December 18, 2008 / 3:40 PM / 10 years ago

UPDATE 1-Next year to be more challenging - India cbank

(Adds details, background, byline)

By Anurag Joshi

MUMBAI, Dec 18 (Reuters) - Next year will be a more challenging year than this has been but India’s central bank will continue to do everything possible to lessen the domestic effects of the global financial crisis, its chief said.

In speech released on Thursday but given on Dec. 10, Reserve Bank of India (RBI) Governor Duvvuri Subbarao said the outlook for India and the world remained uncertain and the path of the global crisis and its resolution remained unclear.

While the central bank had a roadmap, it was not possible to deploy it all in one go.

“It would be our endeavour to adapt this roadmap to the evolving global developments and implement it flexibly and pragmatically,” he said.

“Our approach, as indeed of every prudent central banker around the world, has been to ‘cross the river by feeling the stones’.”

Subbarao said India’s economic fundamentals remained strong, but developments in the real economy, financial markets and global commodity prices pointed to a period of moderating growth and declining inflation.

“The year 2009-10 will be more challenging than the current one,” he said.

“The RBI will continue to be on vigil and do everything possible within its mandate to mitigate the impact of the crisis on the Indian economy.”

Since mid-October, the central bank has lowered its key lending rate by 250 basis points to 6.5 percent to shield the economy from the spillover of the global credit crisis.

It has also aggressively slashed banks’ reserve requirements to shore up growth, which many expect to slow to 7 percent in the fiscal year which ends in March from 9 percent in 2007/08.

The government bond market is widely expecting interest rates to fall again soon, with the benchmark 10-year bond yield dropping 30 basis points on Thursday to 5.50 percent.

Subbarao noted inflation had been declining for the four weeks before he spoke, pointing to a faster-than-expected reduction in the pace of rising prices, while a recent cut in state-set fuel prices should further ease inflation pressures.

Data on Thursday showed India’s wholesale price index, its most widely watched inflation measure, rose 6.84 percent in the 12 months to Dec. 6, sharply below the previous week’s 8 percent and lower than a Reuters estimate of 7.49 percent.

Subbarao said there had been a noticeable decline in credit demand in November but it was not clear whether this was a one-off or a trend.

If this were indicative of slowing economic activity, it would be a challenge to banks to ensure credit flow to productive parts of the economy.

But he said banks also seemed to be inhibited from lending by high interest costs on deposits and by concerns about credit quality, but if credit demand was slackening, they should be able to lower their deposit rates.

While advanced economies had seen contagion spread from the financial to the real sector, in India the slowdown in the real sector was affecting the financial sector, which then had a second-order impact on the real sector.

Subbarao said there had been demands for some regulatory relaxation, for instance on non-performing loans by lengthening the cut-off point after which they are classified as bad loans.

But he cautioned against any relaxation, saying delaying recognition of bad loans just made the problem worse and if the global downturn was prolonged, banks should just get on and deal with problem loans fast.

Editing by Charlotte Cooper and Mark Williams

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