India’s Central Bank In Recession-Busting Model

With the Reserve Bank of India’s surprise interest rate cut on Monday, this may actually be the first time ever that India is ahead of the monetary policy curve.

That’s according to Karim Rahemtulla, speaking in the wake of the Reserve Bank of India cutting its overnight lending rate from 9% to 8%, as the country makes a strong move to avert a recession.

The “surprise move” came days before a regularly scheduled meeting of its policy board and after the central bank reduced the cash reserve ratio by 2.5 percentage points to 6.5% – retroactive to October 11.

The so-called “repurchase rate” is the discount rate at which India’s central bank lends money to commercial banks in order to inject liquidity into the market

“By lowering rates, and thereby liquefying the system and offering stimulus to deflect slowing growth, India may be ahead of the curve for the first time in making the correct monetary policy decisions to prevent a recession which it cannot afford,” says Karim.

Without doubt, this is a country that is extremely eager to sustain its investment growth…

A $1 Trillion Market And The Fastest GDP Growth In 60 Years

In late May 2007, the Bombay stock exchange became the third emerging stock market (after China and Russia) to surpass $1 trillion in market value – a surge helped at the time by the nation’s fastest GDP growth in six decades, a flood of foreign investment and a strengthening rupee. On the day the index achieved that milestone, the 30-stock Sensex, closed at 14,508.21 – 1% below its then-record high.

As Karim states, “India has been one of the [world's] largest recipients of foreign direct investment, which accounted for the boom in the stock market over the past five years.

That was then – and this is now. And India’s rate cut this week demonstrates that…

India Feeling The Ripple Affect From The Credit Collapse

India clearly fears that the ongoing turmoil in the credit markets remains a threat – one that could plunge much of the global economy into a recession.

“A 100-basis-point cut is an indirect admission that not all is ‘hunky dory’ with the India growth story,” Nandkumar Surti, chief financial officer at JPMorgan Asset Management India Pvt. Bank in Mumbai, told Bloomberg. “One way to look at it is that the global problem has begun to affect us.”

Fluctuations in India’s bond yields this month were the widest in more than five years as the central bank took steps to ease a liquidity crunch. Ironically, just one day after the central bank cut rates for the first time in four years, an employee strike at the Reserve Bank of India shut down bond trading in Mumbai, leaving many traders unable to bet on additional interest rate reductions. About 25,000 employees of the central bank walked off their jobs to demand higher pensions.

And it’s not just India feeling the pinch…

This Crisis Is Global

As both JPMorgan Chase & Co. (JPM) and UBS AG (UBS) said the world economy is sliding into its first recession since 2001, evidence of the slowdown is apparent with China’s GDP growth slumping to a five-year low in last quarter. And in addition to India, Vietnam also reduced borrowing costs this week.

The near-collapse of the banking systems in both the United States and Europe this month prompted the International Monetary Fund (IMF) to throttle its worldwide GDP growth forecast for 2009 from an earlier estimate of 3.9% all the way back to 3% – a point the IMF itself has labeled as the dividing line between global expansion and a global recession.

After growing at an estimated rate of 9.3% in 2007, the IMF says India’s GDP growth rate may slow to 7.9% this year and all the way down to 6.9% next year.

The projection comes as the Indian stock market has lost over half its value this year, the rupee has fallen to new lows, and cash flow problems cripple banks.

On the bright side, India’s key wholesale price inflation number slowed more than economists expected to 11.4% in the week through to October 4 – a four-month low.

“We expect a further reduction in wholesale price inflation in the next two months,” Indian Prime Minister Manmohan Singh told lawmakers this week. “Nevertheless, we must be prepared for a temporary slowdown in the Indian economy.

So what next?

Despite The Downturn, India Is Upbeat

India’s commerce minister, Kamal Nath, told the BBC that he’s confident India can remain a strong force on the economic stage, arguing that the country’s growth rate was “not as yet” being threatened. Unlike its U.S. counterparts, none of India’s banks have gone bust due to the Asian country’s “stricter norms,” Nath assured.

Also key: Foreign-direct investment remains strong, and export growth soared 31% in September.

However, Karim argues that export growth could pose a problem: “India’s economy, while insulated somewhat from the global crisis because of its minimal reliance on outside trade, may still suffer from the current malaise because of its growing export sector. The rate cuts, which will likely be followed by more cuts, are being made to ensure India’s competitiveness by allowing rupee depreciation, which helps its strong outsourcing and tech sectors.”

That, in turn, will directly benefit such companies as Infosys Technologies Ltd. (Nasdaq: INFY). Wipro Ltd. (NYSE: WIT), Tata Motors Ltd. (NYSE: TTM) and global IT-services provider Satyam Computer (NYSE: SAY), Karim believes. Tata Motors recently gained global fame when it introduced a fully functional $2,500 car called the “Nano” for the India market.

India’s Finance Minister Palaniappan Chidambaram has asked parliament for approval to spend an additional $49 billion (2.4 trillion rupees) on rural jobs, food and oil subsidies in the year ending March 31. The aim is to provide a further boost to the economy, which has grown at a record 8.8% annual clip since 2004.

The China Equation

India’s leadership “must have been worried about global growth, big economies and [the fact that other key economies in] the region [are] slowing,” Sailesh Jha, senior regional economist at Barclays Capital (NYSE: BCS) in Singapore, told Bloomberg this week, referring to the GDP report for China: Hit “The BRICs” for Superior Profits?

Although central banks in the U.S. and Europe have pared interest rates to stave off a recession, only India and China among the so-called “BRIC” economies have joined global policymakers in that battle. Russia lowered its reserve requirement twice in a month, while Brazil reduced the measure four times in three weeks.

Back on October 8, easing inflationary pressures in China enabled its central bank to pare interest rates for the second time in three weeks. It reduced the one-year lending rate from 7.2% to 6.93% on the same day that the U.S. Federal Reserve, European Central Bank and three others lowered rates in unprecedented and co-coordinated worldwide action. China also reduced the proportion of deposits that lenders must set aside as reserves by 0.5 percentage points.

China’s economy, the biggest contributor to global growth, zoomed along at a 9% clip in the third quarter.

The Outlook For India

In a recent report, the Macquarie Research unit of Macquarie Group Ltd. said that Indian real-estate developers are facing a shortage of funds, which may slow demand for steel, cement and transportation products and services.

“The capital crunch has hit the real estate sector very hard,” Macquarie analysts Unmesh Sharma and Bharat Rathi said. “We believe the tightness will continue for a few more months, given the difficulty in raising capital through bank debt, equity markets and (more recently) private equity.”

The decline in demand is already showing in India. The nation’s output at factories, utilities and mines rose 1.3% in August from a year earlier, after a revised 7.4% gain in July, as rising borrowing costs have dampened demand from consumers.

Rajeev Malik, a regional economist with the Macquarie Group in Singapore, recently said that the “downside risks to India’s growth have increased, while the upside risks to inflation have receded. We expect inflation to continue improving, thereby facilitating a shift in the RBI’s monetary stance.”

Best regards,

William Patalon, III
Guest Author, Smart Profits Report