Inflation falls to 10.68%, raises hopes RBI will cut key rate soon

Inflation falls to 10.68%, raises hopes RBI will cut key rate soon

Mumbai: India’s inflation rate fell below 11% for the first time since May, raising hopes for a rate cut by the central bank that left its key policy rates unchanged in the mid-year review of monetary policy on 24 October. Inflation, as measured by the Wholesale Price Index (WPI), dropped to 10.68% in the week to 18 October, according to a government release.

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95c0236a-a69b-11dd-9402-000b5dabf613.flvWith inflation easing, bankers, bond dealers and analysts are convinced that it is just a matter of time before the Reserve Bank of India, or RBI, cuts its policy rate to give a fillip to economic growth which is being threatened by higher borrowing costs and scarce credit for companies and individuals.

“The inflation rate has come down much faster than anticipated. I think this will provide a strong case for RBI to ease lending rates further and support markets," said Anubhuti Sahay, economist at Standard Chartered Bank in Mumbai.

Finance minister P. Chidam-baram has called for a meeting of the chief executives of state-run banks, that account for 70% of the Indian banking industry, on 4 November to take stock of the situation.

Chidambaram met a few senior bankers on 20 October ahead of the monetary policy review and asked them to ensure flow of credit into productive sectors. This time around, bankers said, the focus of the meeting could be on the rate at which loans are given. Two bankers, who did not want to be named, said they would not be surprised if there is a rate cut over the next few days.

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RBI governor D. Subbarao did not announce any monetary measure in his policy but made it clear that the central bank would continue to monitor the situation and act “swiftly".

Earlier this month, the central bank cut the repo rate, or the rate at which it lends to banks, by 100 basis points to 8%, the first such rate cut since August 2003. It also slashed banks’ cash reserve ratio (CRR), or the amount of deposits that commercial banks need to keep with RBI, by 250 basis points to 6.5%, releasing Rs1 trillion into the cash-starved financial system. One basis point is one-hundredth of a percentage point.

RBI left the rate unchanged at its policy review as it felt inflation is still cause for concern. Besides, a cut in the policy rate also puts pressure on the weakening rupee as the interest rate differential between the US and India goes down and rupee assets become less attractive.

The local currency, that fell to a record low of 50.26 a dollar this week, has lost more than 20% against the greenback since January.

With the inflation rate coming down, economic growth is likely to come back on RBI’s radar. Also, the US Federal Reserve’s decision to cut its policy rate by 50 basis points to 1% will give RBI room for a rate cut as the interest rate differential has now narrowed. China cut rates on Wednesday, Taiwan and Hong Kong followed with rate cuts on Thursday and there was speculation that Japan could do so too.

In its monetary policy review, RBI cut its economic growth projection from 8% to 7.5% but analysts said this could be even lower unless the Indian central bank cut interest rates aggressively and created ample liquidity in the system.

The bank may have to cut CRR again, too, because rupee liquidity has continuously been drained—a result of RBI’s aggressive dollar sale in the foreign exchange market. The central bank has been selling dollars to stem the fall of the local currency and for every dollar it sells an equivalent amount of rupee is sucked out from the system.

India’s foreign exchange reserve fell to $274 billion this month from its May level of $316 billion following this.

To maintain liquidity, RBI has cancelled two government bond auctions worth Rs10,000 crore each this month but is slated to hold one auction of Rs10,000 crore on Friday. So far this year, the government has borrowed Rs1.06 trillion from the market to fund its expenditure. The full year’s target is Rs1.45 trillion but economists and bond dealers expect this to go up. So, another round of CRR cut to release liquidity is likely to happen.

The overnight interbank call money rate had come down to 6-6.5% last week but jumped to 13.5% on Wednesday as the markets once again felt the liquidity crunch.

RBI loaned Rs56,095 crore on Tuesday to banks to tide over their temporary asset-liability mismatches.

“Given the tight liquidity, I would think that a cut in CRR and SLR (statutory liquidity ratio) is more likely by RBI. Such cuts would also enable banks to manoeuvre freely and would give them room to cut deposit rate and lower cost of funds. In that case, banks can lower their lending rates," said Harihar Krishnamurthy, head of treasury at Development Credit Bank Ltd. Banks are required to invest 25% of their deposits in government bonds under current norms, but RBI temporarily relaxed this to 23.5%.

The inflation rate reached its 16-year high in August when it touched 12.91%. Since then it has been progressively coming down. RBI expects it to come down to 7% by March 2009 but economists said it could be even lower than that.

“Not only is the inflation target achievable, it could go even below the target," Subir Gokarn, chief economist, Standard and Poor’s, Asia-Pacific, told Mint last week. “The surge in inflation was because of the high commodities—metals, food and oil prices. All these prices have subsided significantly..."

“Probably, in the reading of 29 November, we could see inflation touching single digits," said Shubhada Rao, chief economist at Yes Bank Ltd.

“Inflation is set to plunge over the near term and rate cuts will resume shortly," said Hugo Navarro, an international economist at Capital Economics Ltd in London. “The central bank’s priorities will reverse soon."

India’s financial markets were closed on Thursday.

Rajkumar Ray of Reuters, and Subramaniam Sharma and Cherian Thomas of Bloom-berg contributed to this story.