RBI Policy Review | Banking

July 26, 2011

RBI Monetary Policy Review

Tackling inflation head-on
Hikes repo rate by 50bp to 8.0% Consequently reverse repo rate stands at 7.0% and MSF rate at 9.0% Keeps SLR and CRR unchanged at 24.0% and 6.0%, respectively The Reserve Bank of India (RBI), in a surprise move, stepped up its anti-inflationary stance, raising both repo and reverse repo rates by 50bp each to 8.0% and 7.0%, respectively, in its 1QFY2012 review of the monetary policy. The Central Bank maintained status quo on cash reserve ratio (CRR) and statutory liquidity ratio (SLR) at 6.0% and 24.0%, respectively. The street was almost unanimously expecting a 25bp hike.

Vaibhav Agrawal
022 3935 7800 Ext: 6808 vaibhav.agrawal@angelbroking.com

Shrinivas Bhutda
022 3935 7800 Ext: 6845 shrinivas.bhutda@angelbroking.com

Varun Varma
022 3935 7800 Ext: 6847 varun.varma@angelbroking.com

Key takeaways from policy statement

On the growth front: The RBI has noted that a revised and rebased index of industrial production (IIP) suggested that earlier signals of a growth deceleration in the second half of 2010-11 were exaggerated. In fact, the growth momentum remained strong throughout the year. However, data for April-May 2011 suggest that some moderation might be under way, reflecting in part a lagged response to the monetary tightening that has been effected since October 2009. On the inflationary pressures: In RBIs view, notwithstanding signs of moderation, inflationary pressures are clearly very strong. Importantly, the softening of commodity prices over the past three months did not translate into a decline in either headline wholesale price index (WPI) inflation or non-food manufacturing inflation. If the softening reverses, commodity prices are likely to exert inflationary pressures for some time, making moderation in demand necessary to bring inflation down, in RBIs view. Growth vs inflation: The central bank is of the opinion that, overall, the current balance of global and domestic factors suggests that monetary policy needs to persist with a firm anti-inflationary stance. Moreover, moderating domestic growth will certainly help ease inflationary pressures, which may be reinforced by possible softening in global commodity prices, in RBIs view.

Policy tone remains hawkish

The tone of the overall policy statement remained hawkish as, in RBIs view, demandside inflationary pressures have remained strong and growth though beginning to moderate, it is only gradually easing off. The RBI has revised upwards its inflation forecast from 6.0% to 7.0% by March, 2012 and at the same time has revised downwards its projection for non-food bank credit and M3 to 18.0% (from 19.0%) and 15.5% (from 16.0%), respectively.

Exhibit 1: Revisions in forecasts

Parameter (%) WPI inflation Non-food credit growth M3 growth
Source: RBI, Angel Research

Old 6.0 (Mar-12) 19.0 16.0

Revised 7.0 (Mar-12) 18.0 15.5

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RBI Policy Review

Factors which suggest that we are closer to peak of the current interest rate cycle
Credit demand slowing, deposit mobilization picks up strongly: In spite of the recent 50bp hike in repo rate ahead of streets expectation of 25bp hike, we do not expect the deposit rates to go up further as credit off-take has moderated considerably and deposit mobilization has picked up substantially.

Exhibit 2: Deposit mobilisation substantial

(` cr) 320,000 280,000 240,000 200,000 160,000 120,000 80,000 40,000 Credit offtake (` cr) Deposit mobilisation (` cr) 163,357 147,667 144,022 FY2011# FY2012* 283,979

Source: RBI, Angel Research; Note: # from Mar 26, 2010 to Jul 2, 2010, * from Mar 25, 2011 to Jul 1, 2011

Liquidity has eased off: Even our interaction with various banks indicates slowdown in credit sanctions. On the other hand liquidity has eased off considerably with the overnight borrowing window (LAF) averaging ~`45,000cr during FY2012 YTD as compared to ~`88,000cr in 2HFY2011.

Exhibit 3: Liquidity has eased off considerably

(` cr) 150,000 100,000 50,000 (50,000) (100,000) (150,000) (200,000)

Oct-10

Nov-10

Feb-11

Sep-10

May-10

May-11

Jun-10

Aug-10

Dec-10

Jan-11

Apr-10

Apr-11

Jun-11

Jul-10

Source: RBI, Angel Research

Food and Primary articles inflation has eased off, already: Also the food inflation has cooled off to two-year lows and the primary articles inflation has been easing off in the recent months, indicating some respite on the inflation front as well.

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RBI Policy Review

IIP has moderated considerably; GDP growth at 5-quarter lows: The recent macro-economic data has been indicating moderating growth, indicating at least some respite on the demand-side inflationary pressures. The latest Industrial Production growth for the month of May 2011 came in at 5.6% as compared to 8.5% in May 2010. Also the GDP data for March 2011 quarter saw the easing of growth continuing from 9.4% in 4QFY2010 to 7.8% in 4QFY2011. The recent data on PMI also suggests some moderation in manufacturing activity. Exhibit 4: GDP growth coming off
(%) 10.0 9.0 8.0 7.0 6.0 5.0 4QFY10 1QFY11 2QFY11 3QFY11 4QFY11 9.4 9.3 8.9 8.3 7.8

Exhibit 5: Manufacturing activity also moderating

(%) 12.0 9.0 6.0 3.0 8.5 7.5 4.5 10.0 6.2 11.4 8.1 7.5 8.8 6.7 5.8 5.6

6.4

Aug-10

Dec-10

Nov-10

Mar-11

Oct-10

Feb-11

Sep-10

Apr-11

Jul-10

May-10

Source: Company, Angel Research

Source: Company, Angel Research

Outlook on interest rates

In our view, though the recent hike has extended the monetary tightening cycle (a total of eleven repo rate hikes since Mar 2010), we believe that we are close to the peak of the current interest rate cycle. We do not expect material hike in deposit

rates and in overall cost of funds on account of the latest repo rate hike by the RBI as credit off-take is itself showing signs of moderation on account of increase in overall macro-economic risks and the higher interest rates impacting demand. Moreover, we see cooling global commodity prices, moderating food inflation (at two-year lows), weakening domestic demand, slowing credit (down to sub-20% levels) and higher deposit mobilization, as signals that the economy is close to the peak levels for both inflation and broader interest rates. The key risk factor to our call is the longer-thanexpected persistence of global commodity and energy prices at higher levels.

Impact on Banks
The tone of the policy suggests that the RBI is firmly focused on anchoring inflation expectations even if it means that growth may be sacrificed to an extent. Bankers have indicated that may increase lending rates in the coming days, which in our view could pose risks to credit growth and asset quality. That said, looking at the liquidity situation in the banking system, we do not expect the deposit rates to go up further as credit off-take has moderated considerably and deposit mobilization has picked up substantially. Hence, we do not expect material hike in deposit rates and in overall cost of funds on account of the latest repo rate hike by the RBI. Our overall remains that broader lending and deposit rates may not go up materially from current levels, though the prevalence of higher interest rates for a more extended period of time than earlier anticipated poses near-term risks to GDP growth, credit growth and asset quality for banks.
July 26, 2011

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RBI Policy Review

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July 26, 2011

RBI Policy Review

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