The RBI lowered its GDP growth forecast by 20 bps to 7.4% and its January 2016 inflation forecast to 5.8% from 6% estimated last month. In addition, it has allowed for a gradual increase in the limit on foreign portfolio investments in central and state government bonds. Also, the ceiling for bank investments under the held-to-maturity category will be reduced over time from 22% to 21.5%.
The onus is now on the government to remove impediments to transmission while following a prudent fiscal path, and for banks to pass on the rate cut. The RBI’s policy will remain caution in terms of demand-side pressures on inflation that could arise from the Seventh Pay Commission payout expected in the next two fiscals. Plus the RBI has also set the CPI inflation target at ~5% by end 2016-17 and reiterated it at 4%
Benign conditions create room for the sharp rate cut: Inflation is expected to pick up after August as a favourable base effect wears out but it will remain within the RBI’s 6% target by January 2016. We believe inflation will average 5.4% in the current fiscal compared with 6% in the last. So far this fiscal, inflation has been benign because rising prices of pulses and onions have been offset by a sharp decline in global oil and commodity prices and continued sluggishness in demand conditions The fall in global prices even offset the impact of a depreciating currency . Besides, a fall in capacity utilisation to a 5-year low, damage to farm income and weak growth in non-farm income suggests that recovery in consumer demand is slow. As a result, core inflation has been falling.
Above 6% inflation – This category recorded weighted average inflation of 10.3% in August, up from 8.4% in April 2015. The major items that have contributed to inflation here are onions, tur (arhar), tuition/school/education fees and cooked meals.
0-6% inflation - A majority of items in the CPI basket are included here. Inflation in this category was 4.1% in August, compared with 4.8% in April. The major items with higher inflation rates included house rent, milk, medicines and electricity.
Below 0% inflation - A much smaller proportion of items saw inflation in the negative zone but for these the factors were a mix of global price declines (gold, petrol, sugar) and high base effect of last year (tomato, potato). Inflation in this basket was -10.7% in August, down from -3.2% in April. A favourable mix of global factors, steps by the government control fiscal deficit, restraint shown when raising minimum support prices, and checks on hoarding have reined in overall food inflation despite two consecutive monsoon failures. But we cannot bank on such a benign convergence of events to curb food inflation in future. The larger issue related to food inflation is low farm productivity, wastage, and high vulnerability of agriculture. It’s necessary to address these for a durable fix on food inflation. This will warrant caution on the part of the RBI while deciding on further rate cuts.
Increase in foreign portfolio investment will enable further investments
The move to increase limits on foreign portfolio investment in debt securities and also fix the same in rupee terms (as against the dollar currently) provides more headroom for foreign investments in government securities (G-Secs), as existing limits have almost been exhausted. The RBI will be increasing the limits in central government securities in phases to 5% of the outstanding stock by March 2018. Overall, this is expected to make room for additional investment of Rs 1,200 billion in the limit for central government securities by March 2018 over and above the limit of Rs 1,535 billion for all G-secs. There will be a separate limit for FPI in State Development Loans (SDLs), which is proposed to be increased in phases to reach 2% of the outstanding stock by March 2018. This would amount to an additional limit of about Rs 500 billion.
Bank credit growth to gather steam in latter half of 2015-16
Aggregate bank credit growth declined marginally to 9.11 % y-o-y as on September 4, 2015, from 9.40% in the last fiscal. Poor monsoon, muted investments, rising risk aversion owing to deteriorating asset quality of public-sector banks (PSBs), and an increase in cheaper funds raised via commercial paper ( rose by 40% y-o-y as on September 15, 2015) slowed credit off-take.
Corporate off-take was the most affected, where growth was a dismal 5.6% y-o-y as of July 2015, compared with 11% in July 2014.
We expect a gradual pick-up in the latter half of 2015-16, driven by a rise in retail loan (automobile and home loans), public-sector investments (which will in turn drive-up working capital demand across allied sectors) and small-scale enterprises. Overall, credit growth is projected to increase to 13-15% in 2015-16 vis-à-vis ~12.2% in 2014-15.
Deposits growth also to accelerate
Bank deposit growth slowed to 11% y-o-y as on September 4, 2015, compared with 13.37% in last fiscal, because of lower demand for funds as well as a high-base effect created by a surge in foreign currency non-resident (FCNR) deposits during October-December 2013.
Deposits are forecast to increase 13-15% in 2015-16, compared with a 12.6% rise in 2014-15, backed by an expected pick-up in economic growth and higher disposable income on account of low inflation.
CD ratio to increase in second half of 2015-16
Credit-deposit (CD) ratio stood at 74.2% as on September 4, 2015, down 130 bps compared with September 5, 2014, owing to slowing credit growth.
While credit demand will pick up slightly in the second half of 2015-16, deposits will grow moderately. We, therefore, expect the CD ratio to remain stable at 75-77% in 2015-16.
| Asset quality to remain weak | |||
| Gross non-performing assets (GNPAs), at 4.3% of advances as of March 2015 have increased significantly from 3.8% in March 2014. As of June 2015, PSBs reported GNPAs of 5.47% (83 bps higher y-o-y). The asset quality of private sector banks, though, was relatively robust, with GNPAs of 2%. In 2015-16, GNPAs is estimated to inch up to 4.5% on account of lower sales to asset reconstruction companies (ARCs) and high slippages mainly from restructured standard accounts. In 2015-16, CRISIL expects sales to ARCs to be Rs 60 billion compared with an estimated sale of Rs 160-170 billion in 2014-15 due to regulatory policy changes requiring more capital. | |||
| NIMs to decline marginally in 2015-16 | |||
| Despite the 75 bps cut in the repo rate since January 2015, we have seen lending rates decline only by a gradual 30 bps, given higher risk aversion and pressure on banks’ interest income growth. HDFC bank is the only bank, which has cut its base rate by 65 bps. With a further 50 bps cut today, we expect banks to gradually cut their lending rates and push credit growth as the economic scenario and capital availability for PSBs improves. We expect banks to reduce their lending rate by 30-40 bps in the coming months. While net interest margins (NIMs) of PSBs fell by 9 bps y-o-y in 2014-15, those of private sector banks expanded by 8 bps, led by lower interest expenses arising from a favourable liability mix and higher CD ratio. NIMs are expected to be marginally lower in 2015-16, on account of lower yields and higher GNPAs (especially of PSBs). | |||
We believe the impact of bringing down the ceiling under Held to maturity (HTM) from 22% to 21.5% will be minimal. The decision to reduce Statutory Liquidity ratio (SLR) and HTM ceiling by 0.25% every quarter till March 2017 (starting from January 9, 2016) will potentially help release around Rs 250 billion funds every quarter until March 2017. However, due to lack of adequate lending opportunities, banks are currently investing close to 27% of their net demand and time liabilities in SLR securities, which is way higher than the regulatory requirement of 21.5%.
Contributed by CA Sri Mahendra Kr Jain
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