Market expects speedier, steeper rate cuts

RBI may be forced to cut interest rates earlier than planned and more aggressively than previously hoped, as it comes under pressure to navigate an already faltering economy away from the turbulent economic aftershocks of the Mumbai terror attacks.

Last week’s attacks, which killed around 200 people, targeted key symbols of enterprise in a city that is widely viewed as the country’s economic powerhouse and a key barometer of business confidence. The attacks and the choice of targets appear at least partly aimed at puncturing investor confidence at a time when the country’s economy is already reeling under slowdown.

Much like the 9/11 attacks in the US in 2001, hastened the easing of the monetary policy stance — which had been started by the Federal Reserve in response to the bursting of the technology bubble, many in the market are expecting RBI to adopt a similar response to what many are calling India’s version of 9/11. The Fed progressively brought down its key federal funds rate to 1% in the months, following the 9/11 attacks, although no one in India is expecting that aggressive a move.

“With signs of economic slowdown already staring at us, the terrorist attacks are likely to affect investor confidence. To counter the possibility of still slower capital inflows, the market is hopeful about a sooner rate cut from RBI,” said B Prasanna, MD & CEO, ICICI Securities, a primary dealer in government securities.

Terror attacks in Mumbai are hardly new, but it’s the first time that it targeted five-star hotels frequented by top business figures and foreigners visiting the city. Analysts say the likely fall out of the attacks could be foreign investors getting worried about the safety of their employees and establishments, which in turn could impact already shrinking capital flows into the country.

Economic growth this year is expected by most forecasters at less than 7%, down from the 9%-plus of the previous three years, and some analysts expect it to fall further next year. Anticipating this, and helped by a falling inflation rate, the central bank has already switched gears in favour of an easier monetary policy, but analysts say the Mumbai attacks may force it to become more aggressive.

“Declining inflation and increased downside risk to growth hint that another round of easing by the central bank is imminent. However, the Mumbai attacks could prompt RBI to announce a bigger cut than the 50-basis point we had expected prior to the attacks,” said Rajeev Malik, chief economist with Macquarie Securities in a research report.
The market is already betting on this. Overnight interest rate swaps, a derivative product commonly used by traders to express a view on interest rates, are trading at a 5-year low, suggesting rate cuts are imminent.

Amid all this, RBI has been predictably silent on further rate cuts. However, that it remains biased in favour of softer rates is clear by some of its recent actions — it cut a key short-term rate and slashed banks’ reserve requirements in early November and recently extended the time period for its various liquidity enhancing measures to June next year.

T reported on Saturday that a group of bankers had in a meeting with RBI asked it to cut its reverse repo rates rather than bring down the cash reserve ratio. This, they feel, will give an indication to the market that interest rates are headed south.