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Rupee's slide undermines rate cut hopes

The slide of the rupee to record lows on Tuesday has undermined hopes for a central bank rate cut, bond traders and analysts said.

A Reuters poll last week showed 14 respondents expected at least a 50 basis-point cut in India's key interest rates sometime before September. Gloomy economic data had reinforced the view.

But government plans announced at the weekend to increase spending and the fall in the rupee this week has cast doubt on what the central Reserve Bank of India might do, market sources said.

"Sentiment has soured because of the weakness of the rupee. It is adding some volatility to the bond market," said Sanjeet Singh, debt market analyst at ICICI Securities and Finance Co.

The tightly policed rupee , which had been stable in 2001, has fallen nearly 20 paise in the past three trading sessions.

It hit a historic low of 47.21 per dollar on Tuesday, prompting nervous bond traders to pare positions.

The currency recovered on suspected central bank intervention to trade at 47.11/12 by late afternoon, but sentiment on the currency remains soft.

Traders said a volatile rupee may lead the RBI to postpone its much anticipated bank rate cut, given that it has in the past tightened monetary policy to combat currency market volatility.

Bond yields, which fell to record lows last week on the rate cut hopes, have been driven higher since Monday because of the weakness in the rupee.

B>Increased government borrowing

The 10-year benchmark yield , which had dropped to 9.50 per cent on June 27, is now at 9.55 per cent.

Bond traders said hopes of a rate cut have also been dampened by fears of increased government borrowing after Union Finance Minister Yashwant Sinha said on Saturday his government would boost spending by October to revive the economy.

"Given a drop in revenues due to the economic slowdown, the only way to fund spending is through increased market borrowings," Singh said.

The Union government has budgeted gross market borrowings for 2001-02 at a staggering Rs 1.19 trillion, but analysts say this might be exceeded as revenue collections have been poor.

India's indirect tax collections in April and May fell by Rs 14 billion from the same period last year, due to lower economic activity.

Last week the government said that the economy expanded 5.2 per cent in the financial year 2000-01, less than 6 per cent which had been forecast previously.

The benchmark bank rate is currently at seven percent and has been lowered twice-- by 50 basis points each time-- in February and March.

The Reuters poll conducted last Thursday had shown 11 of the 14 respondents expected a cut of 50 basis points. The remaining three expected a 50-100 basis points cut.

All respondents had said the bank would cut rates before September.

The interest rate hopes had also been raised by cuts in other countries, most importantly the United States.

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