India cash rate leaps; bonds look for rate cut

By Saikat Chatterjee and Swati Bhat

MUMBAI (Reuters) - India's overnight lending rate leaped above 20 percent on Friday as banks stashed cash ahead of a government bond sale, squeezing rates to their highest since the global crisis broke in earnest over India earlier this month.

Stocks soared 9 percent and bond yields, which move inverse to prices, fell as expectations built that India's central bank would cut policy rates after the Federal Reserve and the People's Bank of China lowered theirs this week to cushion the economic impact of the global financial crisis.

The 10-year bond yield slid 8 basis points to 7.43 percent, its lowest since February, as speculation mounted the central bank might take liquidity-injecting steps or ease its key lending rate after a surprise 100 basis point rate cut on October 20.

In New Delhi, the finance minister said the global slowdown would have an indirect effect on the Indian economy, and banks, already short of cash, were reluctant to lend ahead of the 100 billion rupee ($2 billion) debt auction later in the day.

"Falling inflation and oil prices have raised expectations that policy makers will follow up their recent measures with more liquidity boosting steps such as an additional cash reserve ratio cut," said Satish Jeurkar, head of fixed income at Saraswat Bank.

As well as cutting its lending rate, the Reserve Bank of India has scythed a total 250 basis points off its cash reserve ratio, the proportion of deposits banks must keep in reserve, after overnight rates soared to 23 percent three weeks ago.

The CRR now stands at 6.5 percent after a series of hurried measures by the government and central bank to pump cash into the banking system as the global credit crisis hampered Indian banks' ability to raise cash at home and abroad.

Inflation, which hit an annual rate of 12.91 percent in August, eased to 10.68 percent by mid-October, its lowest in 4- months, and analysts say it could be in single digits before the end of 2008.

This, they say, would give the central bank room to cut its key lending rate again from 8.0 percent to shore up growth.

India's economy grew 9 percent in the 2007/08 fiscal year but last Friday the central bank lowered its forecast for the fiscal year ending in March 2009 to 7.5 to 8.0 percent from around 8 percent.

Finance Minister Palaniappan Chidambaram told reporters the central bank had already factored a global slowdown into its economic assessment, and said it could dent job creation.

"If world output slows down it will have an indirect impact on India," Chidambaram said.

Overnight cash rates jumped to 20.00/21.00 percent from Wednesday's close of 13.00/13.50 percent as outflows resulting from a treasury bill sale this week drained available cash.

Thursday was a holiday and banks were also hoarding funds ahead of the government bond auction, which has been called off twice this month because of difficult market conditions.

Dollar sales by the central bank to shore up the falling rupee have also sucked out liquidity, but the currency, which hit a record low of 50.29 per dollar on Monday, was at its highest in a week, boosted by the surging stock market.

The partially convertible rupee gained to 49.36/37 per dollar, its strongest since October 22 and up 0.7 percent from Wednesday's close.

India's foreign exchange reserves have fallen by $31 billion to $273.8 billion in mid-October, indicating the extent of dollar selling by the central bank.

($1=49.3 rupees)

(Additional reporting by Narayanan Somasundaram in MUMBAI and Rajkumar Ray in NEW DELHI; Writing by Charlotte Cooper; Editing by John Mair)