VZCZCXRO3993
PP RUEHAST RUEHCI RUEHDBU RUEHLH RUEHNEH RUEHPW
DE RUEHBI #0096/01 0681327
ZNR UUUUU ZZH
P 091327Z MAR 09
FM AMCONSUL MUMBAI
TO RUEHC/SECSTATE WASHDC PRIORITY 6999
INFO RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHBI/AMCONSUL MUMBAI PRIORITY 2177
RUEHCG/AMCONSUL CHENNAI PRIORITY 2011
RUEHNE/AMEMBASSY NEW DELHI PRIORITY 8239
RUEHCI/AMCONSUL KOLKATA PRIORITY 1802
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SECTION 01 OF 05 MUMBAI 000096 
 
SENSITIVE 
SIPDIS 
 
TREAS PLEASE PASS TO FED 
USDA PASS FAS/OCRA/HIGGISTON 
PASS USDA/FAS FOR OCRA/CARVER/BEAN/RIKER 
PASS TO USTR FOR AADLER/CLILIENFELD 
PASS TO COMMERCE FOR LDROKER/ASTERN/ABAWLE 
 
E.O. 12958: N/A 
TAGS: ECON EAGR EFIN EIND EINV ETRD IN
SUBJECT: RBI CUTS TWO KEY INTEREST RATES TO SPUT LENDING AS INDIA 
CONTINUES TO FEEL EFFECTS OF GLOBAL FINANCIAL STORM 
 
REF: 2008 MUMBAI 499 AND PREVIOUS 
 
MUMBAI 00000096  001.2 OF 005 
 
 
¶1.  (SBU) Summary:  On March 4, the Reserve Bank of India (RBI), 
long anticipated, lowered two interest rates by 50 basis points 
in an effort to boost credit, raise consumer confidence, and 
spur economic growth.  With inflation dropping, the RBI has more 
room to cut interest rates, though most observers did not 
believe the moves would have an immediate impact, both because 
of structural factors, such as lending requirements and sticky 
deposit interest rates, as well as a general drop in credit 
demand.  Despite government monetary and economic stimulus 
plans, Indian market and economic indicators continued a 
negative trend, as growth figures, capital markets, and credit 
growth all declined, and two foreign rating agencies expressed 
concern over India's fiscal deficit.  India's rupee depreciated, 
but in line with other emerging market currencies.  Economists 
and market participants believe that growth is now underpinned 
by major government spending programs, such as the farm loan 
waiver, civil service pay increases, and rural job creation 
schemes.  While the contraction in agricultural growth was a 
surprise, economists believe this would likely be revised upward 
in the next quarter.  Overall, with the general drop in demand 
for credit, the RBI may be out of effective monetary policy 
tools for the moment.  End Summary. 
 
 
 
RBI Lowers Rates After Seeing Slowing Growth and Disinflation 
 
--------------------------------------------- ---------------- 
 
 
 
¶2.  (SBU) On March 4, the RBI lowered its two main monetary 
policy rates to continue efforts to spur bank lending.  The RBI 
lowered the repo rate (the interest rate at which it lends to 
banks) to 5 percent and the reverse repo rate (the interest rate 
that the central bank pays to banks for funds deposited with it) 
to 3.5 percent.  Since September 2008, the RBI has reduced the 
repo rate by 400 basis points in five separate moves.  The 
central bank started cutting the reverse repo rate in December 
2008 to encourage banks to expand lending instead of parking it 
in safer, less-lucrative RBI accounts; this rate has been cut by 
250 basis points in three moves.  The RBI left the cash reserve 
ratio (CRR) -- the amount of reserves which the banks must keep 
with RBI, now at five percent - and the statutory liquidity 
ratio -- the ratio of funds that a bank must invest in 
government bonds, now at 24 percent - unchanged.  The RBI 
estimates that these monetary measures have cumulatively 
released over Rs. 4.280 trillion ($82 billion) into the 
country's banking system since October. 
 
 
 
¶3.  (U) In explaining this move, the RBI stated in a press 
release that while "India's financial sector continues to be 
resilient in the face of global financial turmoil," India's 
growth has been "impacted both by the financial crisis and the 
follow-on of global economic downturn.  This impact has turned 
out to be deeper and wider than anticipated earlier."  Global 
financial and economic conditions have further deteriorated and, 
citing poor economic numbers in the U.S., Japan and the 
Euro-zone, raised questions about the timeframe for recovery. 
Indeed, recently released data indicates that India continues to 
suffer from the effects of the global economic crisis in the 
form of slowing economic growth.  India's GDP grew at 5.3 
percent in the October-December 2008 quarter, down from 7.6 
percent in the preceding quarter.  While service sector growth 
remained steady at around 9.5 percent, agricultural sector 
growth declined unexpectedly by 2.2 percent and the industrial 
sector grew at a tepid 0.8 percent versus 4.7 percent in the 
preceding quarter.  (Note:  Agricultural growth declined from Q3 
2007 growth of 6.9 percent, a very high base.  End note.) 
 
 
 
¶4. (U) Concurrently, Indian financial markets continued to 
perform poorly.  The benchmark Bombay Stock Exchange's Sensitive 
Index of 30 stocks, or SENSEX, has dropped almost 50 percent 
from a year earlier, reaching a three-year low on March 2.  The 
 
MUMBAI 00000096  002.2 OF 005 
 
 
Indian Rupee continued its slide against the dollar, falling to 
a new low of 52/1 USD, a drop of over 30 percent since its high 
in November 2007.  India's trade deficit narrowed slightly in 
January 2009, as imports slowed more than exports.  Imports fell 
by 18.2 percent (against 8.8 percent growth in December) with 
non-oil imports falling to 0.5 percent (as compared to a 32 
percent growth in December) indicating slowing domestic demand. 
Exports fell by 15.9 percent in January, its fourth consecutive 
monthly decline.  In this environment, the Government of India 
(GOI) announced that its fiscal deficit would cross 6 percent of 
GDP in the current financial year, but with off-balance sheet 
items it would be an aggregate 11 percent of GDP.  On the 
positive side, inflation, measured by the weekly Wholesale Price 
Index (WPI) released on March 5, continued easing to 3.03 
percent, down from a high of 12.91 percent in August 2008. 
 
 
 
¶5.  (SBU) In an effort to revive consumption, the RBI, by 
lowering its key interest rates, seeks to encourage banks to 
lend to consumers and companies of all sizes.  However, given 
the current economic conditions, Indian private and public 
sector banks remain risk averse and are reluctant to lend at 
economical rates except to the strongest companies.  As a 
consequence, year-on-year loan growth has dropped to 19.7 
percent, down from the RBI's target of 24 percent and below 
recent trends of 22-24 percent.  Some public sector banks, such 
as India's largest bank, the State Bank of India (SBI), have cut 
their prime lending rates for some types of loans, including 
housing loans, though private banks may not do so.  However, all 
banks must compete for savers against the government's Small 
Savings Scheme, which is available through the Indian Post 
Office and public sectors banks and which pays 8 percent 
interest to depositors.  Private sector banks, in particular, 
are hesitant to lower deposit rates for fear of losing savers to 
public sector banks offering higher rates.  Banks are also 
obliged to lend to exporters and farmers two percentage points 
below their prime lending rates (in the 11-13 percent range), 
making it difficult to lower loan costs without hurting 
profitability. 
 
 
 
Interest Rate Cuts Not Expected to Have an Impact 
 
--------------------------------------------- ---- 
 
 
 
¶6.  (SBU) Overall, market participants and economists in Mumbai 
agreed that the RBI's cuts would not make much immediate 
difference to the credit and financial environment.  Atsi Sheth, 
Chief Economist of Reliance Capital, praised the cuts, but 
commented that the RBI will have to continue cutting all three 
benchmark rates to have an impact; she expected that by June, 
the CRR would be lower by 100 basis points and the repo and 
reverse repo by a further 50 basis points.  Dipti Neelankani, 
Chief Operating Officer, JM Financial, argued that because of 
the upcoming national elections, public sector banks would be 
discouraged from lowering deposit rates; after all, she said, 
more Indians benefit from higher deposit rates than cheaper 
loans, and while this is a short term attitude, it will likely 
prevail over the coming months.  Criticizing the RBI, Neelkani 
said that the current round of rate cuts should have taken place 
four months ago when it was clear that inflation was trending 
downward, and when businesses and consumers could have usefully 
employed credit, improving Q3 results.  Now, the financial 
situation of companies and consumers have worsened, making banks 
less likely to lend.  One risk, she added, is that banks will 
use the RBI's monetary stimuli to buy more government debt to 
finance the ballooning fiscal deficit, instead of lending to 
corporations or consumers. 
 
 
 
¶7. (SBU) Anu Madgavkar, partner at McKinsey and Company, 
disagreed and pointed out that two notable factors may mitigate 
this.  First, the RBI has $30 billion in Market Stabilization 
Scheme (MSS) bonds that can be used to help finance government 
 
MUMBAI 00000096  003.2 OF 005 
 
 
debt.  (Note:  Originally designed to sterilize foreign currency 
inflows to minimize inflationary trends, MSS rules were amended 
in February so that a portion of the amount in the MSS account 
could be utilized for financing Central Government borrowings. 
End Note.)  Second, she expected that much of the borrowing may 
be pushed to the end of the fiscal year because of national 
elections. 
 
 
 
Demand for Credit Tapers Off 
 
---------------------------- 
 
¶8.  (SBU) At the same time the RBI is cutting rates to spur 
lending, statistical data indicate that the demand for bank 
credit is decreasing.  At a conference in Mumbai, Usha Thorat, 
the Deputy Governor of the RBI, confirmed that while there was 
slowing demand for bank credit, she believes that "all 
legitimate requirements of bank credit are forthcoming to Indian 
industry."  However, she admitted that credit to the micro and 
small enterprises sector had contracted.  Sheth explained that 
since December, businesses have benefited from the positive 
effects of lower commodity prices, which has lowered input 
costs, and reduced the amount of needed working capital. 
Concurrently, they have started to cut costs to deal with the 
effects of the slowdown, reducing credit demand.  Madhav 
Bhatkuly, Director of New Horizon Investments agreed, telling 
Congenoffs that Indian industry has excess capacity, and did not 
need credit for capital expenditure.  Jeremy Mistry, 
Vice-President for Investment Banking at Nomura Securities, said 
that some Indian industrial companies would like to raise 
financing to acquire other companies, but are reluctant to add 
debt to their balance sheets and are looking for alternative 
lines of funding, such as joint ventures or private equity.  He 
said that many major companies would use lower interest rates to 
refinance outstanding debt rather than for new capital 
expenditures. 
 
 
 
Unexpected Sources of Government Spending Showing Traction 
 
--------------------------------------------- ----------- 
 
 
 
¶9.  (SBU)  To the surprise of most interlocutors, they 
acknowledge that some spending and tax initiatives appear to 
have had a positive effect on the Indian economy.  Pranjul 
Bhandari, Economist at Goldman Sachs India, argued that with 
government consumption at 24 percent of GDP, "either by design 
or by accident," the GOI is bolstering growth.  Sheth agreed, 
and noted that the latest GDP results showed that the 
multi-billion dollar farm loan waiver announced in February 
2008, as well as increased spending on the National Rural 
Employment Guarantee (NREG) program, continues to inject 
significant funds into the system.  According to Madgavkar, the 
first tranche of pay increases for civil servants released in 
October 2008 have also acted as a stimulus.  She explained that 
automobile company executives believe that many low-level 
bureaucrats are upgrading to automobiles for the first time in 
their lives, presumably from motorcycles or scooters; cement 
industry representatives state that sales of homes in Tier 3 
towns to government employees is underpinning growth in this 
sector.  Madgavkar also believed that the recent excise tax cuts 
have been moderately successful.  However, she estimated that 
the small and medium enterprises (SME) relief packages have not 
been successful because banks are only lending to large 
corporations and ignoring smaller businesses which they perceive 
as being more risky. 
 
 
 
Rupee Deprecating In Line with Other Emerging Market Currencies 
 
--------------------------------------------- ----------------- 
 
 
 
MUMBAI 00000096  004.2 OF 005 
 
 
 
¶10.  (SBU) During the week of March 2, the Indian Rupee (INR) 
dropped to a historic low against the dollar, surpassing 52/1 
USD.  Interlocutors agreed that this depreciation was due mostly 
to external, global pressures.  At a conference in Mumbai, 
Arvind Virmani, the Chief Economic Advisor of the Ministry of 
Finance, pointed out that the U.S. dollar had reached a trough 
in July 2008 but has since appreciated by 20 percent against a 
broad index of currencies.  He noted that the Indian rupee's 
movement was the mirror image of the dollar; it depreciated by 
19.8 percent during the same period.  Kumar Shah, Director for 
Corporate Treasury Sales at HSBC India, expressed his surprise 
over the recent volatility in currency markets.  He explained 
that the bank's hedge fund clients who have invested in baskets 
of emerging market currencies and equity markets have been 
"spooked' by the recent problems in Eastern Europe and have 
pulled out of all emerging markets to seek the safety of U.S. 
Treasuries. 
 
 
 
¶11. (SBU) Sheth noted that since the beginning of the year, the 
INR has depreciated over 5 percent, along with other emerging 
market currencies -- such as the South Korean won (18.8 
percent), the Indonesian rupiah (8.1 percent), the Singapore 
dollar (7.72 percent), and the Malaysian Ringgit (6.6 percent), 
among others -- as investors face redemption pressures in the 
U.S. and seek to avoid risk in emerging markets, and exports - 
to the U.S., especially -- decline.  Madgavakar suspected that 
another factor working against the rupee is that remittances 
from Indian expatriate workers are slowing, as they are laid off 
and forced to return home in the Persian Gulf states and 
elsewhere.  Specific to India, investors express uncertainty in 
the long term due to the large fiscal deficit and in the 
short-term due to the upcoming general elections.  Bhatkuly 
agreed that recent factors affecting the currency markets have 
been "unidirectional" against the INR; besides portfolio 
redemptions and a downturn in exports and remittances, he 
pointed out the GOI and commercial borrowers are scheduled to 
repay - or try to rollover - an estimated $43 billion in 
foreign-owned debt due through April 2009.  (Note:  The RBI's 
third quarter Review of Monetary Policy 2008-09 states that 
$28.1 billion of the $43.2 billion was disbursed between April - 
November 2008.  End Note.)  When pressed, none of our 
interlocutors could explain the reason for the recent speed of 
the depreciation of the Rupee.  Forecasters at HSBC and UBS 
Financial services expect that the INR will reach 55 to the 
dollar before improving. 
 
 
 
Credit Agencies taking another look on outlook for India 
 
--------------------------------------------- ------------- 
 
 
 
¶12.  (SBU) While the outlook of two foreign credit rating 
agencies have turned negative, observers thought these actions 
had only a marginal impact on Indian markets.  On February 23, 
Standard & Poor's (S&P) downgraded its outlook on Indian 
sovereign debt from stable to negative, reflecting its concern 
over India's fiscal deficit.  Concurrently, Moody's placed 
India's sovereign rating under "surveillance."  Reacting to this 
news, Sheth believes that it came too late to affect the 
thinking of experienced foreign investors, but it may have 
deterred new foreign investors from jumping into the Indian 
markets.  Atul Phull, Associate Vice-President of Private Wealth 
Management at Credit Suisse, stated that many of the reasons for 
the downgrade were already priced into the market.  Madgavakar 
pointed out that the downgrade has been superseded by bad global 
market sentiment.  An economist at Anand Rathi, an institutional 
asset management firm, warned that if India was downgraded to 
non-investment grade status, then many debt funds which can only 
invest in investment grade securities would be forced to pull 
out of Indian markets; currently, India is assigned the lowest 
possible investment grade rating. 
 
 
 
MUMBAI 00000096  005.2 OF 005 
 
 
 
India Watchers Undisturbed by Surprising Fall in Agriculture 
Growth 
 
------------------------------------- 
 
 
 
¶13.  (SBU) Because of the tepid, yet expected, growth figures in 
the industrial sector, the Indian media focused on the 
unexpected agriculture sector contraction of 2.2 percent in the 
October- December quarter.  However, interlocutors dismissed 
this statistic as an aberration, pointing out that it had 
dropped from an unusually high base growth of 6.9 percent in the 
same quarter in 2007.  Sheth expected this number to be revised 
upward by approximately 1 percent, once the complete figures 
were in.  She explained that other indicators on activity in 
rural India are much more positive - including rural consumer 
spending -- which hints at an eventual higher figure.  Madgavkar 
stated that, generally, such figures can drastically change 
based on cropping patterns, as farmers plant crops such as wheat 
or cotton, which are receiving higher support prices from the 
government, instead of crops like oilseeds or minor grains. 
 
 
 
¶14.  (SBU) Comment:  While market participants now praise the 
RBI's cautious regulatory environment for helping India avoid 
the roots of the financial crisis, Mumbai interlocutors also 
continue to believe that the central bank has been behind the 
curve in its monetary policy moves to address the economic 
slowdown.  In particular, economists agree that the RBI started 
late in raising rates to counter the effects of rising inflation 
in mid-2008, and appears slow in lowering rates as inflation has 
eased and growth slowed.  In a consensus view, the recent 
interest rate cuts are not expected to have a simulative effect 
on the Indian economy in the near future.  In fact, many 
economists immediately noted expectations for further rate 
reductions.  Currently, it is not clear whether lowered interest 
rates would spur bank lending, as credit demand has been 
dropping due to decreased consumer spending.  However, some 
central government initiatives -- particularly the farmers' loan 
waiver, the extension of the NREG scheme, and higher government 
salaries resulting from the latest Pay Commission report -- 
appear to be underpinning growth for the Indian economy in the 
near term.  All in all, India's economy continues to be affected 
by the global economic crisis, though, at almost 6 percent 
growth, it is riding the storm better than others.  End Comment. 
FOLMSBEE