Thursday 24 January 2008

Chidambaram Says Flows to Rise After Fed Cut

India's Finance Minister Palaniappan Chidambaram said the unexpected cut in U.S. interest rates this week may increase capital flows into the South Asian country.

``The interest differential between the U.S. rate and Indian rate has now widened. We, therefore, expect larger capital inflows,'' Chidambaram told a press conference today in Davos, where the World Economic Forum is being held. ``That's just an expectation and we have to see how it works out.''

The U.S. Federal Reserve Jan. 22 cut its target rate for overnight loans between banks by 75 basis points to 3.5 percent to avert a recession in the world's largest economy. The spread between two-year Indian government bonds and similar maturity U.S. Treasury notes widened to 5.40 percent from 5.01 percent this week, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.

A deluge of money from overseas to take advantage of higher interest rates in India can further strengthen the rupee, already near a decade-high. It could also increase money supply and fuel inflation in Asia's third-largest economy. Chidambaram said in the event of excess capital inflows, the central bank of India would have to respond appropriately.

The Reserve Bank of India has increased its policy rate nine times since October 2004 to a 5 1/2-year high to contain inflation in the world's second-fastest growing major economy after China.

Monetary Policy

Governor Yaga Venugopal Reddy is scheduled to set interest rates next on Jan. 29 when he announces the bank's quarterly monetary policy statement.

Reddy has also increased the cash reserve ratio, or the proportion of deposits that lenders need to place with the central bank as reserves, five times since December 2006 to drain excess cash from the banking system and contain inflation.

``Our stance is that we do not favor capital controls,'' Chidambaram said. ``Controls means clamping down on certain inflows. There are hierarchies of capital. Foreign direct investment is obviously `good capital' so why should we moderate that? Some capital is speculative. Therefore we'd like to moderate those inflows.''

The rupee has gained 12 percent in the past year while inflation is at 3.79 percent, a four-month high.