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India Macro Weekly
Lending rates: Set to cycle up
„Hot topic: Lending rates set to cycle up 75bp…
We grow more confident of our call of lending rates going up 75bp in the industrial
season after September. Indeed, some banks are already hiking lending rates.
First, credit growth is well on track to our 20% FY11 forecast. Second, the RBI's
CRR hikes have slowed deposit growth to 14% from 20% levels. Even if deposit
growth revives to 17.5% by March 10, as we expect, banks will still face excess
credit demand, given the 8.2% of GDP fiscal deficit. Finally, RBI rate hikes have
pushed up the benchmark risk-free 10y to a mid-cycle 7.5-8% trading range. This,
in turn, has compressed the spread between the still down-cycle lending rates
and the 10y, now 400bp, below the usual 450bp. Key risk: Delhi’s reluctance to
allow higher lending rates to ‘protect’ growth. Do read our last credit report here.
… with credit well set on 20% track…
We continue to expect loan demand to clock 20% growth in FY11. In fact, our
bank analysts, Rajeev Varma and Veekesh Gandhi, report that many leading
banks are actually guiding 22-25% FY11 loan growth. Credit offtake has already
climbed to 20.5% by July (although this is partly exaggerated by telcos' bridge
loans to fund the US$22bn BWA/3G payment). Loan demand is also broadbasing
from retail and services to industrial credit. Do read our banking analysts here.
… when CRR hikes are slowing deposit growth…
The RBI's 100bp CRR hike is generating excess credit demand by curtailing
deposit expansion at a time of strong loan demand and a high fiscal deficit. We, of
course, expect deposit growth, now 14%, to climb back to 17.5% by March 11.
Even so, our proprietary BofAML liquidity model finds that 20% loan demand and
a high fiscal deficit will accord banks the pricing power to raise rates, even though
we are erasing the 2HFY11 50bp CRR hike earlier penciled in.
… and RBI rate hikes have pushed up risk-free rates
RBI rate hikes – 125bp over and 50-75bp to go - have pushed up the benchmark
risk-free 10y to a mid-cycle trading range of 7.5-8%. In our view, this cannot but
pressure up lending rates from down-cycle levels. The spread between bank
lending rates and the 10y, now 400bp, has already compressed below the
medium-term 450bp average. Do read our last rates report here.
Week ahead: 10.4% July WPI inflation
July WPI inflation will likely clock 10.4% (consensus, 10.4%), close to June's,
tomorrow. This, in turn, should support our summer peak off view. Agflation, after
all, is coming off. Besides, WPI data should start recording the March-April
softening of metal prices. As inflation softens, we expect the RBI to pause after
hiking 50-75bp. Deputy governor Gokarn has already said that the RBI has “done
enough” to contain inflation expectations. So why hike at all? Because core
inflation will still likely persist in a high 7-8% range till end-10
Lending rates: Set to cycle up
We grow more confident of our call of lending rates going up 75bp in the industrial
season after September. Indeed, some banks have already hiked lending rates.
First, credit growth is well on track to our 20% FY11 forecast. Second, the RBI's
CRR hikes have slowed deposit growth to 14% from 20% levels. Even if deposit
growth revives to 17.5% by March 10, as we expect, banks will still face excess
credit demand, given the 8.2% of GDP fiscal deficit. Finally, RBI rate hikes have
pushed up the benchmark risk-free 10y to a mid-cycle 7.5-8% trading range. This,
in turn, has compressed the spread between the still down-cycle lending rates
and the 10y, now 400bp, below the usual 450bp. Key risk: Delhi’s reluctance to
allow higher lending rates to protect growth.
Bottom line: 75bp lending rate hike post-September
We grow more confident of our call of lending rates going up 75bp in the industrial
season after October (Chart 1). Will this impact recovery? Not really. Chart 2
shows that the Indian economy slows (accelerates) when the real lending rate
1
,
currently 6.25%, pierces (slips below) the 7.5-8% potential growth rate.
#1. Credit well on 20% track…
Incoming data support our standing view – no longer contrarian, alas! - of
recovery pushing up FY11 credit offtake to 20% levels (Chart 3). July credit
offtake, at 20.5%, is well on track and then some. Our bank analysts report that
many leading banks are actually guiding 22-25% FY11 loan growth here.
driven by credit broadbasing, 3G, lower ECBs ...
Who’s borrowing? The current credit upcycle is running a typical recovery relay
race. Loan demand is spreading to industrial credit from services and retail
(Table 2). Besides, telcos have funded most of their US$22bn BWA/3G payments
by bridge loans (although US$8bn will likely be converted into external
commercial borrowing (ECB) by end-10.). Finally, corporates have been drawing
domestic loans so far as ECB demand has been sluggish.
#2. RBI CRR hikes generating excess loan demand…
The RBI's 100bp CRR hike is generating excess credit demand by curtailing
deposit expansion at a time of strong loan demand and a high fiscal deficit. We,
of course, expect deposit growth, now 14%, to climb back to 17.5% by March 11
(Chart 4). Even so, our proprietary BofAML liquidity model finds that 20% loan
demand will generate excess credit demand of 8.6% of deposits (Table 3). This
should accord banks the pricing power to raise rates, even though we are erasing
the 50bp CRR hike earlier penciled in for 2HFY11.
How reliable has our model been? Past performance suggests that ex ante
forecasts of excess credit demand have usually pushed up lending rates ex post
(Chart 5). The only aberration is FY09 because the RBI aggressively switched to
monetary easing from tightening after the Lehman collapse in October 08.
(cutting deposit growth (along with inflation, 3G ...
Why are deposits slowing? The RBI has reined in high-powered reserve money
slowing down money (and deposit) creation (Chart 6). Second, high inflation is
also pushing up cash demand as the public, after all, now requires more pocket
money for day-to-day transactions (Chart 7). Thirdly, telcos have drawn down
their deposit accounts to pay for BWA/3G spectrum.
…though September should bring some relief ...
We, of course, expect deposit growth to bottom out in September. What
changes? First, we expect the RBI to inject liquidity to fund loan growth. Second,
a peak off in inflation should pull down public cash demand. Third, public spend
should partly return 3G money back to banks. Fourth, deposit rates are moving
up. Finally, there is the base effect of deposits slowing to 18.2% in September -
March 10 from 21.8% in April-August 09.
#3. RBI hikes pushing up risk-free rates
RBI rate hikes – 125bp over and 50-75bp to go - are also pressuring lending
rates. This has normalized the risk-free 10y benchmark rate to at a mid-cycle 7.5-
8%. As a result, the spread between the 10y and the down cycle erstwhile
11.75% SBI advance rate
Can banks sell gilts to fund loans? Fiscal deficit a constraint
Can’t banks fund private credit demand, it is natural to ask, by selling off gilts?
We doubt if Delhi can afford such rebalancing by public sector banks when the
fiscal deficit will be a high 8.2% of GDP (raised from 8% after the recent increase
in expenditure). Sure, banks hold surplus gilts of 4.5% of book beyond the 25%
mandated statutory liquidity ratio. Our estimates in Table 4 suggest an excess gilt
supply of Rs1400bn even if banks buy our projected Rs1750bn in Table 4. It is for
this reason we have a contrarian call of RBI liquidity support (Rs300bn so far).
Can RBI inject money at 10% inflation? 8% growth at stake
But can the RBI, runs another common question, really boost money supply and
deposits at 10% inflation? Our estimates in Table 5 suggest that the RBI will need
to inject Rs1970bn/US$44bn of reserve money to generate the 17.5% money/
deposit growth to meet 20% loan demand necessary to fund growth. As inflation
peaks off ahead, the focus of policy cannot but turn to stepping up money growth,
for all the current hullaballoo about the RBI being behind the curve (Chart 9).
What if capital flows dry up? OMO, CRR cuts
This begs the question, can the RBI provide liquidity if capital flows dry up? As of
now, we assume that reserve money would be funded by OMO, T-Bill auction
cuts and fx intervention after capital flows return in 2HFY11. If flows do not return,
the RBI will likely step up OMO: Table 4 shows they can easily buy Rs1000bn in
2H10. In our view, the RBI would also not balk at cutting CRR if needed.
to 400bp below the average 450bp
Appendix: India's monetary policy
Multiple objectives: Growth, price stability, INR, financial
stability
The RBI pursues multiple objectives as the central bank, manager of public debt,
supervisor of banks and regulator of money, gilts and fx markets. The relative
emphasis is contextual and the RBI publishes inflation and growth "projections".
Financial stability is also a key policy concern. Although the RBI officially only
contains currency volatility, the exchange rate regime is really a managed float.
Multiple indicators: Money, credit, interest/exchange rates,
credit, inflation, fiscal position, balance of payments
Monetary policy is formulated on the basis of information gleaned from a set of
macroeconomic indicators: broad money, interest rates, equity prices, currency,
credit extended by banks and financial institutions, fiscal position, trade, capital
flows, inflation rate, exchange rate, refinancing and transactions in foreign
exchange juxtaposed with output trends.
Multiple transmission channels: Money, credit, interest
rate, exchange rate
Multiple monetary policy transmission channels require the RBI to operate
through both the quantum, as well as the price of money. Monetary policy
impulses travel to the real economy by affecting both credit available and
increasingly, interest rates. The RBI also informally targets the real effective
exchange rate although the official position is really managing volatility.
Multiple instruments: CRR, LAF repo/reverse repo
amounts/rates, Bank Rate, OMO, oil bonds, fx intervention,
supervisory norms
The simultaneous co-existence of multiple channels of monetary policy
transmission naturally necessitates an array of monetary policy - quantum and
rate - instruments. Daily fixed rate repo and reverse repo auctions under the
Liquidity Adjustment Facility (LAF) serve as the primary instrument of monetary
policy. Changes in the LAF repo and reverse repo rates (and the Bank Rate)
signal the RBI's interest rate stance and alter the price of primary liquidity.
Liquidity operations usually try to encase call rates in a corridor defined by the
LAF reverse repo and repo rates.
Second, the management of liquidity by the LAF is supplemented by changes in
the cash reserve ratio (CRR) (and standing facilities). The RBI also uses the
Market Stabilization Scheme for the monetary management of capital flows.
Rupee liquidity generated by RBI fx intervention to cap rupee appreciation is
mopped up by the government in gilt auctions under this scheme. The RBI has
been buying oil bonds from oil marketing companies to release fx for oil imports
under its Special Monetary Operations (SMO). The RBI also conducts outright
open market operations in government paper. This is now supplemented by
periodic cancellation of Treasury Bill auctions.
Finally, the RBI typically follows a counter-cyclical policy on supervisory
standards.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
India Macro Weekly
Lending rates: Set to cycle up
„Hot topic: Lending rates set to cycle up 75bp…
We grow more confident of our call of lending rates going up 75bp in the industrial
season after September. Indeed, some banks are already hiking lending rates.
First, credit growth is well on track to our 20% FY11 forecast. Second, the RBI's
CRR hikes have slowed deposit growth to 14% from 20% levels. Even if deposit
growth revives to 17.5% by March 10, as we expect, banks will still face excess
credit demand, given the 8.2% of GDP fiscal deficit. Finally, RBI rate hikes have
pushed up the benchmark risk-free 10y to a mid-cycle 7.5-8% trading range. This,
in turn, has compressed the spread between the still down-cycle lending rates
and the 10y, now 400bp, below the usual 450bp. Key risk: Delhi’s reluctance to
allow higher lending rates to ‘protect’ growth. Do read our last credit report here.
… with credit well set on 20% track…
We continue to expect loan demand to clock 20% growth in FY11. In fact, our
bank analysts, Rajeev Varma and Veekesh Gandhi, report that many leading
banks are actually guiding 22-25% FY11 loan growth. Credit offtake has already
climbed to 20.5% by July (although this is partly exaggerated by telcos' bridge
loans to fund the US$22bn BWA/3G payment). Loan demand is also broadbasing
from retail and services to industrial credit. Do read our banking analysts here.
… when CRR hikes are slowing deposit growth…
The RBI's 100bp CRR hike is generating excess credit demand by curtailing
deposit expansion at a time of strong loan demand and a high fiscal deficit. We, of
course, expect deposit growth, now 14%, to climb back to 17.5% by March 11.
Even so, our proprietary BofAML liquidity model finds that 20% loan demand and
a high fiscal deficit will accord banks the pricing power to raise rates, even though
we are erasing the 2HFY11 50bp CRR hike earlier penciled in.
… and RBI rate hikes have pushed up risk-free rates
RBI rate hikes – 125bp over and 50-75bp to go - have pushed up the benchmark
risk-free 10y to a mid-cycle trading range of 7.5-8%. In our view, this cannot but
pressure up lending rates from down-cycle levels. The spread between bank
lending rates and the 10y, now 400bp, has already compressed below the
medium-term 450bp average. Do read our last rates report here.
Week ahead: 10.4% July WPI inflation
July WPI inflation will likely clock 10.4% (consensus, 10.4%), close to June's,
tomorrow. This, in turn, should support our summer peak off view. Agflation, after
all, is coming off. Besides, WPI data should start recording the March-April
softening of metal prices. As inflation softens, we expect the RBI to pause after
hiking 50-75bp. Deputy governor Gokarn has already said that the RBI has “done
enough” to contain inflation expectations. So why hike at all? Because core
inflation will still likely persist in a high 7-8% range till end-10
Lending rates: Set to cycle up
We grow more confident of our call of lending rates going up 75bp in the industrial
season after September. Indeed, some banks have already hiked lending rates.
First, credit growth is well on track to our 20% FY11 forecast. Second, the RBI's
CRR hikes have slowed deposit growth to 14% from 20% levels. Even if deposit
growth revives to 17.5% by March 10, as we expect, banks will still face excess
credit demand, given the 8.2% of GDP fiscal deficit. Finally, RBI rate hikes have
pushed up the benchmark risk-free 10y to a mid-cycle 7.5-8% trading range. This,
in turn, has compressed the spread between the still down-cycle lending rates
and the 10y, now 400bp, below the usual 450bp. Key risk: Delhi’s reluctance to
allow higher lending rates to protect growth.
Bottom line: 75bp lending rate hike post-September
We grow more confident of our call of lending rates going up 75bp in the industrial
season after October (Chart 1). Will this impact recovery? Not really. Chart 2
shows that the Indian economy slows (accelerates) when the real lending rate
1
,
currently 6.25%, pierces (slips below) the 7.5-8% potential growth rate.
#1. Credit well on 20% track…
Incoming data support our standing view – no longer contrarian, alas! - of
recovery pushing up FY11 credit offtake to 20% levels (Chart 3). July credit
offtake, at 20.5%, is well on track and then some. Our bank analysts report that
many leading banks are actually guiding 22-25% FY11 loan growth here.
driven by credit broadbasing, 3G, lower ECBs ...
Who’s borrowing? The current credit upcycle is running a typical recovery relay
race. Loan demand is spreading to industrial credit from services and retail
(Table 2). Besides, telcos have funded most of their US$22bn BWA/3G payments
by bridge loans (although US$8bn will likely be converted into external
commercial borrowing (ECB) by end-10.). Finally, corporates have been drawing
domestic loans so far as ECB demand has been sluggish.
#2. RBI CRR hikes generating excess loan demand…
The RBI's 100bp CRR hike is generating excess credit demand by curtailing
deposit expansion at a time of strong loan demand and a high fiscal deficit. We,
of course, expect deposit growth, now 14%, to climb back to 17.5% by March 11
(Chart 4). Even so, our proprietary BofAML liquidity model finds that 20% loan
demand will generate excess credit demand of 8.6% of deposits (Table 3). This
should accord banks the pricing power to raise rates, even though we are erasing
the 50bp CRR hike earlier penciled in for 2HFY11.
How reliable has our model been? Past performance suggests that ex ante
forecasts of excess credit demand have usually pushed up lending rates ex post
(Chart 5). The only aberration is FY09 because the RBI aggressively switched to
monetary easing from tightening after the Lehman collapse in October 08.
(cutting deposit growth (along with inflation, 3G ...
Why are deposits slowing? The RBI has reined in high-powered reserve money
slowing down money (and deposit) creation (Chart 6). Second, high inflation is
also pushing up cash demand as the public, after all, now requires more pocket
money for day-to-day transactions (Chart 7). Thirdly, telcos have drawn down
their deposit accounts to pay for BWA/3G spectrum.
…though September should bring some relief ...
We, of course, expect deposit growth to bottom out in September. What
changes? First, we expect the RBI to inject liquidity to fund loan growth. Second,
a peak off in inflation should pull down public cash demand. Third, public spend
should partly return 3G money back to banks. Fourth, deposit rates are moving
up. Finally, there is the base effect of deposits slowing to 18.2% in September -
March 10 from 21.8% in April-August 09.
#3. RBI hikes pushing up risk-free rates
RBI rate hikes – 125bp over and 50-75bp to go - are also pressuring lending
rates. This has normalized the risk-free 10y benchmark rate to at a mid-cycle 7.5-
8%. As a result, the spread between the 10y and the down cycle erstwhile
11.75% SBI advance rate
Can banks sell gilts to fund loans? Fiscal deficit a constraint
Can’t banks fund private credit demand, it is natural to ask, by selling off gilts?
We doubt if Delhi can afford such rebalancing by public sector banks when the
fiscal deficit will be a high 8.2% of GDP (raised from 8% after the recent increase
in expenditure). Sure, banks hold surplus gilts of 4.5% of book beyond the 25%
mandated statutory liquidity ratio. Our estimates in Table 4 suggest an excess gilt
supply of Rs1400bn even if banks buy our projected Rs1750bn in Table 4. It is for
this reason we have a contrarian call of RBI liquidity support (Rs300bn so far).
Can RBI inject money at 10% inflation? 8% growth at stake
But can the RBI, runs another common question, really boost money supply and
deposits at 10% inflation? Our estimates in Table 5 suggest that the RBI will need
to inject Rs1970bn/US$44bn of reserve money to generate the 17.5% money/
deposit growth to meet 20% loan demand necessary to fund growth. As inflation
peaks off ahead, the focus of policy cannot but turn to stepping up money growth,
for all the current hullaballoo about the RBI being behind the curve (Chart 9).
What if capital flows dry up? OMO, CRR cuts
This begs the question, can the RBI provide liquidity if capital flows dry up? As of
now, we assume that reserve money would be funded by OMO, T-Bill auction
cuts and fx intervention after capital flows return in 2HFY11. If flows do not return,
the RBI will likely step up OMO: Table 4 shows they can easily buy Rs1000bn in
2H10. In our view, the RBI would also not balk at cutting CRR if needed.
to 400bp below the average 450bp
Appendix: India's monetary policy
Multiple objectives: Growth, price stability, INR, financial
stability
The RBI pursues multiple objectives as the central bank, manager of public debt,
supervisor of banks and regulator of money, gilts and fx markets. The relative
emphasis is contextual and the RBI publishes inflation and growth "projections".
Financial stability is also a key policy concern. Although the RBI officially only
contains currency volatility, the exchange rate regime is really a managed float.
Multiple indicators: Money, credit, interest/exchange rates,
credit, inflation, fiscal position, balance of payments
Monetary policy is formulated on the basis of information gleaned from a set of
macroeconomic indicators: broad money, interest rates, equity prices, currency,
credit extended by banks and financial institutions, fiscal position, trade, capital
flows, inflation rate, exchange rate, refinancing and transactions in foreign
exchange juxtaposed with output trends.
Multiple transmission channels: Money, credit, interest
rate, exchange rate
Multiple monetary policy transmission channels require the RBI to operate
through both the quantum, as well as the price of money. Monetary policy
impulses travel to the real economy by affecting both credit available and
increasingly, interest rates. The RBI also informally targets the real effective
exchange rate although the official position is really managing volatility.
Multiple instruments: CRR, LAF repo/reverse repo
amounts/rates, Bank Rate, OMO, oil bonds, fx intervention,
supervisory norms
The simultaneous co-existence of multiple channels of monetary policy
transmission naturally necessitates an array of monetary policy - quantum and
rate - instruments. Daily fixed rate repo and reverse repo auctions under the
Liquidity Adjustment Facility (LAF) serve as the primary instrument of monetary
policy. Changes in the LAF repo and reverse repo rates (and the Bank Rate)
signal the RBI's interest rate stance and alter the price of primary liquidity.
Liquidity operations usually try to encase call rates in a corridor defined by the
LAF reverse repo and repo rates.
Second, the management of liquidity by the LAF is supplemented by changes in
the cash reserve ratio (CRR) (and standing facilities). The RBI also uses the
Market Stabilization Scheme for the monetary management of capital flows.
Rupee liquidity generated by RBI fx intervention to cap rupee appreciation is
mopped up by the government in gilt auctions under this scheme. The RBI has
been buying oil bonds from oil marketing companies to release fx for oil imports
under its Special Monetary Operations (SMO). The RBI also conducts outright
open market operations in government paper. This is now supplemented by
periodic cancellation of Treasury Bill auctions.
Finally, the RBI typically follows a counter-cyclical policy on supervisory
standards.
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