India seeks lower interest rates, cuts unlikely

India seeks lower interest rates, cuts unlikely
REUTERS

NEW DELHI, JULY 2: Interest rates have bottomed out and are not likely to drop from current levels, analysts say.

India on Friday lowered to 11 per cent from 12 per cent the interest rate on a key long-term savings scheme in which the retirement funds of employees of most state-run firms are kept, aligning it with other retirement schemes.

The rate cut on the Employees Provident Fund (EPF) scheme - effected after the Finance Ministry overrode objections from the Labour Ministry -- indicated the government's intention to keep rates down, but markets were not impressed.

Bonds rallied briefly after the announcement before paring gains as uncertainty over the outlook for the money market took over.

"The cut in EPF rate is a continuation of the policy seen earlier in the year," said Vasan Shridharan, treasury economist at Standard Chartered bank.

"But I do not see this having an impact on interest rates by itself," he added.

Interest rates have been on a soft trend since the start of the year when government first cut rates on some state-administered savings schemes in January.

The climate for lower rates further improved when the Reserve Bank of India (RBI) in April cut its benchmark bank rate, at which it offers refinance to banks and primary dealers, and the repurchase rate for government securities.

But analysts feel rates have now bottomed out amid worries over the impact of the government's massive borrowing needs for 2000/01 (April-March) on money market liquidity.

The government has budgeted gross market borrowings of Rs 1.17 trillion ($26.2 billion) in the current fiscal year.

Net of repayments, its borrowings will drain some Rs 764 billion from the market, more than 61 percent of the estimated bank deposit growth of Rs 1.25 trillion in 2000/01.

The net borrowing is little higher than last year's Rs 731 billion but analysts say the difference this year is that the corporate credit demand is expected to be much higher because of an industrial recovery.

Industrial output grew 12.2 per cent year-on-year in April, after an eight percent growth in the year ended March 31, 2000. Industrial output grew only 3.9 percent in 1998/99.

Other factors tilting the balance against further rate cuts are high inflation and recent RBI move to defend the currency.

Inflation, measured by the wholesale price index, was 6.28 per cent in the week ended June 17. It has not shown any sharp swings in recent weeks, but it has stayed above six percent since May -- a sharp jump from a little above two percent in mid-February.

The International Monetary Fund (IMF) on Friday cautioned India to be on guard against rising inflation and said there was little room to cut interest rates further.

"Directors agreed that the scope for further easing appeared to have been exhausted and they suggested that the authorities should be prepared to act to avoid an intensification of price pressures," an IMF statement said.

Analysts expect the RBI to keep a tight rein on liquidity to ensure that cheap funds are not available for speculating against the rupee, which has fallen about 2.5 per cent against the dollar since early May. The Indian currency had depreciated two percent in the previous 12 months.

Industry officials said any rise in interest rates would affect sentiment among corporates.

"Banks are bound to use the higher inflation to argue for higher lending rates ... higher rates will boost their revenues," said T K Bhaumik, senior policy adviser to the Confederation of Indian Industry (CII), the country's leading industry body.

"But this will be counter-productive to growth. We expect double-digit growth in industrial output this year and any hike in rates will affect this," he said.