The RBI cuts the Cash Reserve Ratio by 50 bps to 5.50% in order to infuse permanent liquidity in the system. While RBI’s priority gradually seems to be shifting towards growth, we do not think that today’s CRR cut will bring forward the Repo rate cut cycle as inflation risks continue to remain high.
RBI cuts CRR to infuse “permanent primary liquidity”
We have been strong proponents of a CRR cut and had been highlighting that “a cut is justified in the current scenario, considering a) a significant worsening of banking system liquidity, much above RBI’s comfort level b) inability of open market operations to infuse incremental permanent liquidity in the banking system in the face of additional government borrowings c) increasing constraints faced by corporates in raising external financing d) Possibility of a spike in currency in circulation ahead of elections.
The only reason we thought a CRR cut may not happen today was RBI’s insistence that CRR would be used as a monetary policy and not a liquidity management tool. With today’s policy, RBI goes back on its word and cuts CRR by 50 bps to 5.5% with an intention of infusing INR 320 bn of primary liquidity into the banking system. While this will help correct the banking system liquidity deficit, we don’t expect it to slip towards RBI’s comfort zone of -1% of Net Demand and Time Liabilities (NDTL) and expect it to hover over INR 1 tn by March-2012 without further CRR cuts by the RBI. Also, considering that credit growth demand remains weak (RBI has cut its credit growth projection from 18% YoY earlier to 16% YoY now) and may not result in immediate lending rate cuts by RBI, the CRR cut should not be inflationary.
RBI priority shifts to growth RBI highlights that “the growth-inflation balance of the monetary policy stance has now shifted to growth” with a significant slowdown in investment activity. It has downgraded its GDP projection for FY12 from 7.6% YoY to 7%, but doesn’t seem exceedingly worried about growth as it looks for a modest recovery, from these levels, in FY13. We think that given the inflation risks remain high – moderation in food inflation is only temporary, global energy prices have failed to correct, the large element of suppressed domestic fuel inflation will likely resurface as coal and diesel price hikes materialise – RBI rate cuts may not be aggressive enough to support growth and growth may continue to hover around 7% YoY in FY13.
Other key takeaways from the monetary policy review Non food credit growth has been trending lower. Non-food credit growth moderated from 21.3% at end-March to 15.7% by end-December 2011, a rate below the indicative projection of 18% set out previously.
• Credit deceleration was particularly sharp for PSU Banks, with growth moderating from 21% to about 15% during the same period.
• Disaggregated data for November showed that there was a general deceleration in the credit flow across sectors, except for personal loans.
• The deceleration was particularly sharp in agriculture, real estate, infrastructure, engineering, cement and cement products.
This would likely mean that our FY12E credit growth expectations are likely to come down. The downgrades would be more skewed towards PSU banks which we believe have slowed down credit disbursements to focus more on asset quality and recovery.
Impact of CRR cut on Indian Banks
• Positive impact on NIMs by 5bps: The 50bps CRR cut will release ~Rs 320bn of liquidity into the banking system. Banks can redeploy this liquidity into interest earning assets. This along with reduced cost of funds due to liquidity easing measure can aid margins by 5 bps.
• Banks unlikely to cut interest rate: We believe this is not material enough for banks to consider passing on this marginal benefit to the borrowers. Few bankers have already indicated that they are not going to change their base rates post the monetary review.
We don’t think Repo rate cuts will be brought forward While RBI’s priority gradually seems to be shifting towards growth, we do not think that today’s CRR cut will bring forward the Repo rate cut cycle as inflation risks continue to remain high. We think the RBI will be keenly watching the outcome of the forthcoming Union Budget of 2012-13 and government’s attempts towards fiscal consolidation before calling for a victory over inflation. It notes that “in the absence of credible fiscal consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending”. We expect the first Repo rate cut in April 2012 and a total of 100-125 bps in FY13.
The rate cut cycle this time is unlikely to be as aggressive as in 2008. Back then, the entire rate cut cycle was short in duration – merely six months – and heavy on quantum - with an initial 100 bps cut in Repo rate and cumulative cuts of 425 bps. That was in response to a sudden and highly uncertain global crisis. The backdrop this time is serious, but very different; a structurally challenged by better understood developed world scenario, but combined with a more difficult domestic scenario. In the absence of a systemic crisis caused by a tail event in Europe, we think a better parallel for assessing the impact might be the rate cut cycle of 2001-2004, which was far more gradual –extended over 3 years - and less aggressive – with cumulative cuts of 400 bps in the Repo rate. In that cycle, from an average of 7% in the one year before the rate cuts began, WPI inflation slipped to an average of 3.7% in the two years following the first rate cut, with manufacturing inflation slipping from 3% YoY to 2.2% in the corresponding periods.
The critical factors in rate actions ahead will be core inflation and exchange rate pass-through, where signs of moderation are yet to emerge. With this combination of persistent domestic structural inflationary factors, stubbornly high oil price, and twin deficit concerns meaning a weak Rupee; it’s unlikely that inflation will moderate in a hurry in FY13 as it did in the 2001-2004 rate cut cycle. We expect WPI inflation to average 7.2% in FY13. Another CRR cut before that cannot be ruled out if liquidity continues to deteriorate. Given our view that uncertainty on inflation may continue beyond March 2012 and government finances may not improve significantly it is hard to see the RBI doing a sudden volte face and aggressively easing. Though our view on USD/INR reversal to 50.00 has materialized, we think further downside below 49.00 may be capped till there’s clarity on the Union budget.
(Deepali Bhargava is chief economist, India for Espirito Santo Securities (formerly Execution Noble))
