India May Reduce Key Interest Rate as Inflation Slows

By Paul Gordon and Cherian Thomas

Nov. 19 (Bloomberg) -- India's central bank has scope to cut borrowing costs further as growth slows and inflation approaches a level ``we can live with,'' Finance Minister Palaniappan Chidambaram said.

The inflation rate dropped the most in close to two decades to 8.98 percent this month as commodity prices tumbled. Chidambaram expects price increases to slow to between 6.5 percent and 7 percent by December, almost half the 16-year high reached in August.

``How rapidly inflation declines will decide how the central bank moves,'' India's longest-serving finance minister since 1980 said in an interview with Bloomberg Television in New Delhi yesterday. ``We have not yet licked inflation, though our expectation is it will come down.''

Chidambaram yesterday met with Governor Duvvuri Subbarao as Indian policy makers work to limit the impact of a global recession on Asia's third-largest economy. The finance minister said companies benefiting from lower borrowing costs should cut prices to help revive domestic demand.

``The writing is on the wall for interest rates to drop in India,'' said Ravi Chaudhry, chairman of Cemex Investment & Services Ltd., a New Delhi-based company that provides investment advice to governments including Norway and Brazil. ``The crisis in the U.S. is endemic.''

The U.S., Europe and Japan slipped into recession last quarter, and China's economy, the biggest contributor to global growth in 2007, is slowing.

`Rapid Rate'

``We need to ensure that our domestic economy, at least the insulated parts of the domestic economy, continues to grow at a rapid rate,'' said Chidambaram, who holds an MBA from Harvard. ``It's the external sector that's causing us problems, so we will have to compensate that. If exports decline, we will have to compensate that by stimulating domestic consumption.''

India, whose 1.1 billion population is second only to China's, is relying on spending by local consumers and companies to make up for a slump in overseas sales. Exports, which make up about a fifth of the $1.2 trillion economy, grew in September at the slowest pace in 18 months.

Subbarao cut the central bank's benchmark repurchase rate by 1.5 percentage points to 7.5 percent in the past month, in addition to slashing lenders' reserve requirements in cash and bonds by 3.5 percentage points and 1 percentage point respectively.

``We expect inflation to decline with falling commodity prices,'' Chidambaram said.

Anticipating Cuts

Bond investors are speculating on further reductions in interest rates. The yield on the benchmark 10-year Indian government bonds, which has declined 25 basis points since the start of last week, was almost unchanged at 7.45 percent at 10:20 a.m. in Mumbai today.

The key Sensitive index, which has halved this year, rose 2 percent to 9,118.98 on the Bombay Stock Exchange, while the rupee declined 0.1 percent to 49.70 against the U.S. dollar.

State-run banks, which control half the assets in India's banking sector, slashed their prime lending rates by 75 basis points following the reductions in central bank rates.

Non-state lenders are waiting to see ``if there is enough liquidity in the system'' before they cut their rates, said K. V. Kamath, chief executive officer at ICICI Bank Ltd., India's second-largest lender.

Ball in Suppliers' Court

``Now I think the ball is in the court of suppliers and manufacturers -- they have to cut prices,'' Chidambaram said. ``If they cut prices I am a 100 percent sure that demand for homes, cars and two-wheelers will sharply pick up.''

The lawyer-turned-politician said the government will consider a stimulus package if required, aimed at supporting specific industries.

Chidambaram said the global credit crunch posed different risks for India than for China, which earlier this month unveiled a $564 billion spending plan.

``I don't think we need to compare China and India,'' the minister said. ``Each country has to address the problems it faces. In our case the problems are providing liquidity, getting the price right and ensuring banks get over their innate caution and deliver credit at that price.''

India's efforts at propping up the economy may see the government miss its budget deficit target of 2.5 percent of gross domestic product in the year to March 2009.

Chidambaram on Oct. 22 obtained parliament approval to spend an extra 2.4 trillion rupees ($49 billion) in the year to pay for food subsidies and a rural jobs program, and to refund commercial banks that waived farm debt.

``This is not the year to worry about the fiscal deficit,'' he said. ``We will overshoot the target a bit. We will reach the target later. It doesn't matter.''

To contact the reporter on this story: Cherian Thomas in New Delhi at cthomas1@bloomberg.net.