RBI may go forward with rate cut option

MUMBAI/NEW DELHI: Indian bankers are betting on a rate cut by the Reserve Bank of India (RBI) following the 75-basis-point Fed rate cut on Tuesday. A rate cut looks highly probable, given the huge difference between Indian and international rates.

The US Federal Reserve announced the first interest rate cut, both Fed Funds rate and discount rate, this year after the bond and foreign exchange markets in India had shut for the day. Bank of Canada was quick to follow, reducing interest rates by 25 basis points to 4%, following the emergency measures in the US.

Bank of Japan released statements affirming its stance of not lowering interest rates, despite acknowledging that the recent weakness in financial markets did pose a risk to the nation’s economy. Back home, treasury managers at local bond houses and multinational banks now feel that the rate action in the US could force RBI to follow suit.

A finance ministry source said, “The overall impact should be positive for the markets. However, it would increase the interest rate differential and make external commercial borrowings (ECBs) more attractive. This could prompt RBI to go for a cut in domestic interest rates.”

Few market insiders expect RBI to step out of schedule and announce a rate cut before the monetary policy review on January 29. “Judging by what happens in the market on Wednesday, RBI may take a call on whether to advance its response without waiting till January 29,” a source said.

Treasury officials expect a softening in interest rates. RBI does not have much headroom to maintain status quo and remain insulated.

“It will have to cut the repo rate by 25 basis points. In addition to this, we do not rule out a cut in the cash reserve ratio (CRR) since the government has said liquidity has to be maintained due to the choppy markets. Also, since the busy season is on, there is a case to support liquidity. A 75-basis-point cut is substantial and can snowball into a global contagion,” an official added.

For starters, the lowering of rates in the US would make borrowing in overseas markets a lot cheaper for local corporates. These companies would also stand to benefit from a further rise in rupee levels against the dollar.

The six-month London inter-bank offered rate (Libor) is currently quoting at 3.68%, but following the rate cut in the US, it is expected to come down sharply. This could significantly lower the cost of funds for those companies.

As such, there has not been much activity in the loan syndication market since the beginning of the New Year. This could be mainly attributed to RBI tightening overseas borrowings norms for Indian corporates.

Yes Bank president, financial markets and institutions Ajay Mahajan said, “There has not been a whole lot of corporates borrowing offshore, but with the Libor coming down, there will be interest savings for companies which have borrowings in foreign currencies.”

On the impact of the Indian forex and bond markets, Mr Mahajan pointed out, “The impact of the Fed rate cut will not be direct, but the overall attractiveness of the rupee over the dollar will possibly increase with the differential being created. Bonds will react positively to the rate cut, with the differential in the US and Indian markets widening. It also raises the expectation of a repo rate cut by RBI sooner than later.”