Last updated: April 17, 2012 11:38 am

India cuts rates in effort to boost growth

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India’s central bank cut key lending rates for the first time in three years on Tuesday in an aggressive effort to stimulate growth and boost investment at a time when the gloss is rapidly coming off Asia’s third-largest economy.

The Reserve Bank of India cut the repo rate – the rate at which the central bank lends to commercial banks – by 50 basis points to 8 per cent. The more than expected reduction was widely welcomed by business.

Having increased interest rates 13 times since March 2010, the RBI’s move reflects a shift in the bank’s policy from focusing exclusively on reining in inflation – which at 6.89 per cent remains high – to reviving the country’s slowing economy.

“The rate cut shows that the attention has now shifted towards stimulating growth, there is no doubt about that,” A. Prasanna, an economist at ICICI Securities, said. “The RBI was worried about inflation but from the latest data we can see that it has come down and is somewhat under control.”

The bank also doubled, to 2 per cent, the borrowing limit for banks at the marginal standing facility – which provides emergency funds to banks at 1 percentage point above the repo rate – in a move that will boost liquidity in the system.

The decision, announced by Duvvuri Subbarao, India’s central bank governor, comes after China, Brazil and Indonesia moved to ease liquidity, as emerging economies try to shield themselves from the European debt crisis.

Growth in the last quarter of 2011 was the slowest in almost three years, rising 6.1 per cent in the three months to December 31, compared with more than 8 per cent a year earlier. Meanwhile, inflation has eased persistently over the past year. The wholesale price index rose 6.89 per cent in March – below 7 per cent for the third consecutive time.

The central bank said it expected growth to rise to 7.3 per cent in the fiscal year ending March 2013 and forecast that annual inflation would be 6.5 per cent for the same period.

Mr Subbarao said that he was confident the rate cut would lead banks to reduce lending rates for industry and consumers. But some industrialists remained sceptical.

Harsh Piramal, the head of the auto components and textiles businesses for the Ashok Piramal Group, a Mumbai-based conglomerate, said the cut was “mildly positive . . . but it is also going to take a while to filter through to . . . businesses like ours.”

Some economists also expressed concern that the sharper than expected cut could have been premature, given looming inflation risks.

“It is . . . difficult to reconcile the aggressive move with the fact that fundamentals have not really changed materially since the last monetary policy meeting in March,” said Leif Lybecker Eskesen, HSBC’s India economist.

The governor disputed this view, citing the recent fall in inflation. He also forecast growth to rise to 7.3 per cent in the fiscal year ending March 2013, and predicted that annual inflation would be 6.5 per cent for the same period.

However, Mr Subbarao said that space for further rate cuts was very limited as he warned that the economic environment remained challenging and stressed that monetary policy alone would not be enough to reignite investment. For this to happen, the government needed to cut subsidies, reduce the current account deficit and unblock the supply-side bottlenecks that had hit growth, he said.

Indian business leaders, who have vehemently criticised the central bank’s tight monetary policy over the past two years, backed the governor’s call for a resumption of political reforms and an end to the political paralysis that marked the last year of the government of Manmohan Singh, prime minister.

“While the cut in policy rates by [the] RBI is an encouraging move, we also need the government to push reforms as this would improve business sentiment and spur investments in the economy,” said R.V. Kanoria, president of the Federation of the Indian Chamber of Commerce and Industry.

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