Monday 28 January 2008

Bets India May Cut Interest Rates Increase After Fed Reduction

Bets that India may cut interest rates tomorrow increased after the U.S. Federal Reserve's reduction last week on speculation the central bank will try to prevent an inflow of foreign cash seeking higher returns.

The repurchase rate may be lowered, according to six of 18 economists surveyed by Bloomberg News, from none before the Fed cut its benchmark rate by 75 basis points to 3.5 percent on Jan. 22. The decision is due at noon in Mumbai tomorrow.

The spread between two-year Indian government bonds and similar-maturity U.S. Treasury notes has widened to 5.13 percent from as low as 1.84 percent in June. In 2007, stock purchases by overseas investors and remittances prompted Governor Yaga Venugopal Reddy to order banks to set more money aside to prevent the cash from fueling inflation.

``Not cutting rates will provide arbitrage opportunities and attract capital flows,'' said Krish Ramkumar, who manages the equivalent of $1 billion in debt at Sundaram BNP Paribas Asset Management Co. in Mumbai. ``If not tomorrow, then soon after the environment will force the central bank to cut.''

The yield on India's benchmark nine-year government bonds has dropped 37 basis points to 7.42 percent this month, supporting the view that Reddy may lower rates.

Still, most economists expect the bank will keep the repurchase rate, the central bank's overnight lending rate, at almost a six-year high of 7.75 percent as it assesses the effect of the Fed's move on capital flows. Most of the economists said the central bank's two other policy rates will be kept unchanged.

Interest Rate Gap

``The interest differential between the U.S. rate and Indian rate has widened and we, therefore, expect larger capital inflows,'' Finance Minister Palaniappan Chidambaram said last week in Davos, Switzerland. ``That's something the central bank will take on board, I suppose, before it decides its policy.''

Reddy has increased the reserve ratio, or the proportion of deposits commercial banks need to place with the central bank, five times since December 2006.

The benchmark interest rate has been lifted nine times since October 2004 to curb inflation as the economy averaged growth of 8.6 percent a year since 2003.

India's benchmark wholesale price inflation is now 3.83 percent, less than the Reserve Bank's 5 percent target and almost half the level of a year ago. The bank is concerned the rate is yet to reflect the 57 percent increase in oil prices in 2007 as state-run refineries subsidized petrol, diesel and cooking gas.

Oil Prices

In the last monetary policy statement in October, Reddy described inflation as ``suppressed'' as the economy hadn't taken into account the surge in oil prices. India's government may decide to raise prices of auto fuels by the end of January, Oil Minister Murli Deora said Jan. 3.

``I would expect Reddy to hold his cards as they are,'' said John Stuermer, head of Asian emerging markets at Bear Stearns & Co. in Singapore. ``It isn't clear whether inflation is under control.''

China, whose record trade surpluses threaten to stoke consumer-price gains and inflate asset bubbles, this month ordered banks to set aside larger reserves for the 11th time in 13 months.

Central banks in Asian economies such as Taiwan, Japan and the Philippines, which depend on exports to the U.S. to sustain growth, are under pressure to reduce interest rates or hold off further increases, economists say.

Commercial Rates

The combination of higher policy rates and the cash reserve ratio has forced India's commercial banks to increase their lending rates to the highest in almost a decade. State Bank of India, the country's biggest lender, charges 12.75 percent interest on loans to its best customers, the most since 1999.

``Higher interest rates have adversely affected the automobile industry,'' said R. Seshasayee, managing director at Ashok Leyland Ltd., India's second-biggest maker of trucks and buses. ``A reduction in rates would perk up the industry.''

India's industrial production rose 7.3 percent in November from a year earlier after gaining 11.8 percent in October, the government said this month.

ACC Ltd., India's biggest cement maker by capacity, said sales declined 6 percent last month. Growth in passenger car sales halved to 8.8 percent in December.

Growth in India, Asia's third-largest economy, may ease to 8.4 percent in 2008 from 9 percent last year and 9.4 percent in 2006, the World Bank said in a report Jan. 9.