India's central bank is expected to follow an easing of reserve requirements with more steps to add cash to money markets, but analysts say double-digit inflation means it cannot take part in any global round of rate cuts.
The Reserve Bank of India (RBI) on Monday cut the percentage of deposits banks have to hold with it in cash by 50 basis points to 8.5 percent, freeing up 200 billion rupees. Though it said the move was "ad hoc and temporary in nature", analysts expect more cuts in the cash reserve ratio (CRR) or other measures to alleviate tight cash conditions caused by a combination of the global credit crunch and local factors.
"We believe the RBI will keep cutting CRR to offset liquidity measures caused by intervention in FX markets and slowing capital inflows," said Chetan Ahya, an economist at Morgan Stanley. Monday's move followed steps in mid-September to keep markets liquid, including additional market operations and allowing banks to borrow more from the central bank, as pressures on funds grew at home and from abroad despite record cash injections.
The reserve ratio had been increased by 25 points at the end of August, and had been increased by 150 basis points this year. "The CRR cut shows that the RBI is willing and able to respond," Macquarie Securities economist Rajeev Malik said. Cash rates shot to an 18-month high of 17.50 percent last Wednesday, almost double the central bank's 9.0 percent lending rate.
The central bank added a daily average of more than 900 billion rupees ($19 billion) in the holiday-shortened week. Foreign funds have been selling Indian stocks and repatriating the money. In 2007, record net buying of $17.4 billion helped the stock market surge 47 percent to record highs. Net selling this year is nearing $10 billion, and the market is off more than 40 percent at two-year lows.
That has also hit the rupee, which has fallen 18 percent against the dollar this year to its lowest in nearly six years, but the central bank's intervention to support it has drained cash from the money market, heightening the cash squeeze.
As well, the government added an extra bond auction of 100 billion rupees at the end of the first half of the fiscal year last month, and an auction of another 100 billion rupees this week will absorb half the funds released by the CRR cut.
While the Reserve Bank is going to keep pumping cash in the market, analysts said it was not yet in a position to join in any global round of rate cuts by central banks that may arise to deal with the spreading global financial crisis.
Australia's central bank cut interest rates by 100 basis points on Tuesday, double market expectations and raising some hopes that there could be a co-ordinated round of central bank cuts to restart money markets and support growth. "With inflation still hovering around 12 percent, we do not think that the RBI is ready, as yet, to cut the repo rate," Goldman Sachs economist Tushar Poddar said.
The Indian central bank increased its repo rate three times in June and July, taking it to a seven-year high of 9 percent as annual inflation surged into double-digits. Though inflation has eased from a high of 12.6 percent in early August, at 12 percent it is still well above the central bank's target of around 7 percent by March 2009.
And while the Reserve Bank was eager to stress on Monday it was not relaxing its fight against inflation, analysts said the first CRR cut in more than five years signalled rates had peaked, especially as it came ahead of a scheduled review.
"The fact that officials could not wait until their 24th October monetary policy meeting underscores the RBI's sense of urgency and rules out any further rate hikes in the near term," Hugo Navarro of Capital Economics said.