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India seen cutting rates, but muted gain for economy

India's central bank is expected to cut rates for the third time this year, tracking rate cuts overseas, but analysts see limited immediate gains for the slowing economy.

Eleven out of 12 bankers and analysts polled by Reuters on Wednesday, a day after the Federal Reserve cut US rates for the fifth time this year, expected the Reserve Bank of India would announce a half point cut in its bank rate to 6.5 per cent.

One respondent to the poll expected a full point rate cut.

Most respondents expected the cut to take place before the end of June. Some saw it in the July-September quarter.

The bank rate, a benchmark used by commercial banks to price their loans, has already been cut twice this year - by a half point each in February and March.

Indian bond markets have already discounted a half point cut in the bank rate, with the yield on the benchmark 10-year government bond now at 10.02 per cent compared with 10.35 per cent in early April.

Justification

Analysts say there is strong justification for a rate cut.

A slowing economy calls out for some stimulus to demand, which cannot be provided by a cash-strapped government at the moment while risks are mitigated by benign inflation and a relatively stable currency.

Further, with the economy increasingly opening up to the outside world, domestic borrowers need access to funds at rates comparable to levels prevailing elsewhere in the world if they are to remain competitive.

India's GDP is expected to have grown by some 6.0 per cent in 2000-01, its second straight year of slower growth. GDP grew 6.4 per cent in 1999-00 and 6.6 per cent a year earlier.

While 6 per cent growth rate is healthy in the current scenario of global slowdown, it is a far cry from the double digit growth analysts say is needed to dent poverty levels.

Gains seen limited

But while there are strong grounds for a rate cut, analysts see only limited gains from the move.

"Both external and internal demand have been shrinking as can be seen from the slowdown in export growth and in consumer goods sales," said Indranil Pan, associate vice-president at financial services firm Kotak Mahindra Capital Company.

Pan felt domestic conditions were more immediately relevant to a revival as exports form less than 10 per cent of India's GDP.

"The key is demand from the farm sector and that depends on the monsoon rains," he noted.

Other analysts agreed.

"There is no magic wand...a rate cut is necessary but not sufficient for reviving the economy currently," said Mahesh Vyas, executive director of independent forecaster Centre for Monitoring Indian Economy.

"A rate cut will help in the long run but in the short term, I expect demand to pick up only if we have three good seasons for the farm sector in a row," he said.

With roughly two thirds of India's billion-plus population depending on agriculture or related activities, demand from the farm sector is a critical driver of economic growth.

Patchy monsoon rains have hit agricultural growth over the past two financial years and there are fears the current summer crop may be affected.

Government to benefit

One immediate beneficiary of lower rates will be the government, which currently spends nearly 50 per cent of its revenue receipts on interest payments.

The central bank has already signalled its softer stance at least for the very short term by lowering its repo and reverse repo rates by a quarter percentage point each.

It has also cut banks' cash reserve ratio by a half point.

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