VZCZCXRO5646
RR RUEHAST RUEHBI RUEHCI RUEHLH RUEHNEH RUEHPW
DE RUEHNE #2962/01 3251229
ZNR UUUUU ZZH
R 201229Z NOV 08
FM AMEMBASSY NEW DELHI
TO RUEHC/SECSTATE WASHDC 4287
INFO RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHGV/USMISSION GENEVA 7959
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RULSDMK/DEPT OF TRANSPORTATION WASHDC
RHMFIUU/FAA NATIONAL HQ WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHDC

UNCLAS SECTION 01 OF 03 NEW DELHI 002962 
 
SENSITIVE 
SIPDIS 
 
STATE FOR SCA/INS AND EEB 
USDOC FOR ITA/MAC/OSA/LDROKER/ASTERN/KRUDD 
DEPT PASS TO USTR MDELANEY/CLILIENFELD/AADLER 
DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA MNUGENT 
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN 
 
E.O. 12958: N/A 
TAGS: EAGR ECON EFIN EINV ETRD IN
SUBJECT: MUMBAI ASSESSES THE MARKETS, EXPECTS MORE RBI MOVES 
 
¶1.  (SBU) Summary.  In meetings in Mumbai on November 14-15, Mumbai 
financial and market analysts shared their views on liquidity 
conditions and their expectations for further monetary actions with 
Econoffs from New Delhi and Mumbai.  They also conveyed a "wait and 
see" approach to re-entering India's debt and capital markets, 
pointing to political uncertainties stemming from ongoing state 
elections and imminent national elections, as well as global 
financial and economic uncertainties.  End summary. 
 
STILL A LACK OF LIQUIDITY? 
-------------------------- 
 
¶2.  (SBU) Most market participants agree that the Reserve Bank of 
India (RBI) has moved relatively quickly to shore up liquidity in 
the system since mid-September, when some interbank lending rates 
shot up to more than 20%.  However, Ridham Desai, Managing Director, 
Morgan Stanley, asserted that there was still a liquidity, as 
opposed to a confidence, problem.  He linked it to declining net 
capital inflows, which are putting downward pressure on the rupee. 
Because of the speed of the weakening rupee, the RBI has been 
intervening in the forex markets to prop up the rupee by the sale of 
dollars.  Those sales take rupees out of the system, thus 
counteracting the central bank's efforts to enhance liquidity. 
 
¶3.  (SBU) Desai described a drastic reduction in trade credit in 
October, as well as potential drops in worker remittances and 
Non-Resident India (NRI) fixed deposits as other possible weaknesses 
in India's balance of payments in the months ahead.  He estimated 
that, at $14 billion so far this year, non-foreign institutional 
investor (FII) outflows, especially trade credit, have been higher 
than FII outflows of roughly $11 billion, which have been the main 
focus for explaining the weakening rupee.  (Comment:  Since FII 
outflows have been rather steady through 2008 and did not noticeably 
spike in September-October, when the rupee dropped the most, 
non-FII, especially trade finance-related outflows are likely an 
important part of the picture.  End comment.)  These reduced inflows 
would continue to put pressure on the rupee, Desai expected, and 
thus prolong RBI currency intervention at the cost of enhanced 
liquidity. 
 
¶4.  (SBU) While not disputing Desai's assertion that India's markets 
lack liquidity, JP Morgan's Ritu Kocchar and Ashvin Parekh of Ernst 
and Young pointed to a few changes that have eased domestic pressure 
on liquidity and, to some degree, on the rupee.  They noted that 
money market redemptions - which surged in September and October as 
Indian global companies tapped their cash reserves to help finance 
their domestic working capital as well as their overseas 
subsidiaries denied dollar financing -- have eased considerably, in 
light of several recent RBI facilities and possible improvements in 
short-term financing abroad.  Others also pointed to the 
government's issuance of new oil bonds to the state-owned oil 
marketing companies (OMCs). 
 
¶5.  (SBU) The RBI is currently accepting the oil bonds directly from 
the OMCs in exchange for hard currency to the OMCs to finance their 
imports.  OMCs had been borrowing large amounts in the domestic 
markets to cover the losses they were incurring because of 
government controls on domestic energy prices.  The OMCs' borrowing 
(and dollar) needs have dropped drastically with the oil bonds and 
RBI exchange facility.  (Comment: Soon the need for oil bonds and 
exchange facilities will also drop drastically as the OMCs' oil 
price contracts roll over to represent current spot prices at less 
than half of July's peak.  End comment.) 
 
¶6.  (SBU) In contrast, Vivek Kudva, President, Franklin Templeton 
Asset Management India, stated that banks were unwilling to lend, 
independent of liquidity, because the banks fear a recessionary 
impact on corporate business.  Commercial banks are also imposing 
high costs on letters of credit and trade finance right now as well, 
he said.  Kocchar agreed that bank sentiment was low and thought 
that a reduction in interest rates would boost banks' confidence in 
corporate borrowers' ability to service their loans. 
 
WHAT CAN THE RBI STILL DO? 
-------------------------- 
 
¶7.  (SBU) Even in the wake of the RBI's significant efforts to 
enhance liquidity since September, including a 150 basis point 
 
NEW DELHI 00002962  002 OF 003 
 
 
reduction in the benchmark lending rate and a 300 basis point 
reduction in the cash reserve ratio (CRR), interlocutors thought 
there was still more that could be done.  Kocchar singled out the 
CRR as the most effective tool available to the RBI, since it 
immediately affects liquidity in the system.  She easily expected 
the CRR, now at 5.5%, could go below 3%.  Kocchar cited the RBI as 
having said there is no floor to the CRR.  While she has heard 
predictions of a rate reduction in January and April (in the run-up 
to national elections), Kocchar also thinks the RBI could reduce the 
CRR by 50 basis points as early as this month, while state elections 
are underway.  Morgan Stanley's Desai thought the CRR could be 
lowered to zero, which he calculated would release more than $40 
billion in liquidity. 
 
¶8.  (SBU) Kocchar also anticipated more interest rate reductions 
through the repo rate, the rate at which the central bank lends to 
other banks.  She anticipated that could help improve sentiment in 
the financial system. Sentiment still needs a boost, she claimed, 
because lending has not really revived, even as the RBI has enacted 
near weekly liquidity enhancements totaling more than $25 billion. 
Kocchar pointed to the government's borrowing program (which crowds 
out liquidity to the private sector) as well as continued market 
uncertainties as leading to lending volatility, exacerbated by 
banks' wish to reduce assets to increase safety and security. 
 
EXPECTATIONS OF INCREASED PRESSURE ON CORPORATE LOANS 
--------------------------------------------- ----- 
 
¶9.  (SBU) In addition to improving sentiment, Kocchar thought that 
lower rates would ease pressure on retail loans, as consumers' cost 
of financing would go down.  In contrast, Kocchar expected lending 
to small and medium enterprises (SMEs) to be hardhit, as corporate 
loans to this segment will be stressed by the SMEs' decreased 
ability to service their loans amidst a business cycle downturn. 
Others also pointed to a weakness in corporate loans.  Morgan 
Stanley's Desai remarked that a number of Indian companies, 
including a few large ones, will have to restructure their loan 
portfolios.  While Indian companies are relatively underleveraged 
financially, Desai argued that many of them had significantly 
increased their operating costs in recent years, by expanding 
production and payrolls.  As India's economy slows as a fallout of 
the global financial crisis and downturn in global demand, the 
decline in revenues will make it harder to support operating costs. 
He expects this period to last about a year and a half, before the 
Indian economy picks up.  (Comment:  Unlike American firms, Indian 
firms will be reluctant to lay off workers as a cost-cutting 
strategy, and will instead turn to banks for restructuring their 
loans, and to the government for assistance on duties, tariffs, or 
price support measures.  End comment.) 
 
¶10.  (SBU) Ernst and Young's Ashvin Parekh estimated that banking 
non-performing loans (NPLs) had risen from a recent low of $9 
billion to around $20 billion, although still a small percentage of 
total banking assets at roughly 3.5 percent.  He also expected that 
some major corporates as well as SMEs might need to restructure 
loans, since both primary and secondary equity markets had dried up 
in recent months, foreclosing that route for big companies.  Parekh 
attributed it to instances of overexpansion, like Desai. 
 
CURRENT POLITICAL ECONOMY PROMOTES WAIT AND SEE 
--------------------------------------------- - 
 
¶11.  (SBU) DK Joshi, Principal Economist, CRISIL, stated that he was 
waiting for the 2008 annual reports of US companies in order to gain 
a "true picture" of the US economy and hence its impact on India's 
economy.  Ashvin Parekh of Ernst and Young characterized Indian 
markets as being in a holding pattern, pointing to industrial 
production, corporate results, and inflation data in January as 
major signposts for business decisions in 2009.  Kochhar also 
expected a "wait and see" in the markets, although she attributed 
this to the state and upcoming national elections.  She said that 
companies are hesitating to undertake expansion because there is no 
policy clarity right now. 
 
¶12.  (SBU) Morgan Stanley's Desai also stated that the business 
community was unsure about how elections would shape the business 
environment.  He said this was not because of hesitancy if either 
the BJP or Congress end up at the helm, but because of concern that 
 
NEW DELHI 00002962  003 OF 003 
 
 
the Left parties would come back in a coalition government, which he 
calculated as a 50% chance of happening.  Desai anticipates four 
"equally probable" electoral outcomes: the UPA wins with the Left, 
the BJP-led NDA coalition comes to power, the UPA comes in with 
Mayawati and the BSP, or a "Third Front" is formed of the Left 
parties with Mayawati.  Overall, though, Desai said he tells 
potential investors that foreign direct investment is still a good 
option and even more affordable now as Indian companies realize 
their valuations must come down.  Ajay Shah, Senior Fellow at the 
National Institute of Public Finance and Policy echoed the effect of 
the Indian election cycle on investment and business decisions.  He 
suggested that if the elections came out with a bad outcome (which 
he defined as a weak coalition/non standard coalition/hung 
parliament), which he put at a 30% probability, then it could have a 
detrimental impact on the economic policy framework and financial 
markets. He was of the opinion that investments would be postponed 
until election results were out and there was a clear cut policy 
framework in place. 
 
COMMENT 
------- 
 
¶13.  (SBU) Mumbai interlocutors expect businesses and banks to wait 
a few months for clearer signs of the extent of the impact of the 
global economic slowdown on India (more septel).  This inclination 
seems bolstered by a sense of political uncertainty cast by ongoing 
state elections, which could signal whether national elections will 
be held early and how different parties will fare.  This feeling of 
political uncertainty is likely to last until after national 
elections, to be held by no later than May 2009.  In the meantime, 
since local economists are not clear how much the current signs of 
slowdown stem from a decline in demand and how much from lack of 
financing, a lending paralysis could exacerbate an otherwise modest 
situation.  However, there are signs of improving liquidity in the 
system, as the RBI has undertaken more than a dozen policy measures 
since mid-September.  Even more importantly, the central bank still 
holds more policy tools in the CRR and repo rate to get banks 
lending again.  We expect the RBI to deploy them in the weeks ahead. 
 
 
WHITE