The Reserve Bank of India lowered its key policy rates for the first in nine months but remained cautious about slower growth and government’s large fiscal deficit. The inflation-growth dynamics reached its tipping point, which led to a reduction in the lending rate and cash reserve ratio (CRR) by 25 bps to 7.75 per cent and 4 per cent, respectively.
The policy repo rate under the liquidity adjustment facility (LAF) was reduced from 8.0 per cent to 7.75 per cent with immediate effect.
The CRR, the cash that banks have to keep with the RBI without any interest, was reduced from 4.25 per cent to 4.0 per cent of their net demand and time liabilities (NDTL) effective the fortnight beginning February 9.
As a result of this reduction in the CRR, around Rs 18,000 crore of primary liquidity will be injected into the banking system.
Factors that changed RBI’s tough stance
Against the backdrop of global and domestic macroeconomic conditions, outlook and risks, the policy stance in this review has been shaped by two major considerations.
First, headline WPI inflation and its momentum edged down in November-December on the back of softening of non-food manufactured products inflation, even though food inflation has risen, adversely impacting households’ inflation expectations. The RBI believes that the headline inflation has peaked and there is an increasing likelihood of inflation remaining range-bound around current levels going into 2013-14.
Secondly, growth has decelerated significantly in 2011-12 and 2012-13 so far and overall economic activity remains subdued.
Going forward, the apex bank would be conditioned by the evolving growth-inflation dynamic and the management of risks from twin deficits -- large fiscal deficit and slowing growth.
Policy guidance
The Reserve Bank’s industrial outlook survey indicates positive business sentiment in Q3 and Q4. In its latest urban households’ survey, inflation expectations for Q4 edged up marginally. Wage inflation in rural areas remained high, notwithstanding some recent moderation. As these wage increases have not been accompanied by improvement in productivity, they have imparted inflationary pressures. House price inflation, as measured by the Reserve Bank’s quarterly house price index, also remains elevated on a y-o-y basis.
An analysis of the early results of corporate performance in Q3 indicates that both sales and expenditure growth moderated while profit margins remained broadly unchanged.
The year-on-year money supply (M3) growth fell to 12.9 per cent by mid-January and remained below the indicative trajectory of 14.0 per cent. This essentially reflected the deceleration of growth in aggregate deposits and moderation in economic activity.
Recently, private lenders ICICI Bank and Axis Bank increased their deposit rate by 25-30 bps in their long tenure term deposits.
The non-food credit growth, at 16.2 per cent by mid-January, was around the indicative trajectory of 16 per cent. However, bank credit to industry showed a significant deceleration while credit to agriculture registered an increase.
The widening wedge between the credit and deposit growth along with the festival demands tightened the liquidity conditions. The Reserve Bank conducted open market operations (OMOs) on five occasions during December 2012 to January 2013, thereby injecting liquidity of Rs 47,000 crore into the banking system. Despite these measures, the average net LAF borrowings at Rs 91,000 crore in January (up to January 27), was above the Reserve Bank’s comfort level.
Market response
As regards monetary policy transmission during Q3 of 2012-13, the average term deposit rates of scheduled commercial banks (SCBs) declined marginally. Although a few banks reduced their Base Rates modestly during the quarter, the weighted average lending rate as well as the modal Base Rate remained broadly unchanged over the quarter.
Some banks trimmed lending rates in certain segments, while the overall monetary transmission remained flat.
Bond and stock markets were largely flat as the dealers had priced in a quarter percentage point rate cut. Benchmark government 10-year yields were largely unchanged at 7.87 percent, while the Nifty ended up 0.3 per cent while the banking sub-index closed up 1.3 per cent.
Banker's Response
Pratip Chaudhuri, Chairman, State Bank of India
We welcome the monetary policy for expanding liquidity by cutting CRR and also lowering interest rate environment by lowering the policy rate. It would be helpful in improving investment climate and start the capex cycle. SBI would do full monetary policy transmission and reduce cost of capital.
Aditya Puri, Managing Director, HDFC Bank
We also have to understand that both a cut in CRR and repo reduces the costs for us. Approximately the cost reduction for us will be Rs 70 crore. So even if we do reduce lending rates a large portion of that will be met by actual cost reduction.
Chanda Kochhar, Managing Director, ICICI Bank
This is the best time for the small depositors because the indication we are getting is that on the lending side there is going to be a transmission and on the deposit side we are going to watch the situation. But clearly in the long term the banks cannot take a hit and price will get adjusted.
SS Mundra, CMD, Bank of Baroda
The net interest margins (NIM) will see an impact due to lower lending rates. But we must remember that the profile of depositors in the banking system is now shorter. This means that a larger number of deposits will now come for reprising at lower rates.
KR Kamath, CMD, Punjab National Bank
Interest rate is also reflected in EMIs which may not always be correct. Today if we are looking at growth in this country fresh investments have to happen. When we said transmission has to happen it also includes other segments like infra or SME.
Abraham Chacko, Executive Director, Federal Bank
Most of the NPAs have not come from the priority sectors. Big ones have come from the large corporate. So I completely support that we should not stop lending to the important sectors but be judicious while doing so.
V Lakshmi Narasimhan, Chief Financial Officer, Magma Fincorp
As long as the twin issues of fiscal deficit and inflation are under control, we can expect RBI to take a proactive action on further rate cuts. The measures announced by the RBI today will spur growth and ease the prevailing tight liquidity condition.
Shinjini Kumar, Director, PwC India
This is consistent with the 'growth push' that the economy needs. However, worries on account of current account are very real and our ability to take advantage of the stimulus will depend upon how we manage to attract stable capital inflows, to solve fiscal issues and to address supply side bottlenecks.
Road ahead as analysts see it
Standard Chartered
After today’s policy action and the guidance provided by the RBI, we reiterate our call of another 25bps repo rate cut to 7.50% at the next policy meeting on 19 March. We believe further easing is justified given our expectation that February WPI inflation – which policy makers will have before the March decision – will fall below 7 per cent. There will also be more clarity on fiscal consolidation after the FY14 budget presentation in February.
Deutsche Bank
We expect three more cuts of 25bps each in the meetings ahead. The March call seems quite safe, in our view, but the subsequent calls will hinge on local and global developments.
CRISIL
As inflationary expectations adjust downward, banks will have greater flexibility in reducing deposit rates, thereby lowering their cost of funds. This will create further space for a reduction in lending rates in coming months.
(Edited by Prem Udayabhanu)
