Banking: Mid-term review of Monetary Policy 2010-11:: Emkay

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Banking

Mid-term review of Monetary Policy 2010-11

n     RBI hikes both Repo and Reverse Repo by 25bps maintaining the LAF corridor at 100bps

n     Inflation, capital flows and rising current account deficit continue to remain key risks to the economy

n     RBI highlights specifically for first time that that the likelihood of further rate actions in the immediate future is relatively low

n     The increase in risk weights and standard asset provisioning for some home loans more negative for real estate companies than banks and will have very marginal impact

Rate hike calibration may see a pause

The RBI raised the repo rates and the reverse repo rates by 25 bps, reiterating on the

calibrated direction of policy rate hikes. The CRR remains unchanged and so does the

bank rate. However, the RBI has made a mention in its policy review that the probability

of rate hikes in the near future would be low.

LAF corridor remains unchanged

The rate hike has maintained the LAF corridor at 100bps that would help in containing

volatility in the call rates. We also see two reasons behind keeping the corridor

unchanged at 100bps – (1) most of the banks have towed in line with RBI’s directions to

raise deposits rates and deposit mobilisation and (2) the spread is near its low of 2005-

06.

Liquidity may continue to remain tight

The advance tax payouts and the Coal India IPO have exerted pressure on the

balancing liquidity scenario, putting the system in a state of deficient liquidity. With scant

liquidity in the system, Repo balances last week touched a high of `1.3 tr., pushing the

call money rates intraday up to 12%, before closing at 7.5% owing to a flush in liquidity

through a second LAF. With another round of advance tax payouts by the end of this

calendar year, liquidity is likely to remain scarce.

We expect the RBI to only intermittently intervene to ease liquidity as the current

tightness in liquidity would also help the transmission of its monetary policy actions to

lending rates.

Inflation baseline projection for at 5.5% for Mar FY11

The RBI in its second quarter policy review has pegged the baseline inflation (New Series)

figure for Mar FY11 at 5.5%. This projection is in line with our view of easing inflation rates.

The RBI has made note that primary articles inflation is posing to be a problem due to its

structural nature, but it also observes that core inflation (non-food manufacturing) has

eased as a response to the RBI’s calibrated policy rate hikes.

The RBI acknowledges that inflation remains a concern as emerging market economies

(EME’s) see rising domestic demand generating inflationary pressures. Further investment

flows into these economies could aggravate the scenario by increasing commodity prices.

We expect the course of inflation to be southbound for the rest of the fiscal year. The month

of November is likely to see a significant drop in inflation to 7% levels, with primary article

inflation touching 14% levels. This would have a positive impact on real interest rates which

would enter positive territory of ~0.9% in the month of November, from the current negative

figure of -0.8%.

Intervention in FX market one of the ways to improve liquidity

Left to itself and with no intervention on the part of the RBI, rising real interest rates would

attract inflow of foreign capital that would compound the current rupee appreciation. It would

exert pressure on the trade balance that presently shows a deficit of $ 9.12 Bn as on Sept.

2010.

We feel that intervention on the part of the RBI would be the way out to stabilise the rupee.

This intervention could be unsterilised in nature as excess liquidity is absent in the system.

Such unsterilised intervention would also help bringing money supply growth closer to its

target rate of 17% for the fiscal. Howe

Current account deficit (CAD) stays a concern in a sluggish global economy

The RBI sees the continued sluggishness in the global economy clubbed with domestic

recovery to pose a problem for the CAD. Domestic growth, it feels, would lead to an

increase in import growth that may eventually bring the CAD to above 3% of GDP. Though

currently the deficit is being financed by the capital account surplus, any level of 3% and

above would be unsustainable in the long run.

System rates not to see much hike

We believe that the banks are done with the increase in the deposit rates for while and

consequently also the advances rate. Hence, we do not expect the banks to raise either

deposit or advances rates post this policy action.

Looking at rise in the bond yields over past few days, we believe that the G-Sec yields have

already factored in the rate hike and looking at the RBI’s guidance of less likelihood of rate

increase in immediate future, the 10-year bond yield is likely to soften

Home loan proposals not very negative for banks – positive for NBFCs

The RBI has proposed three key measures to contain asset inflation, especially in the real

estate. Since, the new provisions are applicable only to commercial banks as of now, the

competitive pressure for NBFCs will ease unless these provisions are also adopted by the

National Housing Bank.

Provisions Comments

The loan to value (LTV) ratio in respect

of housing loans hereafter should not

exceed 80%

1. Most of the PSU banks have LTVs between 70-

80%, so would not affect in big way

2. Impact to be marginally higher for private banks

Increase the risk weight for residential

housing loans of Rs7.5mn and above

irrespective of the LTV ratio, to 125%

1. For most of PSU banks the LTVs is anways lower

than Rs2mn, more than 70% of the loans are less

than Rs3mn in size

Increase the standard asset provisioning

by commercial banks for all such loans

to 2 per cent.

1. Even for the size of SBI, which has been offering

teaser rate loans for CY09 onwards, the quantum of

the provisions would not be more than Rs4bn/10%

of the quarterly profits

2. This is even after assuming that all home loans

between the launch of the product and as of date fall

under teaser loan category for all players

Guidelines for new banking licenses by January 2011

The RBI had floated discussion paper on the guideline of licenses for new banks in August

2010. The draft guidelines for issuance of new banking licenses are likely to be put up by

January 2011.