MUMBAI (Reuters) - The deadly attacks in India's financial heartland struck when the economy was already vulnerable from the global credit crisis, so could hurry the central bank into cutting interest rates again to bolster investor confidence.
Analysts said the assault by Islamist militants will further undermine sentiment and worry the central bank, which has seen the main Bombay Stock Exchange index drop more than 50 percent this year and the rupee shed a fifth of its value as the global financial storm hit India.
Some economists said the central bank could be tempted to cut rates by a full percentage point as soon as Friday. That would bring the benchmark repo rate down to 6.5 percent, the lowest since June 2006.
"I think this will accelerate the process of monetary easing. Large terrorist attacks of this kind lead to a huge problem in the money market," said Abheek Barua, chief economist at HDFC Bank in New Delhi.
"The fact that this was explicitly focused on foreign nationals including those on business, sends a different kind of message altogether. This kind of thing can do damage to sentiment both in terms of foreign institutional investment and foreign direct investment and add to the slowdown in the economy," Barua said.
Some 17 hours after the late evening assault on Wednesday, soldiers were exchanging intermittent gun fire with the militants, who attacked some of Mumbai's plushest hotels frequented by bankers, businessmen and investors.
More than 100 people were killed and a similar number were still trapped inside the Taj Mahal hotel, a city landmark.
"The names ring a bell. These are the hotels they have been staying in. These are the landmarks they know. These are the bars they would hang out in," said Jan Lambregts, head of Asia research with Rabobank Global Financial Markets in Hong Kong.
The repo rate, which the central bank uses to infuse cash into the banking system, currently stands at 7.5 percent. Inaction by the central bank, could prove damaging for financial markets.
"If they don't cut, capital flight will likely pick up momentum. If these attacks did not occur, the need to cut would not have been strong enough," said Suresh Ramanathan, regional FX and rates strategist with CIMB investment bank in Kuala Lumpur.
INFLATION SUPPORT RATE CUT
A fall in inflation to six-month lows also favors a rate cut, the analysts said.
India's closely watched wholesale inflation has come off a peak of 12.9 percent in August, which was the highest rate since annual numbers in the current series became available in April 1995.
It surged into double digits in June after India raised state-set fuel prices and as the economy absorbed the impact of rising prices for raw materials.
The latest weekly reading on Thursday though saw the wholesale price index up 8.84 percent in the year to November 15, easing from the prior week's 8.9 percent rate and the lowest level since May.
Food prices have not come off so much globally but raw foodstuffs that go into the final products have come off a lot. That will give them the room to act in this economic weakness," Rabobank's Lambregts said.
Investors have already moved to price in added risk on India following the attacks. Although domestic financial markets were closed on Thursday, offshore trading in credit default swaps, insurance-like contracts, on state-owned State Bank of India widened 20 basis points to 440 basis points. The bank's CDS are seen as a proxy for India because the government doesn't have any sovereign bonds outstanding.
The implied 1-month deposit rate in the rupee is already up by 130 basis points at 9.339 percent, CIMB's Ramanathan said, showing the market was pricing in the risk premium of holding rupee in the short term.
Investors have been clamoring for the Reserve Bank of India to cut rates again.
Since the start of October, it has cut the repo rate by 150 basis points to 7.5 percent to try to shield the economy from the global financial crisis that has already tipped advanced economies such as Japan and the euro zone into recession.
The government bond market was disappointed the central bank did not act last weekend after speculation sparked by a meeting between the finance minister and the central bank governor.
Those expectations pushed the yield on 10-year bonds to its lowest in nearly three years last Friday at 7.10 percent. By Monday it bounced back to 7.20 percent.
However, the yield fell again after China's big 108 basis point rate cut on Wednesday raised expectations once again for an Indian rate cut. The yield was at 7.09 percent on Wednesday before the militant attacks.
The rupee hit an all-time low against the U.S. dollar this month and the Bombay stock index fell to a 3-year low last month.
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