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 the 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 effective Oct. 11.

The move signaled Governor Duvvuri Subbarao sees weaker growth as 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 key stock index, which surged after the rate decision, pared gains at the 3:30 p.m. close in Mumbai. The rupee weakened.

The yield on the most frequently traded 13-year government bonds slid 28 basis points to 7.72 percent. The key Sensitive Index, which gained as much as 5.6 percent, rose 2.5 percent to 10,223.09. The rupee fell 0.2 percent to 48.9750 a dollar. A basis point is 0.01 percentage point.

Policy Statement

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.

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

Finance Minister Palaniappan 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, which grew at a record 8.8 percent pace since 2004.

`Indirect Admission'

``A 100 basis point cut is an indirect admission that not all is hunky dory with the India growth story,'' said Nandkumar Surti, who manages 16 billion rupees in debt funds as chief financial officer at JPMorgan Asset Management India Pvt. in Mumbai. ``One way to look at it is that the global problem has begun to affect us.''

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.

Global Action

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.

Slowing inflation in China enabled the central bank on Oct. 8 to cut interest rates for the second time in three weeks. It reduced the one-year lending rate to 6.93 percent from 7.2 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.

`Capital Crunch'

``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 percent in August from a year earlier after a revised 7.4 percent gain in July, as rising borrowing costs since 2004 have 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.''

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