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Interest rate cut on cards, feel bankers

Vidya Ranganathan in Bombay

The clearing of India's Union budget by Parliament this week has boosted the possibility of a third central bank interest rate cut this year to stimulate a slowing economy.

A majority of bankers and traders believe it is a matter of weeks before the Reserve Bank of India announces a 50 basis points cut in the key bank rate.

The bank rate is at 7 per cent now.

The market's bullishness about a cut has been fuelled by the
RBI's Monetary & Credit Policy for 2001-02, unveiled last week, which signalled a preference for a softer monetary stance.

Finance Minister Yashwant Sinha unveiled his reform-focussed Union Budget at the end of February.

But it could not be taken up for discussion earlier due to turmoil in Parliament over a scandal which erupted last month after bureaucrats and politicians were shown on tape accepting bribes for defence deals.

The deadlock ended this week after the government consented to a parliamentary probe into the scandal and the budget was approved on Wednesday.

"Now that the budget has been passed and any doubts about the rollback of small savings rate cuts removed, it's a matter of time before the RBI cuts the bank rate again," said Monish Tahilramani, head of interest rates trading at HSBC.

A snap Reuters poll of 14 Indian banks and traders on Thursday showed that the majority believe there is a good chance the central bank will cut its key bank rate once again by June.

High fixed rates on the small savings instruments have for long deterred the central bank and the banking system from lowering interest rate levels.

Will rate cut help?

But other reasons that may stay the RBI's hand include the rupee which has just recovered from a brief bout of volatility, trends in the seemingly benign inflation and the massive government borrowing for the year, which has just started.

Fortunately for India, interest rate differentials matter little for foreign investment.

So far in 2001, India has been flooded with over $2.0 billion of portfolio investments, a size of flows unseen in the past and far greater than the $1.56 billion received in the whole of 2000.

The United States has so far cut rates four times in 2001, mounting pressure on other central banks to keep pace.

India has cut its bank rate twice so far since February by a total of 100 basis points, and may do so again in keeping with its objective of providing industry low-cost funds.

But in an uncertain economic scenario, where there is little demand, bankers wonder what rate cuts will do.

In April-February, industrial output grew just 5.1 per cent compared with 6.5 per cent growth in 1999-2000, while manufacturing sector growth was flat.

Coupons on bonds issued by top-rated firms are currently less than 11 per cent, having fallen about 700 basis points in five years, yet industrial growth has ranged between 4.0 and 6.5 per cent during the period.

"Lower interest rates are just an enabling factor, necessary but not sufficient for growth," said Neeraj Gambhir, vice-president at financial services firm ICICI Ltd.

The government will benefit from lower rates. It currently spends half its revenues servicing past debt and has a massive Rs 1.19 trillion to borrow this year.

While that may result in lower coupons on bonds, banks are exposed to the risk of revaluation losses on such bonds as the year progresses and yields inch up.

Poll on rate cut expectations:

Institution	Chances of rate cut	Timing	Extent of cut
ABN Amro Bank	rate cut unlikely	NA	NA
ABN Amro Securities	90%	Q2	50 bps
American Express	90%	1-15 May	50 bps
Bank of America	over 50%	Q2/Q3	50 bps
Bank of Baroda	60%	end-May	50 bps
Citibank	60%	June	50 bps
Corp Bank Securities	100%	Apr or mid-May	50 bps
DSP Merrill Lynch	75%	September	25-50 bps
Global Trust Bank	70%	July	50 bps
HSBC	60-65%	By May 10	50 bps
ICICI	80-85%	mid-June	50 bps
IDBI Bank	75%	mid-May	50 bps
JP Morgan	100%	Q2	50 bps
UTI Bank	75%	mid-May	50 bps

(Q2, Q3 refer to second and third quarter of the financial year 2001-02)
(bps: basis points)