monetary policy impact note

8/8/2019 Monetary Policy Impact Note

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1

Mid-Quarter Monetary Policy Preview

RBI fast paces rate normalisation September 16, 2010

In its first mid-quarter monetary policy review held today, Reserve Bank of India (RBI)

raised repo rate and reverse repo rate by 25 bps and 50 bps respectively, thus narrowing

the LAF corridor further to 100 bps. RBI’s decision was mainly influenced by a still

unacceptably high level of inflation but steady growth prospects. The prevalence of

negative real interest rates despite interest rates hikes in the past also weighed on RBI’s

decision. Striking a note of caution regarding the uncertain global scenario, RBI said that

the big picture has not worsened significantly since its July 2010 review. With this move

the central bank so far has increased the repo by 100 bps and reverse repo by 150 bps in

2010-11.

Repo rate to remain the operative rate as liquidity will remain stressed

The net liquidity in the banking system which had moved into deficit territory since June,

2010 moved into the surplus territory in the last week of August 2010, due to various

liquidity boosting measures introduced by the RBI. Although the RBI absorbed average

liquidity to the tune of Rs 157 billion during the period August 23-September 8, the liquidity

situation has again slipped into deficit territory since last couple of days, making the repo

rate the operative policy rate (Chart 2). Going forward also the operative rate is likely to berepo rate due to the large outflow of liquidity from the system on account of advance tax

payment. This also means better monetary policy transmission into the economy. The

narrowing of the LAF corridor is expected to reduce volatility in call money rates.

WPI inflation moderates but still remains a concern

Notwithstanding the slight moderation in WPI inflation to 8.5 per cent (with the new base)

in August 2010, it is still at an unacceptably high level and is way above its trend level of

5.0-5.5 per cent during the past decade (Chart 3). Despite some early signs of downturn

in non-food manufacturing inflation (proxy for core inflation), overall inflation is expected to

remain elevated for some more months. This clearly has implications for real interest rate,

which is currently in the negative territory and is impeding healthy deposits growth. Against

this backdrop, RBI wants to continue its gradualist approach towards interest rate

normalisation, in order to firmly anchor inflationary expectations.

Recent volatility in industrial production raises some doubt

The Industrial production (IIP) growth has remained strong so far in this fiscal, with June

being the only exception. Industrial growth has averaged 11.4 per cent in the first 4 months

against a tepid 4.7 per cent during the same period last year. Growth, particularly, in

capital goods and consumer-durables sector has remained strong, reflecting buoyancy in

both investment and consumption demand. However, high volatility in growth during the

past two months has raised some doubts about the effectiveness of the index to capture

the underlying momentum in the industrial sector. The robust 13.8 per cent IIP growth in

July 2010, after removing the capital goods component shows an increase of mere 7.0 per

cent (chart 4). For the remaining months of this fiscal we expect industrial growth to be in

single-digits due to the high base effect of last year.

Table 1: CRISIL macroeconomic forecast for 2010-11Forecast

5. 5

8. 6

8. 4

8. 0

8.5-9.0

8.3-8.5

43.5-44.0

5. 0

P arameter

Gro wth (%)

Agriculture

Industry

Services

Total GDP

Inflation WPI Average

Interest Rate 10-year G-sec (Year-end)

Exchange Rat e Re/US$ (Year-end)

Fiscal deficit Fiscal Deficit (as a % of GDP)

Chart 1: Policy Rates - Move towards normalisation

0

2

4

6

8

10

Apr-08 Oct-08 May-09 Nov-09 Jun-10

CRR: 6%

Reverse Repo: 5%

Repo: 6%

Source: RBI

Chart 2: Liquidity to remain under pressure

-1000

-500

0

500

1000

1500

2000

0

1

2

3

4

5

6

7Net LAF transactions, Rs bn (LHS) Call Rates (%)

Source: RBI and CCIL

Chart 3: Inflation remains above RBI’s comfort level

-4.0

0. 0

4. 0

8. 0

12.0

J a n - 0 8

A p r - 0 8

J u l - 0 8

O c t - 0 8

J a n - 0 9

A p r - 0 9

J u l - 0 9

O c t - 0 9

J a n - 1 0

A p r - 1 0

J u l - 1 0

W PI

RBI's comfort

level = 5%

Source: Ministry of Industry

Chart 4: Volatile capital goods inflate IIP

13.8%

7.0%

0.0

5.0

10.0

15.0

20.0

A p r - 0 9

J u n - 0 9

A u g - 0 9

O c t - 0 9

D e c - 0 9

F e b - 1 0

A p r - 1 0

J u n - 1 0

Overal l IIP IIP minus capi tal goods

Source: CSO and CRISIL estimates



MID-QUARTER MONETARY POLICY IMPACT ANALYSIS, SEPTEMBER 2010 2

Lending rates expected to increase in the coming quarters

The increase in the repo rate by 25 basis points is expected to be transmitted to the

banking sector in the form of higher cost of funds. Against this backdrop, CRISIL Research

expects lending rates to rise in the coming quarters. However, the increase in lending

rates will be lower than the increase in the marginal cost of funds due to calculation of the

base rate on average cost of deposits and competitive pressures prevailing in the industry. Credit growth expected to pick up marginally

The aggregate y-o-y bank credit growth of 21.6 per cent as on July 2, 2010, on account of

large borrowings for 3G spectrum and broadband wireless access auctions, and advance

tax payments, moderated to 19.4 per cent as on August 27, 2010. Credit growth is

however expected to pick up marginally in the near term due to high capacity utilisation

levels necessitating capital investments, and increase in infrastructure and retail credit.

CRISIL Research expects credit growth in 2010-11 at 20-22 per cent. Increase in bank deposit rates imminent

Despite hiking deposit rates by 25-150 bps in the second quarter of the financial year, the

deposit growth rate, after peaking at 17.1 per cent on March 26, 2010, has ranged at 14-

15 per cent. This is primarily due to investors preferring to channelise their savings to other

investment avenues on account of negative real interest rates on bank deposits. Hence,

we expect banks to increase deposit rates to mobilise resources to support credit growth.

Consequently, the deposits growth rate is expected to reach 18-20 per cent by end 2010-

11. Incremental credit-deposit ratio declines, expected to fall further

Moderation in credit offtake and stable growth in deposits had led to incremental credit-

deposit ratio declining to 92.4 per cent on August 27, 2010 from 99.9 per cent on July 2,

2010. CRISIL Research expects incremental credit-deposit ratio for 2010-11 to declinefurther to 80.0 per cent, primarily on account of expected improvement in the growth of

deposits.

Chart 5: Growth in credit and deposits

0%

5%

10%

15%

20%

25%

30%

35%

Aug-

08

Nov-

08

Feb-

09

May-

09

Aug-

09

Nov-

09

Feb-

10

May-

10

Aug-

10

Deposi t growth Advances growth

Source: RBI and CRISIL Research

Chart 6: CD and incremental CD ratios

0%

20%

40%

60%

80%

100%

120%

Aug-

08

Nov-

08

Feb-

09

May-

09

Aug-

09

Nov-

09

Feb-

10

May-

10

Aug-

10

Credit-deposit ratio Incremental credit deposit ratio

CD: Credit-deposit


Table 2: Sector-wise bank credit growth

(Growth y-o-y %)

Industry Services Personal Infrastructure

loans

1QFY09 26.9 31.3 15.9 41.7

2QFY09 30.6 35.3 17.4 35.8

3QFY09 30.2 27.6 14.6 38.5

4QFY09 25.8 19.2 8.5 35.1

1QFY10 21.2 20.5 5.5 35.1

2QFY10 17.9 11.0 2.3 44.7

3QFY10 14.2 7.9 0.7 47.2

4QFY10 20.1 15.0 4.7 42.3

1QFY11 25.8 14.1 6.5 44.3


Impact on the Banking Sector



Disclaimer:

CRISIL Research, a Division of CRISIL Limited has taken due care and caution in preparing this Report. Information has been obtained by CRISIL

from sources which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is

not responsible for any errors or omissions or for the results obtained from the use of such information. CRISIL is not liable for investment decisions

which may be based on the views expressed in this Report. CRISIL especially states that it has no financial liability whatsoever to the subscribers/

users/ transmitters/ distributors of this Report. CRISIL Research operates independently of, and does not have access to information obtained by

CRISIL’s Ratings Division, which may, in its regular operations, obtain information of a confidential nature which is not available to CRISIL Research.

No part of this Report may be published/reproduced in any form without CRISIL’s prior written approval.

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