VZCZCXRO8384
RR RUEHAST RUEHBI RUEHCI RUEHLH RUEHNEH RUEHPW
DE RUEHNE #3177/01 3521214
ZNR UUUUU ZZH
R 171214Z DEC 08
FM AMEMBASSY NEW DELHI
TO RUEHC/SECSTATE WASHDC 4753
INFO RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RULSDMK/DEPT OF TRANSPORTATION WASHDC
RUEHRC/DEPT OF AGRICULTURE WASHDC

UNCLAS SECTION 01 OF 03 NEW DELHI 003177 
 
SIPDIS 
SENSITIVE 
 
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: INDIA STIMULUS PACKAGE AND MORE MONETARY EASING: CONTINUING 
MODEST STEPS IN THE RIGHT DIRECTION 
 
REFTEL NEW DELHI 2995 
 
¶1.  (SBU) Summary.  The government on December 7 announced a fiscal 
stimulus package, in step with global calls for boosting consumer 
demand, while the central bank announced lower interest rates and 
other steps aimed at helping those sectors hardest hit by the 
financial crunch.  The stimulus package had been anticipated but 
disappointed market observers because of its modest size (just "up 
to" $4 billion).  However, many economists have noted that the 
government has little fiscal space for much additional spending, as 
the current budget is already expansionary and exceeds fiscal 
spending targets.  Lower policy rates have prompted signs of banks 
reducing their lending rates, but this will take time to cycle 
through the economy.  Many analysts still expect further monetary 
easing, which declining inflation will permit.  New economic data 
suggests the economy continues to slow, but conflicting data 
prevents a clear picture of how much.  End summary. 
 
FISCAL STIMULUS PACKAGE 
----------------------- 
 
¶2.  (SBU) In line with G-20 consensus after the November 15 Summit, 
India unveiled a stimulus package on December 7 aimed at boosting 
consumer demand and confidence.  The key aspects of the package are 
a pledge to spend up to $4 billion more through the end of the 
current fiscal year on March 31, 2009; it lowered the "cenvat" tax - 
a tax on manufacturing - by 400 basis points and lowered petrol and 
diesel prices by roughly 10% and 5% respectively.  The reduced 
cenvat will cost an estimated RS 87 billion ($1.8 billion) in 
foregone revenues. 
 
¶3.  (SBU) The response was mostly disappointment as the promised 
spending is very modest, with no specific spending plans, and some 
industry sectors had hoped for specialized help.  But, as mentioned 
reftel, the government has not had much room to increase spending, 
as it has been running an expansionary, pre-election budget since 
April.  Skyrocketing commodity costs earlier this year also 
propelled oil and fertilizer subsidies to unprecedented heights and 
pre-empted much of the government's potential spending power. 
Indeed, in the supplementary budget demand in November, the 
government asked for an addition Rs. 2.3 trillion ($40 billion) - 
ten times the current fiscal stimulus package.  The grants were 
needed to pay for several programs that had not been funded in the 
budget, including the oil and fertilizer subsidies, the government 
wage increase, farmer debt waiver program, and the rural employment 
guarantee program. 
 
RBI LOWERS INTEREST RATES 
------------------------- 
 
¶4.  (U) The same weekend, on December 6, the central bank, the 
Reserve Bank of India (RBI), announced a long-anticipated reduction 
in its main policy rate, the repo rate, lowering it by 100 basis 
points from 7.5% to 6.5%.  Responding to banks' recent preference 
for parking funds with the RBI under its reverse repo rate, rather 
than deploying the capital, the RBI also lowered that rate from 6% 
to 5% in order to discourage the holding of needed capital. 
¶5.  (U) The central bank announced additional measures targeted at 
the hardest hit sectors, particularly "the housing, export and small 
and medium industry sector."  These include providing a refinance 
line of Rs. 70 billion ($1.4 billion) to the Small Industries 
Development Bank of India (SIDBI) to enhance credit to small and 
medium enterprises (SME).  The RBI also lowered the ceiling on the 
finance rate for export credit as well as offering a 2% interest 
subsidy  to exporters.  Furthermore, the central bank also announced 
that it would give "priority lending" status to loans below Rs. 2 
million ($40,000) granted by banks to Housing Finance Companies 
(HFCs) for lending to individuals for purchase/construction of 
residential units.  On December 11, the RBI announced measures "to 
preserve financial stability and arrest the moderation in the growth 
momentum."  The RBI extended additional support to the housing 
sector by providing a Rs. 40 billion ($800 million) refinancing to 
the National Housing Bank (NHB) against loans and advances to HFCs. 
To ease pressures on loan disbursements to Indian exporters and for 
honoring disbursements under export lines of credit, the RBI decided 
to provide a Rs. 50 billion ($1 billion) refinancing facility to the 
Export Import Bank of India. 
¶6. (SBU) Mumbai-based economists and analysts agreed that these 
 
NEW DELHI 00003177  002 OF 003 
 
 
steps were good, but still not enough to overcome the reluctance of 
Indian banks to lend.  Dr. Rupa Nitsure, Chief Economist at the Bank 
of Baroda, stated that RBI's actions were meant to be 
counter-cyclical, but "would not lead to miracles."  The RBI, by 
reducing interest rates, was now looking at reducing the cost of 
funds for banks so they, in turn, could provide access to capital at 
reasonable rates to cash-strapped companies.  However, she pointed 
out that the State Bank of India (SBI), India's largest bank, was 
attracting large numbers of savers with a rate of return of 10.50 
percent for some new deposits; due to this demand, other banks were 
forced to raise their deposit rates to compete for funds.  As a 
result, banks were unable to bring down lending rates without 
compressing already thin margins, unless deposit rates also were 
lowered.  She recommended that the RBI should ask banks to reduce 
lending rates for certain sectors instead of across the board. 
 
¶7.  (SBU) Dr. Siddharth Roy, Chief Economist of Tata and Sons, 
pointed out that while the RBI has reduced the Cash Reserve Ratio 
and repo rate in a series of moves, more reverse repo rate cuts are 
needed.  Roy asked why in the current uncertain environment banks 
would lend to businesses if they can receive a fairly high five 
percent risk-free return from the RBI in the form of reverse repo by 
depositing their funds there.  He applauded the recent reverse repo 
rate cut by one hundred basis points but said more needs to be done. 
 Roy stated that bank deposit rates are still high, so lending rates 
have stayed at high levels. 
 
IMPACT OF MEASURES 
----------------- 
 
¶8. (SBU) There are initial signs that the monetary steps are working 
to lower the cost of capital in the system, with state-owned banks 
announcing a new housing package and two state-owned banks deciding 
to lower their deposit rates, which give them - and other banks - 
room to lower lending rates as well.  Several market analysts expect 
both the repo and reverse repo rate to come down further, further 
enabling banks to lower interest rates from what is currently among 
the highest India has seen in nearly two decades.  Lower rates will 
make financing affordable to more companies and consumers, which 
could prompt banks to revive lending, something they have been 
loathe to do, as seen by high deposits with the central bank. 
However, while lower interest rates are critical to easing growth 
conditions, most estimate that they have at least a 12-month lag. 
 
¶9.  It will be more difficult to measure the impact of the stimulus 
package on the spending side, although the cenvat reduction has 
already prompted some automakers, including market leaders Maruti 
Suzuki and Tata Motors, to announce they would pass on the tax cut 
to consumers.  Commerce Minister Nath, former Finance Minister 
Chidambaram, and Planning Commission Deputy Chairman Montek Singh 
Ahluwalia have made statements in recent days supporting further 
fiscal measures as warranted. 
 
OUTLOOK 
------- 
 
¶10. (SBU) The RBI's October and November measures have succeeded in 
returning liquidity to India's financial system.  Now the challenge 
is to get banks to feel comfortable lending again in a tougher 
economic climate that includes slower manufacturing activity, 
exports, and the possibility of substantial job cuts.  Many think 
that the repo rate is still too high for many consumers and 
businesses and must come down to 5.0 or 5.5%, i.e., at least another 
100 or 150 basis points. 
 
¶11.  (SBU) Recent macroeconomic data continues to add to pessimism. 
Early assessments of November exports suggest another month of 
contraction, while the index of industrial production (IIP) recorded 
the first contraction on the index's 15-year history in October. 
Excise and customs revenues were down and advance tax payments are 
expected to dip as well.  However, the IIP has been experiencing 
several glitches in data collection and is contrasted by 
April-September sales revenues of listed companies, which continue 
to paint a robust consumption picture, with sales up 30% compared to 
the same period in 2007. 
 
¶12.  (SBU) At the same time, some of the indirect revenue losses are 
due to the government's tariff and tax reductions in the spring and 
 
NEW DELHI 00003177  003 OF 003 
 
 
summer when it was combating rising inflation.  And advance tax 
payments could be suffering from the reluctance of companies to part 
with otherwise working capital until the end of the fiscal year. At 
a 1-percent per month penalty for not paying advance taxes, 
companies may find the penalty cheaper than the cost of borrowing 
from banks.  Finally, inflation continues to ease, which will be 
further enabled by the cenvat reduction and lowered petrol and 
diesel prices (which alone will lower inflation by about 60 basis 
points).  Still declining inflation continues to add policy space 
for the RBI to further reduce rates. 
 
COMMENT 
------- 
 
¶13.  (SBU) The government and the central bank continue to respond 
relatively aggressively to signs of stress in the economy and are 
using rather measured and calibrated responses.  However, the tepid 
response in the stock market to the stimulus package and interest 
rate reduction suggests that the market has already priced in such 
moves and that expectations remain for further steps to be 
undertaken.  The government's finances, already out of whack because 
of the record-breaking fertilizer and oil subsidy costs through the 
first half of the year, will likely fall further out of kilter, with 
estimates of the center's fiscal deficit to GDP climbing to 6-8% of 
GDP, from last year's 2.9%.  One contact acerbically noted that 
worrying about fiscal deficits at a time of such global economic 
challenges is like worrying about cholesterol when a patient has 
cancer.  Many may agree, but the government's more recent fiscal 
rectitude has been the primary reason behind India's sovereign 
rating improvements to investment grade in the last two years.  High 
fiscal deficits could trigger downgrades which increase the cost of 
capital to India's private as well as public sector. 
 
MULFORD