Last week there was a major crash down in the share market to which has to some extent addressed one major concern of RBI governor YV Reddy, over inflated asset prices. The fall can possibly hold off further tightening measures by the central bank.
Bankers are now requesting for a cut in interest rates, on seeing the difference between the US and Indian rates following the 75 basis point cut by the Fed on January 22. Though the finance minister did not hinted to the possibility of cut in rates, but he has said it is left to the central bank.
This step is possibly being taken because both the government and the regulator do not want the stock market recovery to gather strength and turn into a full-fledged rally again.
But regardless of RBI’s disinclination to give in to the market’s demand, a 25 basis point reduction in the repo rate is probably the best alternative before it. Although oil prices continue to be a concern, inflation is still well below the targeted 5%. On Tuesday the RBI will be announcing the third quarter review of its annual policy.
“The argument not to have too wide a rate gap is that it increases the costs of currency intervention/sterilization; the RBI has to buy lower and lower yielding US assets, while the government issues higher-yielding Indian bonds to fund this,“ said economist Robert Prior-Wandesforde, in a report issued by the Hong kong and Shanghai Banking Corporation, Singapore.
Bankers met deputy governor Rakesh Mohan before the policy has conveyed their expectations of the economy. They stated that while credit growth has been decent, because of the rupee’s appreciation there has been a slowdown in textile loans. Even consumer and real estate loans demand have also come down and in line with the signals sent by the central bank. According to Indian Banks’ Association head HN Sinor, the central bank might signal a 25 basis point cut in rates.
A rate cut in January is required to keep in mind that there are all probabilities of the Fed cutting rates before the central bank’s April policy. This might further widen the gap between Indian and international rates. Merrill Lynch’s US economists expect the Fed to cut again at its March 18 meeting before RBI’s end-April 2008 policy.
They expect a 1% Fed rate by the first quarter of 2008-09 to counter a recessionary three consecutive quarters of negative growth ahead. However the Indian economy is not as dependent on exports as some of its Asian peers, the government has become aware of the impact of an export slowdown.
“The central bank may have to continue intervening to maintain the rupee-dollar pair in a tight range. The task will become complicated if risk appetite returns and global capital starts chasing domestic assets again,” said ICICI Securities.
The bond house added that the central bank has to signal lower lending and deposit rates to achieve this objective. “In order to send a clear cut signal, we expect RBI to cut the repo rate by 25 bps to 7.5% in the next week’s policy announcement,” I-Sec said in its report.