>Asia Economic Alert (NOMURA)

Asia Economic Alert

India: RBI cuts policy rates by 50bp, as expected

● In an inter-meeting move, the RBI cut the repo and reverse repo rates by 50bp each to 5.00% and 3.50%, respectively, citing the “deeper and wider than anticipated” growth slowdown.

● With the election code of conduct in place, fiscal policy is largely constrained until after the election in May, leaving monetary policy as the first line of defence against a growth slowdown.

● We continue to expect another 100bp cuts in both the repo and reverse repo rates by mid-2009.

In an inter-meeting move, the Reserve Bank of India (RBI) cut the repo and reverse repo rates by 50bp each to 5.00% and 3.50%, respectively, in line with market expectations. The cash reserve ratio was left unchanged at 5.0%, given sufficient liquidity in the system. Cumulatively, the RBI has now cut the repo rate by 400bp from its peak and the reverse repo rate by 250bp (Figure 1). The recent raft of weaker-than-expected economic data, including the sharp slowdown in real GDP growth to 5.3% y-o-y in 4Q08 from 7.6% in 3Q, along with a weakening global economic outlook, falling business confidence and decelerating investment activity, motivated this cut. According to the RBI, the impact of the global downturn on India “has turned out to be deeper and wider than anticipated earlier.”

We interpret this rate cut as a clear signal from the RBI to commercial banks to cut both deposit and lending rates further. While most public sector banks and some private and foreign banks have reduced their lending rates, in general lending rates have been slow to adjust and have not come down as much as policy rates, largely due to still-high deposit rates. The need for banks to keep borrowing at high-cost deposit rates is likely to fall in the coming months, as we expect credit growth to ease sharply to below 15% y-o-y by 4Q09 from about 20% currently and from a peak of nearly 30% in November 2008. However, concerns over rising credit risk will remain, suggesting that banks are likely to tighten their lending conditions over the coming quarters.

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