Several state-run banks last week announced they would lower interest ratesafter the Reserve Bank of India's (RBI) one percentage point cut in its keybank rate, the repo rate and banks' cash reserve ratio (CRR) and a 50 basispoints cut in savings deposit rate.

The country's largest bank, the State Bank of India, led the way, announcinga 75 basis points cut in its prime lending rate to 11.25 percent from 12,and cut its deposit rates by 50-100 basis points. Other state-run banksincluding Bank of Baroda, Bank of India and Corporation Bank were quick tofollow SBI's lead, announcing their own rate cuts ranging from 50-75 basispoints.

State-run banks account for nearly three-fourths of the deposit and creditbusiness of India's banking system. Lending rates of private and foreignbanks in India are higher than their state-run counterparts. Most of themare yet to respond to the central bank rate cuts. But analysts said afurther drop in rates was unlikely. An analyst at a European brokerage saidhigher budgeted borrowings of the government and high corporate demand couldprevent a fall in interest rates.

"The budgeted borrowings for the year are high and past experience showsthat this is always breached. On the demand side, corporate demand forfunds, particularly for project finance and infrastructure may be high thisyear." Gross government borrowings have been budgeted at Rs 1.17 trillion in2000/01 (April-March). SBI chairman GG Vaidya also indicated as much in arecent interview to Reuters where he said there was no scope for a furtherfall in rates and they would remain stable for the rest of the fiscalyear.

Indian interest rates have been falling steadily since the mid-1990s, but afurther fall from here will take a heavy toll on banks' spreads, which havebeen falling steadily. Margins of leading state-run banks have fallen fromfour percent at the end of March 1997 to less than three in April 2000.

While banks have tackled pressures on spreads from falling lending rates bycutting deposit rates, a further cut in deposit rates could see money movingaway from banks into more lucrative avenues such as mutual funds, analystssaid. Interest rates on deposits have fallen sharply in the past fewmonths, falling by nearly 150 basis points since January.

Yields on bond offerings by financial institutions have fallen by nearly300 basis points in the past 12 months. "A rate of 8.5 percent or so forthree year deposits is unattractive.

Even more so, when inflation rate is moving up and is estimated to touchfive percent in the next few months," the analyst at the European brokeragesaid. With spreads under pressure, and with little room available to lowerdeposit rates, lower rates could only be achieved by banks cutting costs.But that is difficult.

With strong unions dominating the state-run banking sector, options such aswage cuts or laying off surplus staff were unthinkable, analysts said."Banks can't just chop overheads. The other option is to increase fee-basedbusiness, but the market for this business is intensely competitive,"Hemendra Hazari, banking analyst at ASK Raymond James India securitiessaid.

-- (Reuters)