Thursday, November 1, 2007

US rate cut adds to India's worries

Indian stocks hit a new intraday high and the rupee rose to its highest in nearly a decade on Thursday as investors bet that the US Federal Reserve's interest rate cut overnight will lure more investment money into emerging markets like India.

But policy makers worry that more foreign funds flooding into the country could spur inflation and create asset bubbles.

India's benchmark stock index has surged 43 per cent so far this year as foreign investors plowed more than $17 billion (euro12 billion) into the market, with nearly half of that money coming in after the Fed first cut its benchmark rate on September 18.

Lower US interest rates have eased concerns about a credit crisis in the US, helping international investors to feel more confident about seeking higher returns in riskier assets overseas.

On Thursday, the Bombay Stock Exchange's 30-share Sensex rose to as high as 20,157 points, a new intraday high, in reaction to the quarter-point rate cut by the Fed. In late trading, the index fell back as investors booked profits to close down 0.6 percent to 19,724 points.

The rupee rose to 39.23 per US dollar, its highest since February 1998, although it slipped back later as the central bank stepped in to buy dollars.

But earlier this week, ahead of the Fed's move, Reserve Bank of India Governor Y Venugopal Reddy said in a television interview that he was worried that too much money was coming into the country's real estate and capital markets, and could undermine the economy in the long-term.

Inflation has declined to about 3 per cent after hitting a two-year high of 6.7 per cent in February, helped by the RBI's tight money policy and the government's decision to keep retail fuel prices unchanged despite a sharp rise in crude prices on the international market.

And the government is already feeling pressure from ballooning fuel subsidies meant to protect consumers, particularly the poor, from surging oil prices.

"The government would not be able to keep fuel prices unchanged for very long," said D K Joshi, economist at credit rating agency Crisil Ltd.

Analysts say there are limits to how much the central bank can do to keep prices under check.

On Tuesday, the Reserve Bank of India increased the cash reserve ratio, the share of deposits that lenders must hold in cash, by half a percentage point for the fourth time this year. It also decided to keep interest rates unchanged, a move that disappointed many people who had expected a cut in line with what the US Fed and central banks elsewhere have done.

Still, ``there is a lot of liquidity in the system and the capital flows make it difficult to strike a balance between growth and inflation,'' Joshi said.

RBI Governor Reddy said it has become necessary for authorities to take to ``active management of the capital account,'' an euphemism for more curbs on capital flowing into the country.

Last month, authorities moved to curb the use of participatory notes, a financial instrument that allows foreign funds to invest in Indian stocks without getting registered with the market regulator.

Media reports said Thursday that the government was planning tax measures to discourage overseas borrowing by Indian companies, another major source of foreign money.

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