RBI may extend rate cuts

BLOOMBERG SPECIAL

Dropping inflation numbers give RBI the flexibility to lower rates.

India’s industrial production unexpectedly fell for the first time in 15 years, putting pressure on policy makers to add to interest rate and tax cuts to shield the weakening economy from a global recession.

Output at factories, utilities and mines dropped 0.4 percent in October from a year earlier after a revised 5.45 percent gain in September, the Central Statistical Organisation said in New Delhi. Economists expected an increase of 2.1 percent. India last recorded a decline in output in April 1993.

India’s central bank has scope to extend the steepest set of interest-rate cuts since 2000 after inflation slowed to a nine-month low, economists said.

The country’s benchmark 10-year bonds yesterday completed the biggest weekly gain in at least a decade as investors speculated the central bank will add to the three interest-rate cuts of the past two months.

A report this week showed inflation slowed more than economists expected, to 6.84 percent in the first week of December.

Easing inflation may alleviate the central bank’s concern earlier this week that faster than "acceptable" price gains have made monetary-policy management more complex amid slowing growth. The Reserve Bank of India’s actions should have been “more aggressive” to counter the global recession, according to Arvind Virmani, the finance ministry’s chief economic adviser.

“Inflation is no longer a concern now and that gives the central bank huge leeway to cut borrowing costs,” said Sonal Varma, an economist at Nomura International Plc in Mumbai. “Inflation has gone below the central bank’s year-end target for the first time this year, softening its worries over prices.”

Bonds rallied after the December 18 inflation report. The yield on the 8.24 percent note due April 2018 dropped 66 basis points to 5.56 percent in Mumbai, according to the central bank’s trading system. The Reserve Bank hasn’t commented on the latest inflation data.

‘Aggressive cuts’
Slowing inflation is prompting central banks from the US to Malaysia to cut interest rates as global economies slump amid the worst financial crisis since the Great Depression.

The Philippine central bank on December 18 cut its benchmark interest rate to 5.5 percent. The US Federal Reserve lowered its main rate to as low as zero on December 16, and the Bank of Japan reduced its benchmark to 0.1 percent yesterday.

“The key meaningful policy response to the worsening economic situation will be aggressive policy rate cuts,” said Rajeev Malik, regional economist at Macquarie Group in Singapore. “The mother of all monetary easing will continue to play on in India.”

Growth in Asia’s third-largest economy may slow to 7 percent in the year ending March 31 from 9 percent or more annually in the previous three years as the global slump hurts exports, according to the government. India’s industrial production fell 0.4 percent in October, the first decline in 15 years, and exports plunged 12 percent.

‘Difficult year’
“This year is difficult,” Palaniappan Chidambaram, who was India’s finance minister until Dec. 1, said this week. The economy expanded at the slowest pace since 2004 in the three months to Sept. 30. Chidambaram is currently the home minister.

To revive consumer demand and lending, the Reserve Bank on Dec. 6 cut its benchmark repurchase rate to 6.5 percent from 7.5 percent, the third reduction since Oct. 20. The following day, the government announced a $4 billion stimulus package to bolster spending, including lower taxes on consumer goods like cars, television screens and motorbikes.

India is working on more measures to boost economic growth and may announce a second installment of the stimulus package soon, Trade Minister Kamal Nath said last week.

“The central bank is likely to continue with further monetary easing on an ongoing basis,” said Siddhartha Sanyal, an economist with Edelweiss Capital Ltd. in Mumbai, who expects prices in India to fall next year on cheaper commodities. Inflation eased in the week to Dec. 6 after a drop in crude oil costs led the government to cut retail fuel prices, helping cool price-gains further from a 16-year high of 12.91 percent in August. Crude oil has tumbled more than 70 percent from a record $147.27 on July 11.

The central bank will review its inflation forecast in the Jan. 27 monetary-policy meeting, Governor Subbarao said Dec. 11, signaling he may lower an earlier estimate of 7 percent for the current fiscal year.

The author is a Bloomberg News columnists. The opinions expressed are his own