RBI Monetary Policy Review

September 2013 RBI  Monetary Policy Review

In the mid-quarter policy review announced 20.09.2013, RBI Governor Raghuram Rajan stressed on inflation control while taking measures to ease the short-term borrowing cost. The central bank hiked the repo rate by 25 bps to 7.5 per cent, indicating RBI’s concerns on high inflation even in an anaemic growth environment. With WPI inflation now above 6.0 per cent and CPI at 9.5 per cent, this step was necessary to curtail inflation expectations.

The announcement by the US Federal Reserve on September 18 about the postponement of QE3 (quantitative easing) withdrawal will aid the rupee in the near term. This has given RBI some leg room to partly reverse the extra liquidity tightening measures, which were undertaken to stem

the volatility in the rupee. As the uncertainty about the timing and speed of withdrawal of QE3 and its impact on rupee remains, liquidity tightening measures initiated in July were not fully reversed.

On the whole, measures taken by the RBI  will serve to reduce the borrowing costs for banks in the near term. Considering the borrowings of the banks from RBI’s liquidity window over the past one month, around 39 per cent of bank’s borrowings were made at the repo rate and the balance at the MSF (marginal standing facility) rate. If this pattern continues, the weighted average of the borrowing costs of the banks will go down by nearly 40 bps, with the repo now at 7.5 per cent and MSF at 9.5 per cent.

Interest rates had risen since the second half of July when the RBI raised the MSF rate by 200 bps to 10.25 per cent and placed a cap (0.5 per cent of net demand and time liabilities) on borrowings at the repo rate. With these measures, banks were required to borrow at the MSF rate to meet a large part of their daily funding needs . Consequently, other short-term rates also moved up.

RBI’s focus on inflation should be seen in the context of high CPI and rising WPI. Although core inflation is falling right now, the momentum indicators (3-month SAAR of non-food manufacturing inflation) indicate a possible rise in core inflation in months to come. Loosening of monetary policy to support growth, therefore, runs the risk of creating a situation of high generalised inflation as supply shocks from fuel can feed into core inflation. RBI has signalled this through the repo rate hike. So, we can expect interest rates to remain firm through 2013-14.

Loan offtake to remain sluggish in 2013-14 Credit growth, y-o-y Credit growth in the banking sector, which was subdued at 13-14 per cent till mid-July, has been steadily rising over the last three fortnights. Banking credit grew by 17.1 per cent, as of August 23, 2013 as the liquidity crunch, high short-term interest rates in the market and sharp rupee depreciation have pushed companies to borrow funds from banks as against raising funds through non-convertible debentures (NCDs), short-term external commercial borrowings (ECBs) and commercial paper (CPs). However, we believe that such growth will not be sustainable till March 2014, amidst a sombre macro-economic outlook.

We project a 13.5-14.5 per cent y-o-y growth in bank credit in 2013-14, lower than the 16 per cent growth witnessed in the previous fiscal. While investment demand would move at a slower pace, drawdown of sanctioned limits, refinance of foreign borrowings with domestic debt, growth in agricultural loans and certain segments of retail loans, such as home loans, would support credit growth. Deposit to grow by 14-15 per cent in 2013-14 Growth in bank deposits slowed to 13.1 per cent y-o-y, as on August 23, 2013, from 14.2 per cent a year ago. This was primarily because of areduction in the household savings rate, especially financial savings, and repayment of bulk deposits by PSBs.

Bank deposits are forecast to grow at 14-15 per cent in 2013-14, a tad higher than that in 2012-13. Tightening liquidity and increase in short term rates leave little scope for banks to cut deposit rates. Firm deposit rates, and volatilty in returns from other asset classes, are therefore, expected to help sustain investor interest in bank deposits. Lending rates to stay elevated; NIMs under pressure 

With a 25 bps increase in the repo rate and a 75 bps decline in the MSF rate, banks will witness a marginal decline in their cost of borrowings. However, the resultant saving will not be sufficient for banks to lower  their lending rates. We thus expect lending rates to remain elevated. With a rise in the cost of short-term funds, rising delinquencies and increased competition, net interest margins (NIMs) will remain under pressure, especially for public sector banks. Average NIMs are thus expected to decline by 20-25 bps during 2013-14. 

Gross NPA to reach 4.3-4.5 per cent by March 2014 Slow growth in GDP, heightened currency volatility, and higher-than expected interest rates are likely to weaken credit quality of companies. Specifically, stress will increase in sectors such as power, construction, engineering, and steel, and lead to higher non-performing assets (NPAs). We expect the GNPA to reach 4.3-4.5 per cent by March 2014, from 3.8 per cent, as of June 2013.