By Cherian Thomas
Nov. 3 (Bloomberg) -- Indian central bank governor Duvvuri Subbarao has abandoned the ``inflation vigil'' he outlined just 10 days ago in his inaugural monetary policy statement.
For the first time since 1997, the Reserve Bank of India on Nov. 1 deployed all three of its main tools to shore up growth after inter-bank lending rates climbed to 21 percent. Economists at Yes Bank Ltd. and Standard Chartered Bank predict more interest-rate cuts following the weekend reduction.
``India's central bank has no other option but to focus on economic expansion,'' said Shubhada M. Rao, chief economist at Yes Bank Ltd. in Mumbai. ``Global cues have turned against growth and it was surprising to see the hawkish tones on inflation'' last month, he said.
Subbarao, less than two months into the job, has grappled with monetary policy at a time when inflation is double the central bank's target and a global downturn threatens to hit the economy. The central bank's renewed focus on growth aligns with Prime Minister Manmohan Singh's push to buoy the economy ahead of elections due by May.
The decision to cut rates on Nov. 1 is a U-turn from the stance Subbarao spelled out in his first statement. At that time, he said price pressures could come from lower farm production, volatile oil prices and a weaker rupee.
Subbarao's emphasis on inflation in his Oct. 24 statement took investors by surprise. Only four days earlier he had cut the repurchase rate by 1 percentage point following a meeting with Prime Minister Singh. In the previous two weeks he had reduced the cash-reserve ratio by 250 basis points.
Change in Tack
Nov. 1 marked another change. Subbarao slashed the repurchase rate again, lowering it by 50 basis points to 7.5 percent. He also reduced the amount of deposits that lenders need to set aside as cash reserves to 5.5 percent from 6.5 percent, and in government debt to 24 percent from 25 percent.
Last week also saw the capitulation of Japan, which abandoned a two-year struggle to raise the lowest borrowing costs among major economies. The Bank of Japan on Oct. 31 cut its key overnight lending rate by 20 basis points to 0.3 percent after the Fed 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 last week.
India's weekend announcement came as cash dwindled in the banking system, as evidenced by a tripling in overnight call money rates last week. Cash dried up as overseas investors pulled out a record $12.8 billion from Indian stock markets this year and the central bank sold dollars to slow the pace of the rupee's decline.
Foreign Reserves
India's foreign-exchange reserves fell $15.5 billion in the week ended Oct. 24, the most on record, to $258.4 billion. The rupee is down 20 percent this year, the second-worst performer after the South Korean won of Asia's 10 most-active currencies.
``The writing was on the wall for more policy rate cuts because of the liquidity crunch,'' said Indranil Pan, chief economist at Mumbai-based Kotak Mahindra Bank Ltd. ``We will see more liquidity-unfreezing measures.''
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 in its statement on Nov. 1.
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.
Commodity Prices
Standard Chartered economist Anubhuti Sahay expects inflation to slow to as much as 3.5 percent by the end of the second quarter of 2009, helped by a decline in commodity prices. Sahay expects the repurchase rate to be at 6 percent by then.
Investors expect stocks, bonds and rupee, which gained last week, to advance further today. The Sensitive index, which has halved this year, rose 12.5 percent last week, and the rupee climbed 0.7 percent, snapping an 11-week losing streak.
The yield on benchmark 10-year government paper, which dropped 1.12 percentage points to 7.5 percent last month as bonds completed their best month in almost a decade, may decline to 7.35 percent today, said Arvind Sampath, head of interest- rate trading at Standard Chartered Plc in Mumbai.
`It was a good set of measures that addressed the most pressing need of the hour, which is to ease liquidity constraints in the system,'' Sampath said. ``The repo-rate cut is a proactive step that takes advantage of falling inflation to tackle the slowdown in growth.''
To contact the reporter on this story: Cherian Thomas in New Delhi at Cthomas1@bloomberg.net
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