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Mumbai: This week's surprise US interest rate cut, in addition to a brutal stock market selloff, may just have tilted the odds in favour of a modest 25 basis point rate easing by India's central bank next Tuesday.
After five rises, India's lending rate has stayed on hold at 7.75 per cent since March as the Reserve Bank of India (RBI) monitored the impact of its monetary handiwork on troublesome inflation.
A cut on Tuesday would be the first in nearly four years.
Many in the market had thought Indian rates would fall later in 2008 anyhow, but the US Federal Reserve's rate cut this week bought the expected easing forward, especially as many see the US central bank cutting rates further.
Seven out of 13 economists polled by Reuters forecast a quarter-percentage point rate cut on Jan. 29, a bet reflected in the 10-year bond yield, which on Wednesday hit a two-year low.
The Fed's 75 basis point cut has swelled the interest rate differential between the two countries to 425 basis points, its widest in more than three years.
That has raised the chances that capital inflows, which swamped local markets last year, will intensify and fuel asset-price inflation.
And with the rupee hovering at its highest in almost a decade against the dollar, a rate cut could lessen the central bank's need to intervene in currency markets to try to keep the exchange rate stable.
"The RBI's hands are tied now and the arbitrage flows will only intensify if it doesn't cut rates," said Sujan Hajra, chief economist at Anand Rathi Securities, who expects a 25 basis point cut in the repo rate, the main lending rate, on Tuesday.
Anand Rathi estimates nearly $20 billion of arbitrage-seeking flows poured into the country in the July-September quarter, the latest for which data is available, via non-resident remittances, banking assets and other channels.
That is on top of $17.4 billion in portfolio funds which came into the stock market in 2007 and $15.7 billion in foreign direct investment which India received between January and October.
Foreigners haven't been so keen recently, selling $2.6 billion of shares in the five days to Tuesday, when the market hit a trough almost 28 per cent below its January 10 record high amid a global equities rout.
"With the stock market fall, some of the froth has been whipped off and concerns of asset-price inflation have reduced and this may probably be the best time to cut rates," Hajra said.
India has been one of the world's fastest-growing economies in the past four years, clocking 9.4 per cent in 2006-07. The central bank forecasts 8.5 per cent this fiscal year to March 31.
It raised rates five times between June 2006 and March 2007, during which time inflation rose to a high of 6.7 per cent, and has lifted banks' cash reserve requirements by 250 basis points since December 2006.
Scepticism
Some analysts are sceptical that just a quarter point cut will deter the inflows, especially if India is growing so fast.
"If it was really the interest rate differential story, they would have to cut rates much more than that," said an economist at a US investment bank, who declined to be named.
Rather, the economy appears to be losing steam, he suggested.
Capital expenditure by Indian companies remains robust. But export growth in rupee terms slowed to an annual average of 6.9 per cent between June and November, compared with an annual average of 23.3 per cent in the whole of 2006/07 (April-March), Morgan Stanley estimates.
Consumer goods production softened to 3.2 per cent on an annual three-month average between September and November from a peak of 18.5 per cent in the three months to June 2005.
"The cost of interest rates staying higher for a longer period would be significant if it results in a slowdown in the capex cycle, as the weak consumption would break the investment confidence of the corporate sector," Morgan Stanley economists wrote in a report.
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