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RBI moves to ease liquidity
In line with our expectations, RBI in its mid-term monetary policy review
took a pause on monetary tightening. In fact it focussed on easing the
tight liquidity conditions in the money market. In this direction it plans to
repurchase Rs480bn worth of G-Secs and has cut the SLR by 100bps to
24% of net demand and time liabilities (NDTL). These measures are likely
drive moderation in short term interest rates and help correct an inverted
yield curve. Higher LDR and tight liquidity conditions have forced banks to
raise deposit rates more than lending rates; we expect the trend to
continue in 2011 and could put pressure on margins. We like banks with
high CASA ratio and balanced ALM where HDFC Bank, ICICI, SBI and PNB
are well placed.
RBI looks to ease liquidity conditions
In its mid-quarter review RBI took a pause on monetary tightening measures
and focussed on easing the tight liquidity conditions. Firstly, it plans to
conduct open market operations or OMO (buy-back of G-Secs) that will add
Rs480bn to liquidity levels over the next month. Secondly, it has cut SLR by
100bps to 24% of NDTL which will allow banks to limit participation in the
upcoming G-Sec auctions and/ or liquidate their existing holdings. While it
has reduced the limit of the special repo window from 200bps of SLR to
100bps, we do not expect it to impact the liquidity levels as banks have not
been accessing this window to a meaningful extent. RBI has not changed
other policy rates- CRR (6% of NDTL), repo rate (6.25%) and reverse repo
(5.25%), but it feels that inflationary pressures would require hike in policy
rates during 2011.
Inverted yield curve likely to correct
These measures are expected to add Rs480bn (~1% of deposits) to overall
liquidity and help lower banks’ borrowing from RBI which currently is at Rs1tn
(~2.5% of the deposits). Easing liquidity conditions should drive moderation
in shorter-term rates leading to correction in the inverted yield curve- yields
on 1 year AAA rated corporate bonds (9.1%) are higher than those on the 10
year paper (9%). We also believe that banks’ averseness towards lending to
risky segments, including real estate, could have encouraged RBI to take
such a generic liquidity expansionary step.
Prefer banks with better CASA franchise and balanced ALM
In the context of tight liquidity conditions and higher LDR, banks have raised
retail term-deposit rates by up to 200bps, more hike for the shorter buckets.
However, the hike in lending rates has been to a lesser extent (up to 75bps).
We believe that deposit rates will continue to rise faster than lending rates
and this could impact future margins. In this context, banks with a stronger
CASA franchise, balanced ALM and lower dependence on wholesale deposits
are better positioned. Among private banks, HDFC Bank and ICICI are well
placed while SBI and PNB are better positioned than other PSU banks. Axis
has a high CASA ratio, but may face margin pressures due to some ALM gap
and higher share of wholesale deposits.
1. INDIA RBI - Easing liquidity
deficit, worried on inflation
In its policy review, the RBI maintained its
hawkishness but kept the policy rates and the
CRR unchanged, as expected. However, it took
meaningful steps to ease the ongoing liquidity
deficit that has resulted in money market
conditions being much tighter than intended.
Cumulatively, the RBI has so far this year
effectively increased rates by 300bp via a
combination of six hikes in the policy rates and
liquidity management. The CRR is currently at
6%, while the repo rate and the reverse repo rate
stand at 6.25% and 5.25%, respectively. These
two interest rates form the upper and lower
bounds for the liquidity adjustment facility (LAF)
within which the overnight rate is meant to stay.
In recent months, some temporary factors, such as
the large cash surplus of the government with the
RBI (around INR900bn), has amplified the money
market tightness. Consequently, the overnight rate
has been well above the repo rate, which is currently
the main operative policy rate.
To shrink the LAF deficit that had led it to injecting
around INR1 trillion, the RBI announced: (1) a
permanent cut the statutory liquidity ratio (SLR) to
24% from 25%; and (2) open market operation
(OMO) for an aggregate amount of INR480bn in
the next one month. For bonds, (1) will be negative
but (2) will be positive. The combined effect of the
two measures will be to inject liquidity on an
enduring basis of INR480bn. The important aspect
of the SLR measure is that it is permanent rather
than the earlier temporary move (such as waiver of
penalty for maintaining the mandatory SLR). Bonds
at the short end will do better as liquidity improves.
However, the above liquidity-improving measures
do not constitute a change in the current tight
monetary stance of the RBI. While the overall
liquidity in the system has remained in deficit,
consistent with the policy stance and also improved
monetary transmission, the extent of the tightness
has been beyond the comfort level of the RBI.
The economic momentum remains strong, and the
RBI is maintaining its GDP growth forecast of 8.5%
(CLSA: 8.8%) for 2010-11. However, it continued
to sound hawkish, highlighting domestic and
external factors that could add to inflationary
pressures. It also indicated upside risk to its WPI
inflation forecast of 5.5% (CLSA: 6.3%) for March
2011. The hawkishness of the tone is partly to
counter the inaction on interest rates.
We expect inflation to rise from 2Q onwards, and
maintain that the RBI will resume tightening in
January. Despite our expectations of a marginal
moderation in GDP growth in 2011-12, the impact
of higher global commodity prices on inflation will
remain a key worry. Cumulatively, policy rates will
likely increase by 75bps in CY 2011, in our view.
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