker growth a bigger threat than inflation in Asia's third-largest economy. China's economic growth slumped to a five-year low last quarter and Vietnam reduced borrowing costs today, as JPMorgan Chase & Co. and UBS AG said the world economy is sliding into its first recession since 2001.

``They must have been worried about global growth, big economies and the region slowing,'' said Sailesh Jha, senior regional economist at Barclays Capital in Singapore, citing China's GDP report earlier today.

Bonds reversed losses after the central bank's announcement, while the stock index and the rupee, which initially surged after the rate decision, pared gains at 1:40 p.m. in Mumbai.

Next Meeting

The yield on the most frequently traded 13-year government bonds slid 23 basis points to 7.77 percent, according to the central bank's trading system. The local currency rose as much as 0.4 percent to 48.6975 a dollar before trading at 48.7675. The key Sensitive index, which gained as much as 5.6 percent, rose 2 percent to 10173.76.

Subbarao, who took office last month and is scheduled to release his first quarterly monetary-policy statement on Oct. 24, can afford to reverse four years of tighter credit as declining commodities prices ease pressure on inflation.

India's key wholesale price inflation slowed more than economists expected to 11.44 percent in the week to Oct. 4, a four-month low. Crude oil prices have halved since their peak in July. The Reuters/Jefferies CRB Index of 19 commodities dropped to the lowest in four years on Oct. 17.

``I hope this reduction in interest rates will enthuse investors to continue to take forward their investment proposals,'' India's Finance Minister Palaniappan Chidambaram said. The reduction ``is consistent with our objective to moderate inflation as well as ensure satisfactory growth.''

Government Spending

Chidambaram today sought parliament's approval to spend an extra 2.4 trillion rupees ($49 billion) on rural jobs, food and oil subsidies in the year ending March 31 to boost the economy.

The International Monetary Fund said growth in India's economy may slow to 7.9 percent in 2008 and slide further to 6.9 percent in 2009. The IMF estimates India's economy grew 9.3 percent in 2007.

The collapse of banks in the U.S. and Europe prompted the IMF this month to also scale back its forecast for world growth in 2009 to 3 percent -- a level the fund itself has called the dividing line between a global recession and expansion -- from 3.9 percent this year.

Only India and China among the so-called BRIC economies have joined global policy makers around the world to cut interest rates to avert a recession. 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.

Coordinated Action

Slowing inflation in China enabled the central bank on Oct. 8 to cut interest rates for the second time in three weeks. It reduced its one-year lending rate to 6.93 percent from 7.20 percent, on the same day the Federal Reserve, European Central Bank and three others lowered rates in an unprecedented coordinated action. China also reduced the proportion of deposits that lenders must set aside as reserves by 0.5 percentage point.

China's economy, the biggest contributor to global growth, expanded 9 percent in the third quarter from a year earlier, the statistics bureau said today.

Indian real-estate developers are facing a shortage of funds, Macquarie Research said in a report last week, which may slow demand for steel, cement and transportation.

``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.''

`Downside Risks'

The decline in demand is already showing in India. The nation's output at factories, utilities and mines rose 1.3 percent in August from a year earlier after a revised 7.4 percent gain in July, as rising borrowing costs since 2004 to contain inflation sapped consumer demand.

Last week, Jet Airways (India) Ltd. and Kingfisher Airlines Ltd, India's two largest domestic carriers, agreed to cut duplicate routes to counter slowing demand and save as much as 15 billion rupees.

``Downside risks to India's growth have increased, while the upside risks to inflation have receded,'' said Rajeev Malik, regional economist at Macquarie Group Ltd. in Singapore. ``We expect inflation to continue improving, thereby facilitating a shift in the RBI's monetary stance.''

-- With reporting by Bibhudatta Pradhan in New Delhi and Sumit Sharma in Mumbai. Editors: Michael Dwyer, Russell Ward

To contact the reporter on this story: Cherian Thomas in New Delhi at Cthomas1@bloomberg.net.