RBI May Cut Interest Rates Aggressively Following Mumbai Attacks
The Reserve Bank of India (RBI) is facing mounting pressure to cut interest rates earlier and more significantly than initially anticipated. This comes as the central bank grapples with an already weakening economy further destabilized by the devastating economic consequences of the Mumbai terror attacks.
Impact on Business Confidence
The attacks last week, claiming approximately 200 lives, deliberately targeted prominent symbols of commerce in Mumbai. Recognized as the nation's economic engine and a crucial gauge of business sentiment, the timing and location of these attacks seem, at least in part, designed to undermine investor confidence amidst an existing economic downturn.
Parallels to 9/11 and the Federal Reserve's Response
Much like the repercussions of the 9/11 attacks in the US, which accelerated the easing of the monetary policy initiated by the Federal Reserve in response to the dot-com bubble burst, many market observers anticipate a similar response from the RBI. Following 9/11, the Federal Reserve progressively lowered its key federal funds rate to 1%. While no one in India foresees such a drastic measure from the RBI, expectations for a rate cut are high.
"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.
Repercussions for Foreign Investment and Capital Flows
While Mumbai has experienced terror attacks before, this marks the first time that five-star hotels frequented by top business executives and international visitors were targeted. Experts suggest the likely fallout will be increased anxiety among foreign investors concerning the safety of both their personnel and their investments in establishments. This concern has the potential to further diminish capital flows into the country which have already been experiencing a decline.
Economic Growth Forecasts and Monetary Policy
Most forecasters predict India's economic growth this year to be below 7%, a significant drop from the 9%-plus growth experienced in the preceding three years. Some analysts project a further decrease next year. Anticipating this slowdown, and bolstered by a decreasing inflation rate, the central bank has already shifted towards a more accommodative monetary policy stance. However, analysts emphasize that the Mumbai attacks may pressure the institution to adopt a more forceful and rapid approach.
"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.
Market Predictions and RBI's Actions
The market is already reflecting these expectations. Overnight interest rate swaps, a derivative commonly employed by traders to speculate on future interest rate movements, are currently trading at a 5-year low, signaling the anticipation of imminent rate cuts.
The RBI, as expected, has remained silent on the prospect of further rate cuts. Nevertheless, recent actions—reducing a key short-term rate and slashing banks' reserve requirements earlier in November, coupled with an extension on various liquidity-boosting measures until next June—clearly indicate a preference for reduced rates.
It was reported on Saturday that during a meeting with the RBI, a group of bankers advocated for a decrease in reverse repo rates as opposed to reducing the cash reserve ratio. This strategy, they propose, would send a clear signal to the market that interest rates are poised to decline.