January 2013

CRISIL MonetaryPolicyReview
Credit set to become cheaper
CRR cut to make repo rate transmission more effective Overview:
The Reserve Bank of India (RBI), in its monetary policy review on January 29, 2013, reduced the repo rate by 25 basis points to 7.75 per cent. It also lowered the cash reserve ratio (CRR) by 25 basis points to 4.0 per cent in order to reduce liquidity tightness in the system. A sustained decline in core inflation (non-food manufacturing inflation) and the governments continued efforts towards fiscal consolidation paved the way for a repo rate cut by the RBI. Core inflation declined to 4.2 per cent in December 2012 from a peak of 5.8 per cent in August, indicating moderating demand-side pressures in the economy. Last week, the government announced phased deregulation of retail diesel prices as well as a one-time hike in bulk diesel prices, which despite their short-term inflationary impact, are critical for lowering fiscal deficit. The moderation in core inflation suggests that the second-round impact of diesel price increases on inflation are unlikely to be significant due to slowing demand in the economy. A 25 basis point cut in repo rate combined with a reduction in CRR, will enable banks to lower lending rates and improve transmission of monetary policy. As inflationary expectations adjust downward, banks will have greater flexibility in reducing deposit rates, thereby lowering their cost of funds. This will create further space for a reduction in lending rates in coming months.

Declining core inflation paves way for rate cut

WPI inflation declined to a 3-year low of 7.18 per cent in December 2012. Core inflation, as measured by CRISIL Core Inflation Indicator (CCII), fell for a third consecutive month and stood at 5.5 per cent in December 2012. Inflation now appears to be on a downward trajectory and is expected to decline to 6.8 per cent by March-end 2013 as per the RBIs latest forecast.

%, y-o-y 10.5 9.5 8.5 7.5 6.5 5.5 4.5 3.5 Dec-10

WPI

7.18 CCII* 5.5 RBI core inflation Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 4.2

Dec-12

CCII* excludes base metal prices from WPI manufacturing inflation; Source: Ministry of Commerce and Industry, CRISIL Research

Monetary policy transmission to strengthen

9.50

% Deposit Rate* 9.00 8.50 8.00 7.50 7.00 6.50 6.00 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 Repo Rate

The base lending rates across banks have declined by only 25-30 basis points since March 2012, despite a 50 basis point reduction in repo rate in April 2012 Average deposit rates for 1-2 year term deposits across 10 large Indian banks have fallen only marginally from 9.2 per cent in March 2012 to 8.7 per cent in January 2013. As inflation eases further in Q4, 2012, banks will be able to lower deposit rates. Lower deposit and repo rates will enable banks to reduce lending rates in the coming months.

Note: Deposit Rate*: Simple average of 1-2 year term deposits of 10 large Indian banks; Source: RBI, CRISIL Research

CRISIL MonetaryPolicyReview
Credit offtake to revive slightly in 2013-14
Aggregate y-o-y bank credit growth moderated to 15.8 per cent as on January 11, 2013, from 19.4 per cent as on March 30, 2012, due to sluggish investment demand and increased risk aversion, given the deterioration in the asset quality of public sector banks (PSBs) over the past few quarters. The 25 bps cut in cash reserve ratio (CRR) will release non-income generating funds of about Rs 180 billion into the banking system. This would give banks enough room to cut rates on select portfolios ahead of the seasonal pickup in credit offtake in the fourth quarter. Aggregate bank credit is expected to grow by 17-18 per cent y-o-y in 2013-14, driven by improvement in agriculture growth, consumption-led recovery in economy, and preelection welfare spending by the government.
28%

Credit growth

24%

20%

16%

12%

8% Dec-10 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13

Source: RBI, CRISIL Research

Deposits to grow by 14-15 per cent in 2013-14

Growth in bank deposits slowed down to 12.8 per cent y-oy as on January 11, 2013, primarily due to repayment of bulk deposits by PSBs and decline in current account deposits. In 2013-14 as well, mobilising deposits will remain a challenge for banks. While inflation is expected to moderate, term deposit rates are also likely to decline with the reduction in policy rates. We expect bank deposits to grow by 14-15 per cent y-o-y in 2013-14.

28% 24% 20% 16% 12% 8% Dec-10 May-11

Deposit growth

Sep-11

Jan-12

May-12

Sep-12

Jan-13

Source: RBI, CRISIL Research

NIMs to decline by 10-15 bps in 2013-14

NIMs of banks have remained fairly stable in 2012-13. While demand for funds has been subdued, cost of funds has come down due to repayment of high-cost bulk and wholesale deposits. During 2013-14, we expect lending rates to decline because of reduction in policy rates as well as increased competition amongst banks. However, as deposit re-pricing takes place with a lag, the NIMs are expected to decline by 10-15 bps y-o-y.

3.5%

Quarterly NIMs of SCBs

3.3%

3.1%

2.9%

2.7%

2.5% Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12

Source: CRISIL Research

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