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December 2011

CRISIL MonetaryPolicyReview
Rate cut in sight
Overview The RBI clearly signalled today (December 16, 2011) that the policy rate repo rate is at its peak now. It kept the repo rate and CRR unchanged at 8.5 per cent and 6.0 per cent respectively and indicated that a policy reversal is in sight, given slowing growth. While food inflation has fallen sharply in recent weeks, and demand-side pressures (as reflected in manufacturing inflation excluding metals) have begun to decline, imported component of inflation has gone up due to falling rupee. Direct contribution of imported inflation - fuels, commodities and metals - to overall inflation has risen to around 45 per cent, as of November 2011. As a result, WPI inflation remained above 9 per cent in November. With a reversal in monetary policy stance now expected due to moderating growth momentum and higher downside risks to growth, upward pressure on the benchmark 10-year government security (G-sec) yield is expected to ease. 10-year G-sec yield has already been easing in response to the RBIs open market operations (OMOs). Demand-side pressures on inflation begin to decline WPI-based inflation has declined but stayed above 9 per cent in 21 out of the past 22 months. Sharp fall in food inflation is aiding overall decline in inflation. The existing method of measuring core inflation (non-food manufacturing) shows a pick up in November. However, the measure is driven in part by prices of internationallylinked/imported components. CRISIL Researchs alternative measure of inflation which aims at capturing domestic demand-side pressure on inflation (non-metal manufacturing) has in fact shown a decline in momentum since October 2011. ` Chart 2: Contribution to WPI-inflation
Non-metal manufacturing 100% 75% 50% 25% 0% Dec-10 Oct-10 Mar-11 Nov-10 Aug-11 Sep-11 Jun-11 Oct-11 Jan-11 Apr-11 Jul-11 May-11 Nov-11 Feb-11 Primary Imported component

Chart 1: Measures of core inflation

Inflation % yoy 9.00 8.00 7.00 Non-food manufacturing 6.00 5.00 Non-metal manufacturing 4.00 Jun-10 Dec-10 Jun-11 Oct-10 Aug-10 Aug-11 Feb-11 Oct-11 Apr-10 Apr-11

Source: Ministry of Industry, CRISIL Research

Contribution of imported component to WPI inflation has risen The contribution of imported component of inflation has risen to 45 per cent in November 2011, compared to 34 per cent in April. Despite some decline/stabilisation in commodity prices in recent months, sharp fall in the rupee has negated the gains. Since August 2011, when rupee started depreciating, it has lost close to 20 per cent against the US dollar. Rupee touched its lowest level of 54.2 per dollar on December 15. To stem the volatility of rupee caused by excessive speculation, RBI recently tightened regulations related to hedging activities in the forward currency market.

Source: Ministry of Industry, CRISIL Research

CRISIL MonetaryPolicyReview
Chart 3: Repo rate and 10-year G-sec
% 8.5

Pressure on 10-year G-sec yield eases Yield on the 10-year G-sec started easing from December 1, 2011; it has shed close to 30 basis points since then.


This was largely due to anticipation that the rate hike cycle is at its peak and RBI would consider policy reversal in the coming months. In addition, RBIs liquidity easing measures provided a respite to investors, which also helped to soften yields.

8.0 7.0

10 year Gsec

Repo rate

As average borrowings rose to Rs 890 billion in NovemberDecember 2011 almost twice the amount raised in AprilOctober 2011 - the RBI conducted OMOs on three occasions for an amount of about Rs 240 billion.

6.0 Jun-11 Jun-11 Sep-11 May-11 Dec-11 Nov-11 Nov-11 Jul-11 Mar-11 Aug-11 Aug-11 Feb-11 Feb-11 Oct-11 Apr-11 Apr-11

Although the RBI has stated that there are no signs of stress in the money market, average borrowings under LAF remain persistently above its comfort zone, raising the chances of further OMOs.

Source: RBI, CRISIL Research

Inflation to be around 7 per cent by March 2012 Food inflation is falling sharply. Its contribution to inflation has also fallen sharply to 18 per cent in November from about 25 per cent average in the year so far. With good monsoons, pressures from food inflation are likely to ease further. In addition, domestic demand (private final consumption expenditure plus fixed investment) growth has posted sharp slowdown in the recent months. Accordingly, a decline in domestic demand-led inflation is also imminent. With the Euro zone expected to fall back into recession, growth in Japan and the US remaining tepid and a slowdown in Chinas growth, we do not expect much upside in global commodity prices hereon. However, fall in the rupee will weigh on inflation in the short term.

Chart 4: Inflation trajectory

% yoy 11.0 10.0 9.0 8.0 7.0 6.0 5.0 Jul-11 Jan-11 Sep-11 Nov-11 Jan-12 Mar-11 May-11 Mar-12 9.1

Source: Ministry of Statistics, CRISIL Research

Chart 5: Growth in credit and deposits

Deposit growth 30% 25% 20% 15% 10% 5% 0% Credit growth

Deposit growth to be at 18 per cent by end March 2012 With 75-100 basis points increase in deposit rates in the first half of 2011-12, and a correction in capital markets, deposit growth has moved up to 17 per cent as on November 25, 2011 from 16 per cent as on March 25, 2011. CRISIL Research does not expect deposit rates to rise further over the next two quarters. Overall deposit growth would remain at about 18 per cent by end March 2012. With moderation in credit offtake and steady growth in deposits, SLR investments have gone up to 28.2 per cent as of November 25, 2011 from 26.7 per cent as on March 25, 2011.

Aug-10 Nov-09 Nov-10 Aug-11 Feb-10 Feb-11 May-10 May-11 Nov-11

Source: RBI, CRISIL Research

Table 1: Sector-wise bank credit growth

(Growth, y-o-y %) Industry Services Personal loans Textiles Iron & iron pd ts 24.4 33.7 24.7 37.0 29.9 23.2 21.3 23.9 26.2 26.5 28.2 28.0 21.0 26.8 26.1 Infras truct ure 41.7 35.8 38.5 35.1 35.1 44.7 43.2 42.3 44.3 55.0 43.1 38.6 30.2 20.3 21.7

Credit growth to remain at 17 per cent by end March 2012 Aggregate y-o-y bank credit growth moderated to 16.7 per cent as on November 25, 2011 from 21.6 per cent on March 25, 2011 due to slowdown in economic and investment growth, rising interest rates and uncertain global environment. Infrastructure credit growth has moderated to 21.7 per cent in October 2011 from 39 per cent in March 2011. Telecom has been a major dampener with outstanding loan growth coming down to -5 per cent in October 2011. Credit growth to power sector has also declined to 30 per cent in October 2011 from 43 per cent in March. Growth in priority sector lending declined to 10 per cent in October 2011 from 15 per cent in March 2011 with decline in credit growth for agriculture & allied sectors and micro & small enterprises in services sector. CRISIL Research expects credit growth to remain at 17 per cent by March 2012. With repo rate at high level, banks cost of funds has increased. However, sluggish credit demand and the limited ability of banks to pass on the increase in cost of funds would pull down their net interest margins by 1520 bps in 2011-12.

1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 3QFY11 4QFY11 1QFY12 2QFY12 Oct-2011

26.9 30.6 30.2 25.8 21.2 17.9 15.7 20.1 25.8 29.2 27.4 23.6 22.0 22.9 23.1

31.3 35.3 27.6 19.2 20.5 11.0 11.5 15.0 14.1 21.0 25.0 23.9 20.9 19.3 18.2

15.9 17.4 14.6 8.5 5.5 2.3 -0.4 4.7 6.5 8.9 13.4 17.0 17.3 15.2 14.5

20.9 23.1 18.4 12.5 8.3 9.3 9.2 12.7 18.6 16.7 17.0 19.2 20.3 17.5 17.4



Source: RBI

Chart 6: CD and Incremental CD ratios

Credit-deposit ratio Incremental credit-deposit ratio

Incremental credit-deposit ratio to remain at 70-75 per cent by end March 2012 The incremental credit-deposit ratio per cent on November 25, 2011 from March 25, 2011 owing to a moderation given higher interest rates, and a growth in deposits. declined to 73.3 97.2 per cent on in credit off-take relatively higher

120% 100% 80% 60% 40% 20% 0%

Aug-10 Nov-09 Nov-10 Aug-11 Feb-10 Feb-11 May-10 May-11 Nov-11

As this scenario is likely to continue, CRISIL Research expects the ratio to remain at 70-75 per cent by March 2012.

Source: CRISIL Research

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