India has room to cut interest rates but the question is when and whether it should do so and by how much, and falling inflation does not automatically mean rates will drop too, its central bank chief said on Wednesday. India may see a further downturn in investment demand before it turns up and growth may moderate more than expected, Reserve Bank of India (RBI) Governor Duvvuri Subbarao said at a conference in Tokyo.
"There certainly is room for cutting rates. The question is whether we should cut rates, when we should cut rates and by how much we should cut rates," Subbarao told reporters. "It's not automatic that inflation is coming down and you cut rates," he said, speaking after the conference.
Indian federal bond yields rose five basis points after his comments. The yield on the 8.24 percent bond maturing in 2018 hit 6.40 percent from 6.35 percent earlier, before retreating to close at 6.36 percent. Expectations of rate cuts have mounted after the government's interim budget this week offered no fresh fiscal stimulus for growth, which has slowed sharply due to higher interest rates last year and the global economic crisis.
"Given the extent of fiscal stimulus we believe that the onus is now on monetary policy," said Shubhada Rao, chief economist at Yes Bank in Mumbai. "We expect key policy rates to decline by 50 basis points before March." The RBI holds its next policy review in April, although it can change rates in between reviews. It left its key lending rate steady at 5.5 percent in January and has cut it by 350 basis points since October.
Growth is projected to slow to 7.1 percent this fiscal year, which ends on March 31, from 9 percent and above in the past three years. But a top adviser to the prime minister has said the high fiscal deficit could force the RBI to wait before cutting rates.
Annual wholesale price inflation, India's most widely watched inflation measure, fell to 4.39 percent at the end of January, its lowest in just over a year, and the central bank has said it expects inflation to be below 3 percent by the end of March. Subbarao said other variables entered the calculation about adjusting interest rates, and India did not face the risk of inflation, although there was a constant concern that it must protect the poor from price increases.
Subbarao said the foreign exchange market was quite stable, with the rupee moving both ways, and pressure on the exchange rate from large capital outflows last year had largely subsided. Some analysts thought the RBI's forecast of 7 percent economic growth this fiscal year was too optimistic because the March quarter may be worse than previous ones, he noted. "So we still don't know. But the plain fact is that activity is slowing down ... Growth moderation, we believe, will be steeper than earlier suspected," he told the conference.
It was his first public appearance since the government unveiled the interim budget for the 2009/10 fiscal year on Monday, just weeks before a general election due by May. The government projected spending may have to jump later this year to shield the economy from the global slump, fuelling fears of a spiralling fiscal deficit. It expects the central government fiscal deficit to rise to 6 percent in fiscal 2008/09, which would be the highest since 6.1 percent in 2001/02.