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US rate cut could be fodder for Indian rate move

An expected cut in US interest rates next week may provide the conservative Reserve Bank of India with another excuse to lower rates at home, analysts say.

The Reserve Bank of India already has enough reasons to cut interest rates -- a sluggish economy along with benign inflation and a stable rupee.

The RBI has cut its benchmark bank rate twice in 2001 by a total of a point, to seven per cent, but still maintains a wider interest differential with the US, where the Federal Reserve may next week announce its fifth half point cut since January.

Global trends have traditionally had marginal impact on the closed Indian economy, but analysts say the downtrend in world interest rates gives the RBI room to be more aggressive.

"On a cyclical perspective, India needs to cut rates again," says Sanjeev Sanyal, economist at Deutsche Bank, Singapore.

"And despite the minor correlation between rates in the US and India, it helps to have global rates moving in the same direction," he added.

Indian markets have been expecting a rate cut for some time and have built those hopes into bond yields and currency forwards, but the RBI has so far kept traders guessing.

Finance Minister Yashwant Sinha has said the rate decision is strictly the RBI's domain, although he is under pressure to curb a burgeoning fiscal deficit and to raise at low cost a budgeted Rs 1.19 trillion borrowing for 2001-02.

STRONG DOMESTIC REASONS

The RBI has in recent weeks lowered rates on its overnight funding system through repos, adding strength to market speculation that a rate cut is on its way.

Economic indices project a gloomy investment scenario especially in core sectors like manufacturing and infrastructure and the worldwide demand slide is expected to hurt exports.

A handful of sectors like construction seem to be doing alright, but most firms have lowered inventories, citing uncertainties over local demand and the threat of cheaper imports after duty and quota concessions.

"There is a compelling need to cut rates and make credit cheaper and India has the necessary degrees of freedom to do that now," Vasan Shridharan, economist at Standard Chartered Bank, in Singapore said.

Deutsche's Sanyal said the most important factor favouring a rate cut was the fall in structural inflation and the resultant high real interest rates in India.

Inflation growth, measured by wholesale prices, has ranged around five per cent in recent weeks, but analysts said core inflation that excludes volatile food and fuel prices is lower and non-oil inflation is near 20-year lows.

The rupee too has been stable while the dollar gained against major world currencies, except for a brief bout of volatility and swings to lifetime lows in April.

It fell seven per cent in 2000, but at current levels of 46.82/83 a dollar has just lost 0.35 per cent so far in 2001.

Foreign direct investment is strong while portfolio inflows in the four months to April 2001 have crossed $2 billion compared with $1.56 billion in all of 2000.

Analysts said India will continue to benefit from overseas funds seeking low risk returns and that argument should not be used to keep higher interest rate differentials.

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