Markets cheer rate cut, growth worries remain

Markets cheer rate cut, growth worries remain


Mumbai: Rupee bounced to a two-week high and shares jumped on Monday after the RBI cut its policy rates over the weekend to relieve a growing cash squeeze and fend off damage from the global financial crisis.

Making the second cut in its key lending rate in as many weeks, the RBI also took several steps to boost cash in the banking system to help bring the overnight rate banks charge each other down from 21% on Friday.

In response, state-run Union Bank of India cut its prime lending rate by 50 basis points to 13.5% and senior bankers said lending and deposit rates would fall.

But in a sign that India’s once-stellar economic growth rate is slowing, a survey showed factory activity fell to its lowest level in 3 years in October as turbulence abroad and tight credit conditions at home took their toll.

Morgan Stanley economist Chetan Ahya said the central bank’s latest measures were potent enough to bring down inter-bank call rates quickly. Call rates dropped to 7% on Monday.

“However... the cost of borrowing for consumers and companies is unlikely to decline in a meaningful manner until underlying credit demand decelerates sharply and/or capital inflows revive," Ahya wrote in a client note.

The benchmark stock index was up 4.5%, led by banks and index heavyweight Reliance Industries, and marked its highest level in nearly two weeks.

The partially convertible rupee, which hit a record low a week ago at Rs50.29 per dollar, strengthened past Rs49.00 for the first time in two weeks. It was at Rs48.96/98 by mid-morning.

Foreign funds have sold a net $13.1 billion worth of Indian stocks in 2008 after buying a record $17.4 billion last year and the rupee’s fortunes have been closely tied to that outflow.

Saturday’s cut in rates and the jump in stocks boosted currency traders’ hopes that foreign investors would return to India’s market.

Tushar Poddar, an economist at Goldman Sachs, expected bank lending rates to ease by 50-100 basis points in the near term but not substantially more from there as credit risks remained elevated. He saw the central bank cutting reserve requirements and interest rates again in coming months.

The 100 basis point cut in the cash reserve ratio for banks, the amount of funds they have to deposit with the central bank, is expected to release Rs400 billion ($8.2 billion) into the banking system.

“Given that lower interest rates will not be felt for some time, we believe the postponement of capex plans and consumer spending will continue despite the aggressive policy moves," Poddar wrote in a client note.

“We think the downturn is spreading rapidly from the financial sector to real activity, and there are serious downside risks to our growth forecast of 7.0% in fiscal year 2009/10."

India’s economy grew 9% in the fiscal year that ended in March and RBI expects 7.5% to 8.0% growth this year, although many economists forecast it will be closer to 7%.