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Low inflation, rupee's stability may propel RBI to cut interest rates

The Reserve Bank of India is planning to slash interest rates in view of the current low level of inflation combined with sustained stability in the Indian currency and signs of an industrial recovery.

According to financial analysts, with bumper pull factors and a fairly stable exchange rate, inflation is expected to remain at about 2 per cent in the near term.

This creates a strong argument in favour of a reduction in interest rates, particularly when industry is showing preliminary signs of recovery, they observed.

Industrial growth in the first two months of the year has been 6.3 per cent with several sectors showing concrete signs of recovery.

The sentiment towards the Indian rupee is positive with reasonably comfortable foreign exchange reserves despite the recent border conflict in the Kargil sector of Jammu & Kashmir.

A cut in the interest rates will provide a strong positive signal to the corporate sector and help to trigger capital investments, analysts felt.

Besides helping industry to bring down manufacturing costs, leading institution J P Morgan, in its latest market outlook report, said lower interest rates would keep stock market sentiment firm, augment foreign portfolio inflows, and help the government to meet its divestment targets.

But the report felt that a cut in the interest rates, to have the desired impact, should be accompanied by a reduction in the cash reserve ratio for banks. This will make a larger amount of bank finance available to the corporate sector besides improving the margins of banks and helping them to pass on the benefits of reduced costs to end-borrowers.

Also, in the current scenario, the high spread is unlikely to correct itself since overnight rates in the first quarter of the year have been high, consistently above the refinance level.

But a bank rate and repo rate reduction will certainly act as an effective transmission mechanism not only to bring down government bond yields but also to reduce interest rates on other credit products.

Bankers are also unhappy with the RBI for keeping the CRR at a high level of 10 per cent. The CRR was increased in January 1998 and August 1998 to defend the Indian rupee against speculation. But since August, foreign exchange reserves have increased by US$6 billion, inflation has declined from 8 to 2 per cent, and market sentiment has improved considerably.

Bankers felt a strong signal needs to be given through a 1 per cent bank rate and repo rate cut along with a 2 per cent reduction of the CRR in a phased manner.

UNI

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