Dalal Street feels the pressure of sluggish growth

Mumbai The mood on Dalal Street, home to Asia's oldest stock exchange, is sullen. Sluggish economic growth, widening trade deficit and a hazy outlook for corporate earnings have all contributed to the subdued sentiment.

All eyes are now on the Reserve Bank of India (RBI), which will be under pressure to cut interest rates to revive growth, when it announces monetary policy on Tuesday for the new financial year.

While industrial output at 4.1 per cent in February was well off 7 per cent expected by many economists, the government slashed the January expansion to 1.14 per cent from 6.8 per cent announced earlier, citing an error in sugar production data.

"These figures will have a bearing on monetary policy scheduled for (this) week," Finance Minister Pranab Mukherjee said after the factory data was released on Thursday. "The government along with RBI will take steps to revive investment activity in the economy."

If the central bank take the cue and cut the repo rate, India's benchmark interest rate, it would be first reduction in three years.

"The RBI holds all the chips," said equity strategist V. Venugopal. "A 25 basis point cut will not set the market on fire. It will have to do more — another reduction in the CRR."

Proportion of deposits

The cash reserve ratio (CRR) is the proportion of deposits that commercial banks must keep with the RBI. The central bank has slashed the requirement by 125 basis points since January, making available Rs800 billion for loans.

A two-pronged move of lowering the repo rate to 8.25 per cent from 8.50 per cent and cutting the CRR by another 25-50 basis points would help bring down borrowing costs and revive investments, Venugopal said.

However, there are a few hitches. The RBI, like many central banks, abhors price pressures. It had raised the repo rate 13 times between early 2010 and last October, mainly to cool near double-digit inflation.

Inflation for March is due tomorrow and it is unlikely to be far off February's 6.95 per cent.

While the monetary tightening helped in part to bring down inflation to below seven per cent, the hawkish moves played a bigger role to dent consumer spending, slow down factory output and curtail economy activity.

The risks for inflation to accelerate remain. Higher global commodity prices, especially of crude oil that India imports for 80 per cent of its consumption, are beyond the grasp of the RBI. Swings in food production in the world's second most populous nation are another trouble spot for inflation.

Cash shortfall

Morgan Stanley expects the RBI to cut the CRR to help ease the shortfall in cash with banks, but keep rates on hold on Tuesday because of a wide current account deficit, a loan to deposit ratio at an all-time high of 78.1 per cent and persistently high inflation.

"We see aggregate demand pressures from the less productive government spending keeping upside risks to inflation alive," Morgan Stanley economist Chetan Ahya wrote in a report.

Making the grim scenario worse, the government in New Delhi has been rudderless for more than two years. The annual budget in March not only failed to pursue bold reforms, it has sought to impose retrospective taxes and introduce a controversial General Anti-Avoidance Rules, or GAAR.

The tax changes have the potential to stall foreign institutional investors who have been the main drivers for the stock market. Foreign funds currently have a little over $110 billion in Indian shares.

"Suddenly, all business in India has become unpredictable," wrote Jaithirth Rao, a former country head of Citibank in India. "We would like a government that nurtures its citizens; if that is not possible at a minimum it should not harass us."

The top-30 Sensex, which closed at a two-week low of 17,094.51 points after technology bellwether Infosys forecast a lower-than-expected revenue for 2012-13, faces a turbulent period.

The writer is a journalist based in India