CRISIL MonetaryPolicyReview

RBI responds cautiously to government reforms

Overview
The Reserve Bank of India (RBI), in its monetary policy review on September 17th, reduced the Cash Reserve Ratio by 25 basis points to 4.5 per cent while keeping the repo rate unchanged at 8 per cent. The central bank reiterated that while policy reforms and fuel price revisions will help contain fiscal deficit and revive investor sentiments, it is imperative for the government to maintain the recent reforms momentum. If the government continues to show the resolve to reduce fiscal deficit and address supply-side bottlenecks, it will pave the way for monetary easing in the coming months. While WPI core inflation rose to a 6-month high in August 2012, investment demand nearly stagnated and private consumption growth fell to a 10-year low of 4.0 per cent in Q1FY13. We believe the current elevated levels of core inflation may not be sustainable beyond the next few months, as prices begin to adjust to lower demand pressures with a lag. The upward pressure on global crude oil prices as well as revision of electricity and diesel prices will reflect in higher fuel inflation in the short term. However, we believe that the second-round impact could be muted in view of slowing demand.

September 2012

Short-term inflationary pressure rises

Chart 1: Growth-Inflation dynamics

Although short-term inflationary pressure has risen due to high crude oil prices and the recently revised prices of diesel and electricity, it was only expected. Although the surge in global liquidity driven by QE3 could exert pressure on commodity prices, it is likely to be short-lived in the backdrop of slowing global demand.

Policy reforms announced by the government last week including rationalisation of fuel prices and disinvestment in PSUs will help lower fiscal deficit, lift investor sentiments and help attract capital inflows, thereby arresting the rupees depreciation and its adverse impact on inflation.

With domestic demand continuing to slow down, the pressure on core inflation too should begin to moderate early next year. In this situation, if the reform momentum continues, it will create the space needed for lowering the repo rate.
Source: Central Statistical Office, Ministry of Industry

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Chart 2: Investment & consumption growth fall sharply

%, y-o-y growth 18.0 15.0 12.0 9.0 6.0 3.0 0.0 FY 06 FY 07 FY 08 FY 09 FY 10 FY 11 FY 12 Q1 FY13 4.0 0.7

Slowing growth a major cause for concern

Overall GDP growth fell to 5.5 per cent in Q1 FY13. If not for the double-digit growth of the construction sector, overall GDP growth would have been much lower at 5

Fixed Investment

per cent in the first quarter.

Private Consumption

Along with nearly stagnant domestic investments, private consumption growth fell to a decadal low of 4 per cent in Q1FY13. Thus, upside risks to inflation spurred by a pick-up in discretionary consumption spending resulting from lower interest rateshave moderated considerably in the last quarter.

We, therefore, expect rate cuts from the central bank if fiscal policy actions continue to show intent of restructuring government expenditure in favour of investment demand, away from the current focus on consumption expenditure.

Source: Central Statistical Office

Chart 3: Food and Fuel Inflation

Upside risks to food inflation are limited

Overall rainfall deficiency has come down to -8.0 per cent of LPA (long period average) as of September 12th. Although the delayed monsoons have already impacted sowing of some food grains (particularly coarse cereals), the upside risk to food inflation is now expected to be much lower than anticipated.

The immediate direct impact of a revision in diesel prices on fuel inflation is estimated to be 60 basis points. The revision in electricity prices earlier this year will also continue to create an upward pressure of around 35 basis points in September. However, these pressures are short-term in nature and are expected to have limited second-round impact on WPI inflation.

Source: Ministry of Industry

The governments resolve to implement reforms and reduce its fiscal deficit at a time of high global liquidity will help attract capital inflows. This will lift some pressure off the rupee component of inflation. and lower the imported

Chart 4: Growth in credit and deposits

CRR reduction to bring down cost of funds marginally

The RBI has reduced the cash reserve ratio (CRR) by 25 basis points to 4.5 per cent. The move is expected to increase liquidity in the banking system by Rs 170 billion. The CRR cut is also expected to contain liquidity pressures that may arise from advance tax outflows and festival-related currency demand. Release of these non-income generating funds will marginally lower the cost of funds for banks. The lower cost of funds can help bring down lending rates on select portfolio, especially in the retail segment, and add momentum to the pick-up in seasonal demand in the second half of the current fiscal.

Source: RBI, CRISIL Research

Credit offtake to grow by 15-16 per cent in 2012-13

Table 1: Sector-wise bank credit growth

( G ro wt h, y- o - y %) 1 QFY09 2QF Y09 3QFY09 4QF Y09 1 QFY1 0 2 Q F Y 10 3QFY1 0 4 Q F Y 10 1 QFY1 1 2 Q F Y 11 3QFY1 1 4 Q F Y 11 1 QFY1 2 2 Q F Y 12 3QFY1 2 4 Q F Y 12 1 QFY1 3 J uly F Y 13 Indus t ry S e rv ic e s P e rs o na l T e xt ile s lo a ns 1 5.9 17 .4 1 4.6 8 .5 5.5 2 .3 -0.4 4 .7 6.5 8 .9 1 3.4 17 .0 1 7.3 15 .2 1 2.3 12 .1 1 5.0 15 .3 20.9 2 3 .1 1 8.4 12 .5 8.3 9 .3 9.2 12 .7 1 8.6 16 .7 1 7.0 19 .2 20.3 17 .5 1 2.5 10 .4 7.8 7 .5 Iro n & Inf ra s t ru iro n c t ure pro duc t s 24.4 3 3 .7 24.7 3 7 .0 29.9 2 3 .2 21 .3 2 3 .9 26.2 2 6 .5 28.2 2 8 .0 21 .0 2 6 .8 20.0 18 .1 1 9.5 16 .2 41 .7 3 5 .8 38.5 3 5 .1 35.1 4 4 .7 43.2 4 2 .3 44.3 5 5 .0 43.1 3 8 .6 30.2 2 0 .3 20.5 17 .6 1 3.2 15 .5

The banking sectors aggregate credit growth (y-o-y) moderated to 16.7 per cent as of August 24, 2012 from 19.4 per cent as of March 30, 2012 as companies continued to shy away from capital investments given the uncertain macro-economic environment. Growth in infrastructure credit moderated to 15.5 per cent (y-o-y) as of July 2012 from 17.6 per cent as of March 2012. Telecom has been a major dampener, logging a mere 2.6 per cent growth in outstanding loans as of July 2012. Growth in credit outstanding to the power sector has also slowed down to 18.7 per cent as of July 2012 from 22.2 per cent as of March 2012, as the sector continues to be plagued by issues over the rising cost of fuel and its availability. The slowdown in economic growth and its impact on asset quality have significantly affected credit flow to small and medium enterprises, as compared with larger industries. Medium-sized enterprises were the worst affected, with credit growth decelerating to 4.7 per cent as of July 2012 from 11.4 per cent as of March 2012. CRISIL Research expects aggregate bank credit to grow by 15-16 per cent in 2012-13. Growth will be led by increase in demand for retail loans during festive season, a slight improvement in investments expected in the second half of the year and the likely refinancing of foreign currency loans with domestic debt.

26.9 3 0 .6 30.2 2 5 .8 21 .2 17 .9 1 5.7 2 0 .1 25.8 2 9 .2 27.4 2 3 .6 22.0 2 2 .9 1 9.8 2 1.3 20.3 17 .2

31 .3 3 5 .3 27.6 19 .2 20.5 11.0 1 .5 1 15 .0 1 4.1 2 1.0 25.0 2 3 .9 20.9 19 .3 1 4.9 14 .7 1 9.1 15 .0

FY: Financial year Source: RBI, CRISIL Research

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Chart 5: Commercial banks' investment in SLR securities Deposits to grow by 14-15 per cent in 2012-13

At 14.2 per cent as of August 24, 2012, growth in bank deposits (y-o-y) is lower than RBIs projection of 16 per cent for this fiscal as demand for funds moderated and inflation eroded into household savings during this period.

Slower credit growth and the increase in nonperforming assets have led banks to park their funds in safer avenues. Consequently, SLR investments by banks have risen to 29.0 per cent as of August 2012 from 26.5 per cent as of March 2012.

In 2012-13, bank deposits are expected to grow by 14-15 per cent. Factors such as lower household savings rate, lower rate of interest on deposits, high inflation and lesser emphasis on mobilisation of high-cost deposits by public sector banks will moderate the growth in bank deposits.

Source: RBI, CRISIL Research

Chart 6: CD and incremental CD ratios

Incremental credit-deposit ratio likely to be 8085 per cent by end of March 2013

The incremental credit-deposit ratio moderated to 86.5 per cent as of August 24, 2012 from 96.3 per cent as of March 23, 2012, owing to lower credit offtake during this period.

CRISIL Research expects the incremental creditdeposit ratio in 2012-13 to be in the range of 80-85 per cent as deposit mobilisation is expected to be higher vis-a-vis the credit offtake in the rest of the fiscal.

Source: CRISIL Research

Analytical Contacts: Ajay Srinivasan Director, CRISIL Research Email: ajay.srinivasan@crisil.com Media Contacts: Priyadarshini Roy Manager, Communications and Brand Management Email: priyadarshini.roy@crisil.com Phone: +91 22 3342 1812 Jyoti Parmar Assistant Manager, Communications and Brand Management Email: jyoti.parmar@crisil.com Phone: +91 22 3342 1835 Vidya Mahambare Principal Economist Email: vidya.mahambare@crisil.com Neha Duggar Saraf Junior Economist Email: neha.saraf@crisil.com