India Unexpectedly Cut Interest Rates to Spur Growth

By Debarati Roy and Cherian Thomas

Nov. 1 (Bloomberg) -- India's central bank unexpectedly cut interest rates for the second time in two weeks and reduced the amount of money lenders need to keep in government bonds and as cash reserves to boost growth amid a global slowdown.

The Reserve Bank of India lowered its repurchase rate to 7.5 percent from 8 percent, reduced the amount of deposits that lenders need to set aside as reserves to 5.5 percent from 6.5 percent, and cut the amount of money lenders are required to keep in government bonds to 24 percent from 25 percent.

The steps signal a U-turn from the Reserve Bank's policy stance just a week ago, when Governor Duvvuri Subbarao said a ``heightened vigil'' was needed to fight inflation. The U.S. Federal Reserve, the Bank of Japan and other central banks also slashed borrowing costs this week in an attempt to prevent a global credit crunch from pushing the world into recession.

``This is a strong message that growth has become the central bank's priority,'' said Sujan Hajra, chief economist at Anand Rathi Securities Ltd. in Mumbai. ``He has room to cut rates because global interest rates are coming down as well, and so the risk of a further weakening of the rupee is limited.''

Subbarao, who until last week placed equal emphasis on growth and inflation, said Oct. 25 he is concerned a weaker rupee may raise import costs and stoke inflation.

India's currency, which has fallen 20 percent since January, climbed 0.4 percent to 49.4575 per dollar from 49.675 on Oct. 29.

Growth `Moderation'

The Bank of Japan yesterday cut its key overnight lending rate by 20 basis points to 0.3 percent after the Fed three days ago lowered its target rate for overnight loans to 1 percent, matching a half-century low. Norway, China, Taiwan and Hong Kong also trimmed their benchmark rates this week.

India's decision to lower borrowing costs was taken ``in view of the ebbing of upside inflation risks and also to address concerns relating to the moderation in the growth momentum,'' the central bank said today.

Lower inflation has given Governor Subbarao, in the job for less than two months, more room to lower borrowing costs to stimulate growth. Inflation in India has dropped below 11 percent for the first time since May.

Wholesale prices rose 10.68 percent in the week to Oct. 18 from a year earlier after gaining 11.07 percent in the previous week. Economists had expected a 10.80 percent increase.

The central bank last week reduced its forecast for growth in Asia's third-largest economy to as low as 7.5 percent from 8 percent in the year to March 31.

Credit Squeeze

``It's a good set of measures that addresses the most pressing need of the hour, which is to ease liquidity constraints in the system'' and support growth, said Arvind Sampath, head of interest-rate trading at Standard Chartered Plc in Mumbai.

India's money-market rates have more than tripled in the past week, in contrast to the rest of Asia where the rates at which banks lend to each other has been declining.

The overnight call rate in India touched 21 percent yesterday. India's 10-year bonds gained, heading for their best month in almost a decade, on speculation policy makers will be forced to step up efforts to boost cash with banks and ease a credit squeeze.

Today's cut in the cash reserve ratio, the fourth in the past month, will infuse 400 billion rupees ($8 billion) into the financial system, the central bank said. Before today, the bank lowered the ratio by 2.5 percentage points in the past month.

The Reserve Bank also reduced for the first time in 11 years the statutory liquidity ratio, the amount of deposits that lenders need to invest in government debt or bonds of state-run companies, by one percentage point.

``This kind of fund injection is required to bring in stability in the financial market,'' said Jayesh Shroff, who helps manage about $6 billion at SBI Asset Management Co. ``The system has been under stress because of liquidity shortfall.''

Cash dried up in India's banking system as overseas investors pulled out $12.7 billion from India's stock markets.

To contact the reporter on this story: Debarati Roy in Mumbai at droy5@bloomberg.net. Cherian Thomas in New Delhi at Cthomas1@bloomberg.net