INDIA STIMULUS PACKAGE AND MORE MONETARY EASING: CONTINUING

UNCLAS SECTION 01 OF 03 NEW DELHI 003177

SIPDIS
SENSITIVE

STATE FOR SCA/INS AND EEB
USDOC FOR ITA/MAC/OSA/LDROKER/ASTERN/KRUDD
DEPT PASS TO USTR MDELANEY/CLILIENFELD/AADLER
DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA MNUGENT
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN

E.O. 12958: N/A
TAGS: EAGR ECON EFIN EINV ETRD IN

SUBJECT: INDIA STIMULUS PACKAGE AND MORE MONETARY EASING: CONTINUING
MODEST STEPS IN THE RIGHT DIRECTION

REFTEL NEW DELHI 2995


1. (SBU) Summary. The government on December 7 announced a fiscal
stimulus package, in step with global calls for boosting consumer
demand, while the central bank announced lower interest rates and
other steps aimed at helping those sectors hardest hit by the
financial crunch. The stimulus package had been anticipated but
disappointed market observers because of its modest size (just "up
to" $4 billion). However, many economists have noted that the
government has little fiscal space for much additional spending, as
the current budget is already expansionary and exceeds fiscal
spending targets. Lower policy rates have prompted signs of banks
reducing their lending rates, but this will take time to cycle
through the economy. Many analysts still expect further monetary
easing, which declining inflation will permit. New economic data
suggests the economy continues to slow, but conflicting data
prevents a clear picture of how much. End summary.

FISCAL STIMULUS PACKAGE
--------------


2. (SBU) In line with G-20 consensus after the November 15 Summit,
India unveiled a stimulus package on December 7 aimed at boosting
consumer demand and confidence. The key aspects of the package are
a pledge to spend up to $4 billion more through the end of the
current fiscal year on March 31, 2009; it lowered the "cenvat" tax -
a tax on manufacturing - by 400 basis points and lowered petrol and
diesel prices by roughly 10% and 5% respectively. The reduced
cenvat will cost an estimated RS 87 billion ($1.8 billion) in
foregone revenues.


3. (SBU) The response was mostly disappointment as the promised
spending is very modest, with no specific spending plans, and some
industry sectors had hoped for specialized help. But, as mentioned
reftel, the government has not had much room to increase spending,
as it has been running an expansionary, pre-election budget since
April. Skyrocketing commodity costs earlier this year also
propelled oil and fertilizer subsidies to unprecedented heights and
pre-empted much of the government's potential spending power.
Indeed, in the supplementary budget demand in November, the
government asked for an addition Rs. 2.3 trillion ($40 billion) -
ten times the current fiscal stimulus package. The grants were
needed to pay for several programs that had not been funded in the
budget, including the oil and fertilizer subsidies, the government
wage increase, farmer debt waiver program, and the rural employment
guarantee program.

RBI LOWERS INTEREST RATES
--------------


4. (U) The same weekend, on December 6, the central bank, the
Reserve Bank of India (RBI),announced a long-anticipated reduction
in its main policy rate, the repo rate, lowering it by 100 basis
points from 7.5% to 6.5%. Responding to banks' recent preference
for parking funds with the RBI under its reverse repo rate, rather
than deploying the capital, the RBI also lowered that rate from 6%
to 5% in order to discourage the holding of needed capital.

5. (U) The central bank announced additional measures targeted at
the hardest hit sectors, particularly "the housing, export and small
and medium industry sector." These include providing a refinance
line of Rs. 70 billion ($1.4 billion) to the Small Industries
Development Bank of India (SIDBI) to enhance credit to small and
medium enterprises (SME). The RBI also lowered the ceiling on the
finance rate for export credit as well as offering a 2% interest
subsidy to exporters. Furthermore, the central bank also announced
that it would give "priority lending" status to loans below Rs. 2
million ($40,000) granted by banks to Housing Finance Companies
(HFCs) for lending to individuals for purchase/construction of
residential units. On December 11, the RBI announced measures "to
preserve financial stability and arrest the moderation in the growth
momentum." The RBI extended additional support to the housing
sector by providing a Rs. 40 billion ($800 million) refinancing to
the National Housing Bank (NHB) against loans and advances to HFCs.
To ease pressures on loan disbursements to Indian exporters and for
honoring disbursements under export lines of credit, the RBI decided
to provide a Rs. 50 billion ($1 billion) refinancing facility to the
Export Import Bank of India.

6. (SBU) Mumbai-based economists and analysts agreed that these

NEW DELHI 00003177 002 OF 003


steps were good, but still not enough to overcome the reluctance of
Indian banks to lend. Dr. Rupa Nitsure, Chief Economist at the Bank
of Baroda, stated that RBI's actions were meant to be
counter-cyclical, but "would not lead to miracles." The RBI, by
reducing interest rates, was now looking at reducing the cost of
funds for banks so they, in turn, could provide access to capital at
reasonable rates to cash-strapped companies. However, she pointed
out that the State Bank of India (SBI),India's largest bank, was
attracting large numbers of savers with a rate of return of 10.50
percent for some new deposits; due to this demand, other banks were
forced to raise their deposit rates to compete for funds. As a
result, banks were unable to bring down lending rates without
compressing already thin margins, unless deposit rates also were
lowered. She recommended that the RBI should ask banks to reduce
lending rates for certain sectors instead of across the board.


7. (SBU) Dr. Siddharth Roy, Chief Economist of Tata and Sons,
pointed out that while the RBI has reduced the Cash Reserve Ratio
and repo rate in a series of moves, more reverse repo rate cuts are
needed. Roy asked why in the current uncertain environment banks
would lend to businesses if they can receive a fairly high five
percent risk-free return from the RBI in the form of reverse repo by
depositing their funds there. He applauded the recent reverse repo
rate cut by one hundred basis points but said more needs to be done.
Roy stated that bank deposit rates are still high, so lending rates
have stayed at high levels.

IMPACT OF MEASURES
--------------


8. (SBU) There are initial signs that the monetary steps are working
to lower the cost of capital in the system, with state-owned banks
announcing a new housing package and two state-owned banks deciding
to lower their deposit rates, which give them - and other banks -
room to lower lending rates as well. Several market analysts expect
both the repo and reverse repo rate to come down further, further
enabling banks to lower interest rates from what is currently among
the highest India has seen in nearly two decades. Lower rates will
make financing affordable to more companies and consumers, which
could prompt banks to revive lending, something they have been
loathe to do, as seen by high deposits with the central bank.
However, while lower interest rates are critical to easing growth
conditions, most estimate that they have at least a 12-month lag.


9. It will be more difficult to measure the impact of the stimulus
package on the spending side, although the cenvat reduction has
already prompted some automakers, including market leaders Maruti
Suzuki and Tata Motors, to announce they would pass on the tax cut
to consumers. Commerce Minister Nath, former Finance Minister
Chidambaram, and Planning Commission Deputy Chairman Montek Singh
Ahluwalia have made statements in recent days supporting further
fiscal measures as warranted.

OUTLOOK
--------------


10. (SBU) The RBI's October and November measures have succeeded in
returning liquidity to India's financial system. Now the challenge
is to get banks to feel comfortable lending again in a tougher
economic climate that includes slower manufacturing activity,
exports, and the possibility of substantial job cuts. Many think
that the repo rate is still too high for many consumers and
businesses and must come down to 5.0 or 5.5%, i.e., at least another
100 or 150 basis points.


11. (SBU) Recent macroeconomic data continues to add to pessimism.
Early assessments of November exports suggest another month of
contraction, while the index of industrial production (IIP) recorded
the first contraction on the index's 15-year history in October.
Excise and customs revenues were down and advance tax payments are
expected to dip as well. However, the IIP has been experiencing
several glitches in data collection and is contrasted by
April-September sales revenues of listed companies, which continue
to paint a robust consumption picture, with sales up 30% compared to
the same period in 2007.


12. (SBU) At the same time, some of the indirect revenue losses are
due to the government's tariff and tax reductions in the spring and

NEW DELHI 00003177 003 OF 003


summer when it was combating rising inflation. And advance tax
payments could be suffering from the reluctance of companies to part
with otherwise working capital until the end of the fiscal year. At
a 1-percent per month penalty for not paying advance taxes,
companies may find the penalty cheaper than the cost of borrowing
from banks. Finally, inflation continues to ease, which will be
further enabled by the cenvat reduction and lowered petrol and
diesel prices (which alone will lower inflation by about 60 basis
points). Still declining inflation continues to add policy space
for the RBI to further reduce rates.

COMMENT
--------------


13. (SBU) The government and the central bank continue to respond
relatively aggressively to signs of stress in the economy and are
using rather measured and calibrated responses. However, the tepid
response in the stock market to the stimulus package and interest
rate reduction suggests that the market has already priced in such
moves and that expectations remain for further steps to be
undertaken. The government's finances, already out of whack because
of the record-breaking fertilizer and oil subsidy costs through the
first half of the year, will likely fall further out of kilter, with
estimates of the center's fiscal deficit to GDP climbing to 6-8% of
GDP, from last year's 2.9%. One contact acerbically noted that
worrying about fiscal deficits at a time of such global economic
challenges is like worrying about cholesterol when a patient has
cancer. Many may agree, but the government's more recent fiscal
rectitude has been the primary reason behind India's sovereign
rating improvements to investment grade in the last two years. High
fiscal deficits could trigger downgrades which increase the cost of
capital to India's private as well as public sector.

MULFORD