Fiscal stimulus, rate cuts to spur Indian economy

New Delhi/Mumbai, Jan 2 : The Indian government and the central bank moved in tandem Friday with a slew of measures to cushion the impact of the global slowdown on the Indian economy, lowering the cost of funds for commercial banks and infusing further liquidity into the financial system.

The first set of measures came from the Reserve Bank of India (RBI), which cut both the repurchase and reverse-repurchase rate by 100 basis points each and reduced the cash reserve ratio (CRR) by 50 basis points.

"The reduction in the cash reserve ratio will inject additional liquidity of around Rs.20,000 crore (Rs.200 billion/USD 4 billion)," the central bank said in a statement, while announcing the monetary stimulus to prop the economy.

Soon thereafter, the government unveiled its much-awaited second fiscal stimulus package, the last for this fiscal, with sector-specific steps, including the doubling of the cap on foreign funds to invest in bond markets to spur growth.

"We should expect, from all the global projections, that the next year is going to be a very difficult year for the global economy," Planning Commission Deputy Chairman Montek Singh Ahluwalia told reporters here.

"We have to keep in mind the need for contra-cyclical fiscal policy and monetary policy will continue into the next financial year also," Ahluwalia said as he unveiled the fiscal package, approved by Prime Minister Manmohan Singh.

The package followed the first one announced Dec 7, when the government said it will spend additional USD 4 billion in the remaining months of the fiscal to spur growth and cut value added tax across by four percent.

Friday's measures include further access of Rs.30,000 crore (Rs.300 billion) worth of tax-free bonds to India Infrastructure Finance Co and accelerated depreciation of 50 percent for new cars bought till March 31.

Exporters, too, will benefit with an extension of the duty-entitlement passbook (DEPB) scheme and enhanced duty drawback benefits on items like knitted fabrics, bicycles, farm hand tools and some categories of yarn.

The government also decided to set up a holding company, called a special purpose vehicle, to provide liquidity support to non-banning finance companies that are credit-worthy and meet some conditions.

The scale of liquidity potentially available through this window is Rs.25,000 crore (Rs.250 billion), said Ahluwalia, adding the credit targets of public sector banks were being revised upward to reflect the needs of the economy.

The plan panel chief said in order to boost the corporate bond market, the foreign institutional investment limit in rupee-denominated securities would be increased from USD 6 billion to USD 15 billion.

This apart, the realty industry can benefit from the permission to use external commercial borrowings if intended for the development of integrated townships, while enhancing the level of credit for micro units.

Apart from the higher depreciation benefit, the automobile industry can benefit from an arrangement that is being worked out with leading public sector banks to provide a line of credit to lending institutions to finance commercial vehicles.

In its set of measures, the RBI reduced the repo rate to 5.5 percent to make the cost of borrowings cheaper for commercial banks. The repo rate is the interest charged on borrowings by the commercial banks.

The reverse repo rate, on the other hand, is the rate at which the central bank takes back money from commercial banks. A lowering of this rate, presently at five percent, makes it less lucrative for banks to park funds with the central bank.

"The fundamentals of our economy continue to be strong. Once the crisis is behind us, and calm and confidence are restored in the global markets, economic activity in India would recover sharply," said the central bank.

"But a period of painful adjustment is inevitable."