The coordinated response by the central banks across the globe to cut rates at which they lend to banks on Wednesday has increased the spread between India?s interest rates and those abroad, too wide for comfort. The spread between the rates in India and USA is now 7.5%, between UK and India at 4.5 % and that between European Central Bank and RBI?s repo rate is 5.25%.
The differences now make RBI the only major central banker in the emerging markets that has not gone in for a rate cut. This in turn could put pressure on RBI to follow suit, though the rate differences make borrowing abroad much more attractive for Indian companies.
Finance minister P Chidambaram said the government was willing to swiftly move to ensure adequate provision of liquidity to the banking system. ?We have several financial instruments to provide credit and other support to the financial sector,? he said in a statement after a Cabinet meeting .
In a surprising move, the Reserve Bank of India (RBI) on Monday had slashed cash reserve ratio by 50 basis points to 8.5%, effective from October 11. Reacting to this move, bond yields eased to their lowest in nearly five months on Wednesday. The benchmark 10-year bond yield ended at 7.98%, off the session?s trough of 7.94%. It had ended at 8.11% on Tuesday.
Tushar Poddar, vice-president, Asia Economic Research, Goldman Sachs, said RBI will continue to relax the cash reserve ratio and statutory liquidity ratio to manage liquidity, if global financial conditions continue to deteriorate. But he thought a repo rate cut was unlikely till inflation slipped to a comfort zone.
A Standard Chartered Bank report said that the RBI statement had indicated that ?price stability remains an overriding priority?, which meant the interest rate cycle in India had peaked. ?This also leaves room wide open for more CRR cuts if liquidity comes under pressure as global sentiments remain fragile and the Indian rupee continues to weaken. Going forward, we see policy rates on hold, with RBI reducing the CRR further by another 100 basis points,? said the report.
Earlier, the Federal Reserve of USA said it was cutting its key federal funds rate by 50 basis points to 1.5%. China, the European Central Bank, Bank of England, Canada, Sweden and Switzerland also cut rates in the coordinated response which analysts had been demanding. But despite the rate cuts, US markets have slipped further. The Standard & Poor?s 500 Index lost 9.8 points, or 1%, to 986.43 at 11:09 a.m. in New York, while the Dow Jones Industrial Average retreated 126.4, or 1.3 % to 9,320.71.
The action follows the combined push of $247 billion made by the central banks in September to hold back acute liquidity shortage in the world markets. Wednesday?s move is also expected to do more of the same and encourage nervous investors to release cash into the markets taking advantage of the low rates.
?The central banks of the world have finally woken up to the gravity of the current situation,? said Charles Diebel, the head of interest rates strategy at Nomura. ?This is a major step to convincing the world that they are serious about stabilising.?
Britain had earlier offered to pump at least 50 billion pounds ($87.2 billion) into its biggest retail banks to help them survive the crisis. British Prime Minister Gordon Brown said the global financial market had ceased to function after bad debts stemming from a collapse in the US housing market poisoned the system.