CRISIL Monetary Policy Review

Next rate cut could be in October

August 2016

As expected, the Reserve Bank of India (RBI) on Tuesday (August 9) kept the repo rate unchanged at 6.5%. While
the central bank believes a good monsoon would curb rising food inflation, it emphasised that sticky core inflation
and the implementation of the Seventh Pay Commission recommendations, especially the increase in HRA, could
pose a challenge. The central bank has retained its March 2017 inflation target of 5% with upside risks.
Since the last monetary policy meeting, higher food prices and sticky services inflation have meant the June CPI
inflation touched a 22-month high of 5.8%. We believe this surge to be a blip and with adequate monsoon pulling it
back. Overall, we expect inflation to average 5%, GDP to grow at 7.9%, and the RBI to deliver another rate cut of 25
basis points this fiscal.
Our view

For fiscal 2017, we expect CPI to stay soft at 5% on average or 10 basis points (bps) higher than in
fiscal 2016 -- if monsoon progresses well with favourable temporal and spatial distribution. While the upward
push to inflation because of low-base effect will ease off soon, food price movement, especially pulses, from
hereon will be the key monitorable. Progress on sowing and copious rains in pulse-growing regions point
will be very helpful. Additionally, with uncertainty around global demand increasing post Brexit, oil prices
have declined for the first time in July after surging in the preceding five months. Brent crude ended
July at $40.76 per barrel compared with $48.05 at June-end. We expect oil prices to remain contained
at $40-45 per barrel in 2016. That will help keep inflation, fiscal deficit and current account deficit under
control.

Loose monetary policies may continue for longer in advanced economies: Brexit an unexpected
event that materialised on June 23 not only rattled the financial markets but also added more uncertainty
to global growth prospects, especially the UK and Europe. To support the British economy from the
aftershocks of Brexit, the Bank of England cut its benchmark interest rates to record lows and upped its
bond buying programme. On the other side, Japan, too, initiated a large fiscal stimulus programme. Chances
of a rate hike by the US Fed also appears slim at this juncture. For India, with a low current-account deficit
and improving macroeconomic conditions, these developments could mean that it is likely to attract higher
inflows relative to last year.

We expect GDP growth to rise to 7.9% in 2016-17, assuming a normal monsoon (as per the latest data,
monsoons have been 3% above normal so far in August). In comparison, the RBI's growth forecast for the
current fiscal is 7.6% and its inflation target is 5% for March 2017.

Net-net, we expect another 25 bps cut this fiscal which could come as early as October.

Monetary policy effectiveness to improve gradually as liquidity conditions improve

In this rate-cutting cycle that began on January 2015, the RBI has brought down the repo rate by 150 bps.
While market-driven interest rates such as those on commercial paper and certificates of deposits fell
sharply until November, they rebounded early this year on tight liquidity conditions. At the same time, base
lending rates of banks have come down only by about 60 basis points, limiting the boost to consumption
from lower interest rates.

However, in the coming months, policy transmission is expected to improve for two reasons: One, the
government has cut the small-savings rate, effective April 1, 2016, giving more room to banks to reduce
their deposit rates. This, in turn, will help reduce the cost of funds, which is a key component when pricing
loans. And second, the shift to marginal cost of funds based lending rate (MCLR) for pricing loans will also
bring down lending rates.

Classification: INTERNAL

Liquidity has continued to improve with the central bank aiming to maintain it near neutral levels. In
July, liquidity turned excess from minor deficit in June. Accordingly, there was net average daily absorption
through the central banks liquidity adjustment facility or the sum of net repo, net term repo, and marginal
standing facility of Rs 49.9 billion in July compared with a net injection of Rs 413 billion in June.

Going ahead, to manage liquidity in the system, the RBI will have to watch out for spectrum auction in the
next two-three months and maturity and outflow of FCNR deposits from the banking system.

Figure 1: Policy transmission to gradually

Figure 2: Liquidity finally comes out of the deficit

improve

zone
Average
deficit(INR
(INRbn)
bn)
Averagedaily
dailyliquidity
liquidity deficit

% fall
rates
(from(from
Jan 2015)
%
fallin in
rates
Jan 2015)
2500

tilltillDec
1515 till Jul
Dec
till16
Jul 16

1.50
1.50
1.25
1.25

2000

1.2
1.1

1.1

1500

0.7
1000

0.6 0.6
0.5

500

Jul-16
Jul-16

Jun-16
Jun-16

May-16
May-16

Apr-16
Apr-16

Mar-16
Mar-16

Feb-16
Feb-16

Jan-16
Jan-16

-500

Dec-15
Dec-15

Base rate***
rate*** 10 year Gsec
Gsec

Nov-15
Nov-15

Policy
Deposit
Policy Repo Deposit
rate*** Commercial
rate*
rate***
paper
rate**
rate*
paper rate**

Oct-15
Oct-15

0.01

Source: RBI, CEIC, CRISIL Research, Note: *average across maturities, **average across maturities, ***major 10 banks, month-end

Classification: INTERNAL
3

Corporate loan offtake was at a 10-year low at

3.7% in June 2016, compared with 5.5% in the
year-ago period. Loan demand was tepid due to
high leverage of some corporates, low
commodity
prices
and
muted
capital
expenditure.

14%

12%

10%

Jul-16

May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15

May-15

Mar-15

8%

Jan-15

Aggregate fortnightly bank credit growth rose

marginally to 9.2% on-year as on July 22, 2016,
from 8.9% in the previous corresponding period.
Good progression of the monsoon improved
credit growth in the agriculture sector. Also, due
to lower interest rate differential between bank
rate and bond rate, funds raised through
commercial papers declined 27% as of July
2016 vis--vis 57% as of July 2015.

Nov-14

Figure 3: Credit growth (on-year)

Sep-14

Bank credit growth to improve in second half of

2016-17

Source: Reserve Bank of India (RBI), CRISIL Research

Figure 4: Commercial paper outstanding

(on-year)
140%
120%

CRISIL Research expects credit growth at 1112% in 2016-17, supported by favourable

economic growth and narrowing differential
between bank lending and capital market rates,
due to implementation of marginal cost of fundbased lending rate (MCLR) and healthy retailcredit growth.

100%
80%
60%

40%
20%
0%

Sep-14
Oct-14
Nov-14
Dec-14
Jan-15
Feb-15
Mar-15
Apr-15
May-15
Jun-15
Jul-15
Aug-15
Sep-15
Oct-15
Nov-15
Dec-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Jul-16

Source: RBI, CRISIL Research

Bank deposit growth to accelerate in 2016-17

Bank deposit growth slowed to 8.9% year-onyear as of July 22, 2016, compared with 11.2%
rise in the previous corresponding period,
mainly because banks kept deposit rates soft
given limited credit demand.

Figure 5: Deposit growth (on-year)

14%

12%

10%

Jul-16

May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15

May-15

Mar-15

Jan-15

8%

Nov-14

However, for 2016-17, bank deposit growth is

expected to range 10-11%, supported by high
credit growth. In 2015-16, bank deposits
increased 9.0%.

Sep-14

Source: RBI, CRISIL Research

Classification: INTERNAL

CD ratio to increase in 2016-17, as credit growth

improves

Figure 6: Trend in credit-deposit ratio

95%
90%

The credit-deposit (CD) ratio was stable at 75%,

as on July 22, 2016, compared with that in July
24, 2015. However, over the period, the
incremental-CD ratio improved to 77% from 61%
on higher growth in credit versus deposits.

85%

80%
75%
70%
65%
60%
55%

In 2016-17, the CD ratio is expected to range

between 78-80%, as credit offtake is projected
to accelerate. In 2015-16, the CD ratio stood at
77.5%.

50%

Sep-14
Oct-14
Nov-14
Dec-14
Jan-15
Feb-15
Mar-15
Apr-15
May-15
Jun-15
Jul-15
Aug-15
Sep-15
Oct-15
Nov-15
Dec-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Jul-16

Incremental credit-deposit ratio

Credit-deposit ratio

Source: RBI, CRISIL Research

Asset quality to be weak

Figure 7: Trend in asset quality

As of March 2016, public sector banks (PSBs)

reported gross non-performing asset (GNPA)
ratio of 9.4%. Asset quality of private sector
banks was also under pressure, but their GNPA
ratio was healthy at 2.8%.

(per cent)
12

10.50
9.40

10
8

8.5
6

In 2016-17, GNPAs are forecast to remain

elevated, on account of the RBIs diktat to
recognise stressed accounts as non-performing
asset under its asset quality review, and high
slippage, mainly from restructured standard
accounts.

4.40

5.00

3.60

3.20

2.9
2.10

1.80

1.80

2.10

March 12

March 13

March 14

March 15

7.6

3.3

3.8

Gross NPAs (%)

4.3
2.80

3.40

March 16 March 17 F

Public Sector Banks

Source: RBI, CRISIL Research

Classification: INTERNAL
5

In 2016-17, the banking sectors NIM is forecast

to decline 10 bps due to slippage, the new MCLR
regime and the UDAY scheme (is a financial
package for power distribution companies).

Subdued NIM, high credit cost and weak loan

growth will affect the profitability (return on
asset) of PSBs in 2016-17, because of high
provisioning.

3.50

3.20

2.90

Mar-16

Dec-15

Jun-15

Sep-15

Mar-15

Dec-14

Jun-14

Sep-14

Mar-14

Dec-13

Jun-13

Sep-13

2.60

Mar-13

Net interest margin (NIM) of PSBs (as of August

8, 2016 only six banks reported) contracted
approximately 10 basis points (bps) on-year in
the June 2016 quarter, and that of private-sector
banks was stable, led by low interest expense in
the wake of a favourable liability mix and a
higher incremental CD ratio.

(per cent)

Dec-12

Introduction of MCLR, reduction in small-savings

rate and refinement in the liquidity management
framework are expected to improve the
transmission of policy rate cuts till date.

Jun-12

Figure 8: Net interest margin

Sep-12

NIM to decline in 2016-17

Source: Company reports, CRISIL Research

Analytical Contacts:
Dharmakirti Joshi
Chief Economist, CRISIL Ltd.
dharmakirti.joshi@crisil.com

Ajay Srinivasan
Director, CRISIL Ltd.
ajay.srinivasan@crisil.com

Adhish Verma
Economist, CRISIL Ltd.
Adhish.Verma@crisil.com

Media Contacts:
Shamik Paul

Khushboo Bhadani

Media Relations
CRISIL Limited
D: +91 22 3342 1942
M: +91 99208 93887
B: +91 22 3342 3000
shamik.paul@crisil.com

Media Relations
CRISIL Limited
D: +91 22 3342 1812
M: +91 72 081 85374
B: +91 22 3342 3000
khushboo.bhadani@crisil.com

About CRISIL
CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency.
We are also the foremost provider of high-end research to the world's largest banks and leading corporations.
CRISIL is majority owned by S&P Global Inc., a leading provider of transparent and independent ratings, benchmarks, analytics and data to the
capital and commodity markets worldwide.
About CRISIL Research
CRISIL Research is India's largest independent integrated research house. We provide insights, opinion and analysis on the Indian economy,
industry, capital markets and companies. We also conduct training programs to financial sector professionals on a wide array of technical issues.
We are India's most credible provider of economy and industry research. Our industry research covers 86 sectors and is known for its rich insights
and perspectives. Our analysis is supported by inputs from our network of more than 5,000 primary sources, including industry experts, industry
associations and trade channels. We play a key role in India's fixed income markets. We are the largest provider of valuation of fixed income
securities to the mutual fund, insurance and banking industries in the country. We are also the sole provider of debt and hybrid indices to India's
mutual fund and life insurance industries. We pioneered independent equity research in India, and are today the country's largest independent
equity research house. Our defining trait is the ability to convert information and data into expert judgments and forecasts with complete objectivity.
We leverage our deep understanding of the macro-economy and our extensive sector coverage to provide unique insights on micro-macro and
cross-sectoral linkages. Our talent pool comprises economists, sector experts, company analysts and information management specialists.
CRISIL Privacy Notice
CRISIL respects your privacy. We use your contact information, such as your name, address, and email id, to fulfil your request and service your
account and to provide you with additional information from CRISIL and other parts of S&P Global Inc. and its subsidiaries (collectively, the
Company) you may find of interest.
For further information, or to let us know your preferences with respect to receiving marketing materials, please visit http://www.crisil.com/privacy.
You can view the Companys Customer Privacy at https://www.spglobal.com/privacy.
Last updated: April 2016
Disclaimer
CRISIL Research, a division of CRISIL Limited (CRISIL) has taken due care and caution in preparing this Report based on the information obtained
by CRISIL from sources which it considers reliable (Data). However, CRISIL does not guarantee the accuracy, adequacy or completeness of the
Data / Report and is not responsible for any errors or omissions or for the results obtained from the use of Data / Report. This Report is not a
recommendation to invest / disinvest in any company covered in the 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 CRISILs Ratings Division / CRISIL Risk and Infrastructure Solutions Limited (CRIS), which may, in their regular
operations, obtain information of a confidential nature. The views expressed in this Report are that of CRISIL Research and not of CRISILs
Ratings Division / CRIS. No part of this Report may be published / reproduced in any form without CRISILs prior written approval.

Argentina | China | Hong Kong | India | Poland | Singapore | UK | USA

CRISIL Limited: CRISIL House, Central Avenue, Hiranandani Business Park, Powai, Mumbai 400076. India
Phone: + 91 22 3342 3000 | Fax: + 91 22 3342 3001 | www.crisil.com