CRISIL MonetaryPolicyReview

RBI hints at rate cut in early 2013

Overview:
The Reserve Bank of India (RBI), in its monetary policy review on October 30th, reduced the cash reserve ratio (CRR) by 25 basis points (bps) to 4.25 per cent while keeping the repo rate unchanged at 8 per cent. Despite revising its 2012-13 gross domestic product (GDP) growth forecast sharply downwards to 5.8 per cent from 6.5 per cent projected in July 2012, the central bank refrained from reducing the repo rate. This is because upside risks to inflation remain due to high rural wage growth, inadequate supply response in food articles and temporary pressures from administered fuel price revisions. Persistently high non-food manufacturing (core) inflation, largely on account of cost-push pressures from rupee depreciation, was cited as a major concern. Despite a 50 bps reduction in the repo rate in April, 150 bps cut in CRR since January, a 100 bps cut in the statutory liquidity ratio in August and infusion of Rs 1.7 trillion through open market operations, the reduction in average base rates - minimum lending rate charged by banks - has been limited due to high inflationary expectations and increased default risk. After holding the repo rate at 8 per cent since April, RBI has hinted that a rate cut could happen in early 2013.

October 2012

Asymmetric monetary policy transmission

Monetary policy transmission has been weak since the RBI front loaded a 50 bps policy cut in April 2012 to bolster growth. From April-September 2012, the base rates across 10 large Indian banks have fallen by only half of this or 25 bps. In contrast, from July 2010 to March 2012, the increase in the maximum and minimum base rates was commensurate with the 275 bps increase in the repo rate over the same period.
Source: CRISIL Research

Rising corporate risk and high inflation limit policy transmission

The downward rigidity in lending rates reflects: (i) higher default risk as corporate profitability is being impacted by slowing GDP growth, and (ii) bid by banks to maintain the real rates of return in the light of high inflation. Persistently high inflation at over 7.5 per cent for the last 2 quarters provides limited space for reduction in deposit rates, thereby keeping the cost of funds high for banks despite a 50 bps repo rate cut in April 2012.

% 11.0 QuarterlyInflation 9.0 Avg Base Rate*

7.0

Quarterly GDP growth

5.0 Sep-10

Mar-11

Sep-11

Mar-12

Sep-12

Source: CRISIL Research

CRISIL MonetaryPolicyReview
Credit offtake to grow by 15-16 per cent in 201213
Aggregate y-o-y bank credit growth moderated to 15.9 per cent as on October 5, 2012 from 19.4 per cent as on March 30, 2012 on account of growth decelerating across industry segments like textiles, metals, infrastructure and commercial real estate. Aggregate bank credit is expected to grow by 15-16 per cent in 2012-13 from 17.1 per cent in 2011-12. The growth in aggregate bank credit in 2012-13 will primarily be on account of retail loans as several banks have cut interest rates on these products, a slight pick-up in investment activity in the second half of the year, and refinancing of foreign currency loans with domestic debt.
Source: RBI, CRISIL Research

Deposits to grow by 14-15 per cent in 2012-13

The growth in bank deposits slowed to 14 per cent y-o-y as on October 5, 2012, as demand for funds moderated and inflation eroded household savings. The reduction in term deposit rates during the first half of 2012-13 also impacted the mop-up of deposits. In 2012-13, bank deposits are expected to grow by a moderate 14-15 per cent owing to the lowering of deposit rates, high inflation, moderation in credit growth, and lower emphasis on mobilisation of high cost deposits by public sector banks.

Source: RBI, CRISIL Research

Higher provisioning on restructured advances to affect profitability

The RBI, citing tightening liquidity, decided to support growth with a 25 bps cut in the CRR. The reduction would result in non-income generating funds worth Rs 175 billion flowing into the banking system, thereby lowering the overall cost of funds for banks. This is likely to translate into lower lending rates on select portfolios, especially in the retail segment, and further push credit ahead of seasonal demand pick-up in the second half of the year. CRISIL Research forecasts net interest margins of the banking system to decline by 10-15 bps in 2012-13 as sluggish credit offtake will limit the pricing power of banks. The increase in provisioning on restructured advances to 2.75 per cent from 2.0 per cent will pull down the net profits of banks by about Rs 20 billion. A majority of the increased provisioning would be required by public sector banks.

Restructured standard assets to Gross advances

(per cent) Public sector banks Foreign banks New private sector banks Old private sector banks All Banks
Average daily net transaction through LAF
Rs billion 0 -400 -800 -1200 -1600 Oct-10 Feb-11 Jun-11 Oct-11 -613.0

Mar-12 5.74 0.10 1.06 3.42 4.69

Jun-12 6.67 0.08 1.06 3.83 5.37

-573.0

Feb-12

Jun-12

Oct-12*

Note* Oct-12 numbers are until October 25th

Source: RBI, CRISIL Research

4 4

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