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India rate cut seen muted gain for economy

NEW DELHI: India's central bank rate cut is likely to sustain the country's industrial recovery but the full impact will be muted by inherent rigidities in the banking system, analysts said.

While the central bank's Saturday rate cut sent out a strong signal that it wants lower interest rates in the economy, commercial banks may not be in a position to follow suit on lending rates as they are constrained by high transaction costs.

"It is clear that the RBI wants to maintain the momentum in industrial growth," said Vasan Shridharan, treasury economist at Standard Chartered Bank.

Industrial output grew 7.2 percent in April 1999-January 2000 over the same period a year earlier and compared to four percent growth in the whole of fiscal 1998/99 while GDP is seen up 5.9 percent in the 1999/2000 April to March fiscal year.

Analysts argue that lower interest rates are required if the economy is to shift into the higher growth trajectory of seven to eight percent that the government sees as essential if it is to meet the needs of a billion-strong population.

"You need low-cost funds to keep the economy going," Shridharan said.

The Reserve Bank of India (RBI) on Saturday lowered banks' cash reserve ratio (CRR) to eight percent from nine in two equal stages of 50 basis points, effective on April 8 and April 22. The two-phase cut will make available to commercial banks some 72 billion Indian rupees ($1.65 billion) currently deposited with the central bank.

The RBI also slashed its key refinance rate by 100 basis points and the repo rate by an equal amount. The rate on savings deposits with commercial banks was cut to four percent from 4.5.

Analysts said commercial banks were expected to follow the central bank but did not expect lending rates to drop by much.

"Banks will be bound to pass on the benefits to borrowers but the key is whether lower rates are sustainable," said Saumitra Chaudhuri, economic adviser at Investment Information and Credit Rating Agency.

"Whether lower rates are sustainable will ultimately depend on the fiscal deficit. At the moment, the central and state government borrowings between them take away about 85 percent of the national savings and this has to come down," he said.

Chaudhuri said the biggest beneficiary of lower rates was likely to be the federal government which has budgeted gross borrowings for fiscal 2000/01 at a staggering 1.17 trillion rupees. Interest payments will eat up 1.012 billion rupees in 2000/01, nearly half the government's budgeted revenues.

Industry has clamoured for lower interest rates, saying India's real, or inflation-adjusted, interest rates are among the world's highest.

India's leading state-run banks charge their best borrowers around 12 percent, while the country's wholesale price index inflation is currently below four percent.

The stability of the Indian currency, which depreciated just over two percent in the whole of 1999, was another argument advanced by the proponents of lower interest rates.

Cuts in lending rates have been expected since mid-January when the government cut rates on some state-run savings schemes.

But state-run banks, which account for over 75 percent of the banking industry's deposits and advances, have not been able to lower lending rates due to their high transaction costs.

One way to lower lending rates without affecting margins would be to lower deposit rates but banks are wary of doing this as they face severe competition from mutual funds and government-run savings schemes which offer tax benefits.

Indian banks' transaction costs are also high because of high non-performing loan levels, accumulated over years of poorly monitored lending.

Financial sector reforms, introduced in the early 1990s, led banks to tighten lending norms, but the accumulated backlog from earlier years still weighs down balance sheets.-Reuters