Introduction of base rate will result in sharp reduction.
Bankers are still busy with their calculators trying to work out the proposed base rate that the Reserve Bank of India (RBI) plans to introduce from April but they estimate the benchmark rate will decline to around 9 per cent from 11-15.75 per cent at present.

State Bank of India, the country’s largest lender, has estimated its base rate at around 9 per cent against the prevailing benchmark prime lending rate (BPLR) of 11.75 per cent. Ditto for Union Bank of India.

Similarly, a Bank of India executive said the base rate will be around 300 basis points lower than the prevailing BPLR of 12 per cent.

Corporation Bank sees it a tad higher, while Allahabad Bank and Punjab & Sind Bank expect the rate to be between 9 and 10 per cent.

Last evening, RBI issued draft guidelines that proposed to shift from a system of benchmark prime lending rate to a system of base rate from April.

RBI has proposed that banks calculate the base rate on the basis of the cost of funds, overhead costs, adjust for the “negative carry” for funds impounded for the cash reserve ratio (CRR) and the statutory liquidity ratio (SLR) and add a profit margin.

The main ingredient will be the cost of deposits, with banks that have lower costs, such as SBI, having an edge over the others. “Given that the base rate will be a function of the cost of deposits and operating efficiencies, banks with higher Casa (current and savings account balances) and lower cost-assets (ratio) will benefit as their base rate would be lower than industry average, thereby allowing them to earn higher spreads on their products,” ICICI Securities said in a note.

At the same time bankers warned that the rates they have calculated are based on the present cost of deposits. “It base rate may vary every quarter because of cost of funds, CRR and SLR. It will become very dynamic and can change on quarterly or even on a monthly basis,” said Corporation Bank Chairman and Managing Director JM Garg.

The adjustment for negative carry on CRR and SLR will result in a gain of around one percentage point for banks.

While Union Bank of India Chairman and Managing Director M V Nair, who is also the chairman of the Indian Banks” Association said that the move will bring about more transparency in pricing, bankers said, it will put an end to the bargaining power of large companies. That is because RBI wants to put an end to sub-base rate lending for all segments other than export finance and directed rate of interest (DRI) scheme for low income groups.

Bankers said only large public sector companies and AAA-rated private players would be able to avail of loans at base rate. Similarly, only short-term loans such as working capital will be available at the base rate.

Short-term rates for large players may go up, but the good news is that bankers expect the lending rates for small and medium enterprises to fall.

“Even that will be a function of demand and supply, if the credit demand is high and liquidity is tight, then the best borrower will also have to pay a premium,” said Corporation Bank’s Garg.

Canada’s dollar dropped by the most in almost three months as oil fell and a report showed consumer prices rose less last month than forecast, reducing the chance the central bank will raise rates before the second half.

The currency declined for a second day, touching the lowest level in more than two weeks, as stocks fell and the U.S. dollar rose against all of its major counterparts. Canadian government bonds climbed.

“The numbers are suggesting people are getting nervous,” said David Watt, senior currency strategist in Toronto at Royal Bank of Canada, the nation’s biggest lender. “The Bank of Canada is heading to a tightening campaign in the third quarter now the debate is will they go in July or September.”

The Canadian currency, nicknamed the loonie, depreciated 1.6 percent to C$1.0479 per U.S. dollar at 12:10 p.m. in Toronto, from C$1.0314 yesterday. It dropped as much as 1.7 percent, the most on an intraday basis since Oct. 30, to touch C$1.0489, the weakest level since Jan. 4. One Canadian dollar buys 95.43 U.S. cents.

The consumer price index rose 1.3 percent in December from a year earlier after gaining 1 percent in the previous month, Statistics Canada said today in Ottawa. The median forecast of 26 economists in a Bloomberg News survey was for a 1.6 percent gain. Core inflation, which excludes energy and food, was unchanged at an annualized 1.5 percent, less than forecast. The Bank of Canada’s inflation target is 2 percent.

U.S. Dollar Strength
The greenback gained against all 16 of its most-traded counterparts tracked by Bloomberg. The Canadian currency fell against 12.

“The soft CPI numbers were somewhat of a catalyst for the price action, but the U.S. dollar has been strong across the board, which means weakness for Canada, the other commodity currencies and the euro,” said Jack Spitz, managing director of foreign exchange at National Bank of Canada in Toronto.

Crude oil for February delivery dropped 2.4 percent to $77.12 a barrel on the New York Mercantile Exchange. Raw materials generate half of Canada’s export revenue, and crude is the nation’s biggest export. Stocks fell, with the Standard & Poor’s 500 Index plunging 1.6 percent.

The yield on Canada’s two-year note tumbled as much as eight basis points, or 0.08 percentage point, to touch 1.19 percent, the lowest level since Dec. 8, before trading at 1.2 percent. The price of the 1.25 percent security maturing in December 2011 rose 11 cents to C$100.10. The benchmark 10-year note’s yield fell as much as seven basis points to 3.41 percent, the lowest since Dec. 18.

Validates Rate Decision
The lack of change in the core consumer-price data today “validates the central bank’s decision to keep interest rates at rock-bottom levels,” Erin Weir, an economist for the United Steelworkers union in Toronto, wrote in a note. “The prospect of having to raise rates to quell inflation is far away.”

Canada’s central bank held the benchmark overnight lending rate at a record low 0.25 percent yesterday. Policy makers reiterated they will keep the rate there through June, barring a change in the inflation outlook, and repeated that the Canadian currency’s “persistent strength” hampers economic recovery.

The benchmark lending rate was 4.5 percent when the bank began cutting it in December 2007.

Currency traders are betting which countries will raise interest rates as the global economy shows signs of emerging from the worst recession in more than half a century. Investors tend to favor the currencies of nations whose borrowing costs are rising because yields are higher.

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Summary (Euro Outlook: Neutral)
- Events: Tues-German, Euro-zone, ZEW Sentiment, Wed-German PPI m/m, y/y, Thurs-ECB Monthly Bulletin, Flash Manufacturing and Services PMIs for the Euro-zone, France, Germany
- The ECB’s tough choice: remain on target for stimulus exit and rate increases later this year and boost the euro, but a strong euro would do to the weaker economies exports
- EZ ongoing Greek tragedy could spread well beyond its national borders, Spain & others could be worse still, plenty of other fiscal problem children, so ECB must make an example of Greece
- German Economic Minister Bruederle talks down euro sentiment, saying that Germany was not experiencing a self-sustaining economic recovery
- Economic data further undermined euro this past week
- EURUSD maintains its ascending channel for now despite the above travails

Analysis
While the EURUSD can be a misleading gauge of strength for the euro (as it has recently been more responsive to the US dollar), the benchmark pair currently presents an accurate portrayal of the single currency, its main uptrend long broken by dollar strength, now struggling to hold onto another such rising channel.

Key Euro Drivers
Taking a quick glance across the majors, it becomes apparent that nearly every one of the euro crosses is sitting at the bottom of a broad range. It is make or break time for the unloved currency; and the catalyst for its ultimate bearing will likely fall to one of four pressing issues:
1. The financial stability of the European Community (particularly of the PIGS: Portugal, Greece, Ireland/Italy, Spain), referred to often in these pages as sovereign debt threat
2. US dollar performance either improved fundamentals or
3. US dollar performance as a safe haven should risk appetite retreat
4. A meaningful change in interest rate forecasts

The US Dollar
The primary driver of the euro is the interplay of risk appetite and the dollar, points 2 and 3. Because the EUR/USD pair by itself is about 30% of all forex trade, these two currencies tend to push each other in opposite directions. Should risk appetite rally or plummet, expect EURUSD to follow suit. See our US Dollar Weekly Outlook for the key events and forces to watch for measuring the dollar’s outlook, and thus so too the euro’s.

Sovereign Debt Threat
The next major concern is the threat of further sovereign debt downgrade or outright default. This has loomed large over the euro since Dubai World’s problems drew attention to sovereign credit risk and got the various rating agencies attention and alerted them not to be caught unawares again.?? The failing financial health of Greece, which clearly has lacked the political will for real financial reform, has undermined confidence in the euro and in prospects for the growth, stimulus reduction, and rate increases needed to support the euro.

The downside of developing a single market among different nations has been laid bare through the recent economic difficulties. In sum, fundamentally different economies have different needs and priorities While German and France have been quick to recover and can benefit from a stronger euro as the group’s most prosperous members, others have struggled to recover, particularly as a strengthening euro hits their more easily replaceable, less competitive exports, harder.

Most crucially, each member government gives up lot of flexibility to combat financial downturns, like its right to individually adjust monetary policy, manipulate its currency, increase its debt load and more, that have given the US, UK, and others crucial tools to adapt to unfavorable conditions. It is unclear how many of the weaker members will meet the goals policy makers have set out and EU officials have warned no exceptions will be made. Currently the balance of power in setting policy is clearly with the wealthier Northern countries.

The current picture offers no clear solution. The Greek PM reiterated that Greece was not seeking any IMF bailout or planning to exit the Euro Zone, but then again he provided practically no details on how the country would finance its budget or drastically cut its debt-to-GDP ratio in order to meet the EU’s Maastrict criteria. The ECB published its opinion on Greek debt restructuring law, stating that the move could hinder the flow of credit and hurt markets. On Friday, the ECB’s Trichet talked tough, declaring that the country has a “major debt problem” and that no government should expect special treatment,” specifically mentioning both the Greek and Irish situations. His words pushed the 10-year Greek/Bund spread beyond the 280bps level. Spreads among other peripheral European debt have widened noticeably as well: the Ireland/Bund 10-year spread was at +162bps, while the Portugal spread was at over +95 bps, at its widest level since last April. In short, it’s getting more expensive for these countries to borrow, creating a vicious downward spiral.

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China’s economy may grow as much as 16 percent this year with accelerating inflation and the risk of a property bubble unless policy makers reduce stimulus measures, government researchers said today. “If the government continues with the same strength of macro-economic stimulus as in 2009, there will be notable economic overheating in 2010,” Yao Zhizhong and He Fan , economists with the Chinese Academy of Social Sciences, said in an article published in the official China Securities Journal. Local media reported today that new lending surged last week.

A stronger-than-estimated trade rebound in December may give policy makers more room to pare stimulus measures after record lending in 2009. The central bank last week guided three- month bill yields higher for the first time since August and may lift the benchmark one-year lending rate to 5.85 percent by year-end from 5.31 percent, economists forecast.

China’s exports grew 17.7 percent last month from a year earlier, the first increase in more than a year, and imports rose to a record, customs data showed yesterday. Gains were boosted by a low base for comparison in 2008. “The export rebound will add significant momentum to China’s growth, contributing about 7.5 percentage points to growth in gross domestic product ,” Yao and He said. China’s banks lent 600 billion yuan ($87.9 billion) in the first working week of January because of pent-up demand from the end of 2009, Economic Information Daily, a newspaper affiliated to the state-run Xinhua News Agency, reported on its Web site today without citing a source.

Daily Lending Banks loaned about 100 billion yuan a day last week, the official China Securities Journal reported separately today. The publication said Ba Shusong , deputy head of the finance institute under the State Council Development and Research Center, gave the number at a conference. Ba didn’t specify the source of his information. That would compare with 294.8 billion yuan for all of November. December data may be released this week. Chinese lending is usually biggest at the start of each year.

The economy will expand 11.6 percent this year with “moderate” stimulus, Yao and He said. A complete withdrawal of measures to aid growth would see a dip to 7.7 percent, they said. The world’s third-biggest economy expanded 8.5 percent last year, according to the median forecast in a Bloomberg News survey of economists.

Service industries in the U.S. barely expanded in December, underscoring Federal Reserve forecasts that the economic recovery will be slow to develop. The Institute for Supply Management’s index of non- manufacturing businesses that make up almost 90 percent of the economy rose to 50.1 from 48.7 in November, according to the Tempe, Arizona-based group.

Fifty is the dividing line between expansion and contraction. Other reports today showed job cuts are diminishing. Services from retailing to transportation are lagging behind the rebound in manufacturing as consumer demand is restrained by tight credit and 23 months of job losses.

Economists surveyed last month projected the pace of growth will keep unemployment above 10 percent through the first half of this year, making it more likely central bankers will keep interest rates low for an “extended period.” “We’re on a slow recovery path,” said Michael Englund , chief economist at Action Economics LLC in Boulder, Colorado, who forecast a reading of 50. “The economy will grow enough to slowly reduce unemployment, but not nearly enough to get the public to perceive it as low.”

The December figure compared with economists median forecast for an increase to 50.5, according to 67 projections in a Bloomberg News survey. Forecasts ranged from 48 to 52.1. The Standard & Poor’s 500 Index added 0.1 percent to a 15- month high of 1,137.14 at 4:05 p.m. in New York. The Dow Jones Industrial Average increased 1.66 points, or less than 0.1 percent, to 10,573.68.

Manufacturing Stronger The services index is up almost 13 points from a record low of 37.4 reached in November 2008, a period of mounting job losses, falling home and stock prices, and a lack of credit for businesses. The ISM began keeping records in 1997. By comparison, the group’s manufacturing index has increased 23 points since reaching a 28-year low in December 2008. The manufacturing gauge rose in December to the highest level since April 2006 as factories ramped up production to rebuild inventories and meet increasing global demand.

The ISM’s employment index for services rose to 44 last month from 41.6 in November. Separate reports showed that while the labor market is improving, companies are still trimming their workforces. Figures from ADP Employer Services showed companies cut an estimated 84,000 jobs in December, the fewest since March 2008. The decline last month was larger than the 75,000 decrease forecast by economists in a Bloomberg survey. Planned payroll reductions dropped 73 percent in December from a year earlier, according to another report from the job placement firm Challenger, Gray & Christmas Inc. Payrolls Forecast The Labor Department may report on Jan. 8 that employment was unchanged in December after almost two years of job cuts, according to a Bloomberg survey.

The jobless rate probably stayed at 10 percent. The non-manufacturing gauge of business activity, a measure of sentiment, rose to 53.7 in December from 49.6 a month earlier. The ISM’s index of new orders dropped to 52.1 last month from 55.1 and a gauge of backlogs eased. Categories in the ISM services survey include utilities and resources, health care, housing, and finance and insurance.

Retailers are offering discounts on merchandise such as Nike Inc. footwear to encourage sales. Nike, the world’s largest athletic-shoe maker, said Dec. 17 that it’s “cautious” about its outlook. “While we’re seeing hopeful signs of recovery in consumer sentiment around the world, macroeconomic indicators remain mixed,” Chief Financial Officer Donald Blair said on a conference call. Same-Store Sales Retailers may report same-store sales rose 1.8 percent in December, after 2008 marked the worst decline in more than 40 years, according to analysts estimates compiled by Retail Metrics Inc. Retailers report monthly sales tomorrow.

The economy grew at a 2.2 percent annual pace in the third quarter following four quarters of contraction that marked the deepest recession since the 1930s. Economists at JPMorgan Chase & Co., Goldman Sachs Group Inc. and Morgan Stanley in New York are among those projecting the economy expanded by at least a 4 percent annual rate in the final three months of 2009. The pace will probably cool early this year. “Lingering credit constraints are a key reason why I expect the strengthening in economic activity to be gradual and the drop in the unemployment rate to be slow,” Fed Vice Chairman Donald Kohn said Jan. 3 in a speech to the American Economic Association in Atlanta. Fed Chairman Ben S. Bernanke and his fellow policy makers have left the benchmark lending rate in a range of zero to 0.25 percent to support an economy that is recovering from the worst recession since the Great Depression. Central bankers said Dec. 16 that high unemployment and “subdued” inflation warrant low interest rates “for an extended period.”

last night, the central bank announced that from June 5 yuan from financial institutions to raise the deposit reserve ratio by 0.5 percentage points. From May 19 yuan from financial institutions raised benchmark deposit and lending interest rates. Analysis of Shanghai researcher points out that this is the last 10 years the first time also announced that raising the deposit reserve rate and the benchmark deposit and lending interest rates. Shows that the management tried to reduce market risk, and resolve the determination of a speculative bubble. This is for real estate loans has little effect on the insurance industry and good.

The first time the five-year deposit interest rate increases 0.54
banks face earnings pressure
It is worth noting that this at the central bank announced that financial institutions in the five-year benchmark deposit interest rates 0.54 percentage points, and contrast, the five-year benchmark lending rate 0.09 percentage point hike alone. Personal housing accumulation fund the five-year loan rate was only 0.09 percentage points adjusted upwards accordingly.

In this regard, the Central Plains Analysis Securities researcher said, “This is the profitability of the mainland banking sector will constitute the new pressures. Prior to China’s deposit and lending rates increase in the basic, as adjusted and the bank to pay interest on deposits has improved significantly, while the lending interest rate to accelerate the decline in access. This has always been dependent on income spreads most commercial banks, will have a negative impact. “It is understood that this adjustment, the long-term deposit, loan spreads at 2.25, while the original rate of 2.7, reduced 0.45 points to reach 17% decline.

At the same time, Lyon, a researcher at that “interest rate increase the profitability of insurance companies for the mainland to form good, because the current structure of insurance assets ratio of more than 20% for bank deposits. Research data indicate that rising interest rates 0.27 basis points each, life insurance companies and other large stock price is expected to be up 5 percent support. ”

Short-term lending rates higher than long-term
curb excessive speculation
At the same time, the adjustment of short-term Loan interest rates range, significantly higher than long-term. Galaxy Securities analyst Gao Xiaofeng analysis, “the original short-term lending rates relatively low, since the first quarter of this year, subject to hot pursuit, this part of the funds into the stock market. The encounter marked increase, which would lead banks to tighten short-term loans due in order to market liquidity will gradually shrink, but it also requires a process will have obvious market reaction. ”

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Mauritius’ embattled central bank chief has said he will step aside temporarily to help an inquiry into accusations that he abused expenses, if the Indian Ocean island’s prime minister asked him to do so. An increasingly acrimonious feud among the board at the Bank of Mauritius this week saw Governor Rundheersing Bheenick reject calls from a majority of board members for his resignation.

Bheenick said in an interview with Reuters late on Friday he was ready to assist the inquiry called for by the Treasury. “I am willing to step aside while the fact-finding committee is doing its job if the prime minister, who appointed me as governor of the Bank of Mauritius, gives his approval,” he said. Analysts warn that the central bank’s independence has been thrown into question by the deepening rift at a time when the Indian Ocean island’s almost $10 billion economy remains vulnerable to the fragile global outlook.

Bheenick said the six board members who publicly demanded he step down should also “take some distance from the bank” during an eventual inquiry. Relations between Bheenick and Finance Minister Ramakrishna Sithanen, who nominates board members, have been strained since the governor’s appointment by the prime minister in early 2007. The poor rapport came to a head last year when the central bank and Treasury were at odds over how to tackle a slowing economy and near double-digit inflation.

NO IMMEDIATE RATE RISE A Reuters poll this week showed the annual average rate of inflation falling to 2.7 percent by end-December from a peak of 9.9 percent in October 2009. It was forecast to rise to 5.1 percent by the end of 2010. Bheenick said he saw no need to increase the bank’s benchmark lending rate from 5.75 percent until there were clear signs of the economic recovery fuelling inflation. “For the moment the problem is not inflation, it is deflation. I don’t think the repo rate is going to increase immediately,” he told Reuters.

Consumer prices in the import-dependent economy are expected to trend upwards mid-2010, Bheenick said, as economies worldwide rebound and commodity prices pick up. Official forecasts put economic growth at 4.3 percent next year. Respondents to the Reuters poll were less optimistic, with a median forecast of 3.6 percent.

Mauritius, which analysts say imports some 80 percent of its food, should move to shield itself from future spikes in food and oil prices, Bheenick said. “As an import-dependent nation, Mauritius must think about developing offshore farming in neighbouring countries like Madagascar and Mozambique,” he said. The palm-fringed island, which is widely covered by sugar cane, plans to buy 20,000 hectares of prime farmland in Mozambique to ease food security worries.