December 2014

CRISIL Monetary Policy Review

RBI opens the door for a rate cut early next year
Overview: In its monetary policy meeting today (2 December 2014), the Reserve Bank of India (RBI) held the repo rate steady at
8% as expected. We expect inflation to average at 6.7% in FY15 and the RBI to cut rates by April 2015.
In todays rather dovish monetary policy statement, RBI indicated that a change in its monetary policy stance is premature at this
juncture. However, if the fall in inflation is sustained, inflationary expectations remain contained and fiscal developments are
encouraging then a change in monetary policy stance is likely early next year. The RBI kept its central estimate for growth at 5.5%
while revising its inflation projection down to 6% by March-end FY15. In the medium term, RBI expects inflation to hover around 6%
assuming a normal south-west monsoon, lower crude oil prices and no change in administered prices barring electricity. RBI governor
also mentioned that the RBI is in the process of finalizing the monetary policy framework, and the government seems comfortable
with adopting a target of around 4% with a band of +/-2% beyond 2016.
The liquidity in the banking sector has improved and currently the reverse repo rate of 7% is effectively the short-term effective rate
to which other short-term market rates are linked. The yield on 10-year g-sec has also been easing in recent months due to higher
liquidity, falling inflation and lower pressure on government borrowings with declining oil prices. However, even as deposit rates and
short term rates are starting to decline, lending rates will be slow in coming down.

RBI waits for the inflation dip to sustain

Retail inflation dipped by 100 basis points to 5.5% in October driven by lower vegetable prices and transport costs and is expected
to have fallen further in November. The month-on-month momentum in inflation was muted in October signaling that the fall in inflation
was in large part due to a strong base effect from last year. Headline inflation has averaged at 6.6% for the last three months with
core inflation at 6.3% (versus 7.5% in May Jul 2014). We expect inflation to record a sub-5% figure in November post which this
downward glide will feel the brakes.
As the favorable base effect wears off post November, and a pick-up in domestic activity restricts a fall in core inflation, headline CPI
will move upwards in Q4. The overarching good news on inflation is that the crude outlook has turned even more bearish for this, as
well as the next fiscal. In the recent OPEC meeting, countries refrained from reducing production indicating that the downward
pressure on oil prices is here to remain. We now expect oil to average at lower $ 88 93/bbl. in FY15 and at $77 82/ bbl. in FY16
compared to our earlier forecast of $100 - 105/bbl. in FY15 and $90 - 95/bbl. in FY17. Prospects of lower oil prices over the medium
term will also temper inflationary expectations going ahead.
Balancing these factors we expect inflation to average at 6.7% for FY15 and around 6% in FY16. We expect inflation to average at
5.7% in H2 FY15. For next year, we assume a normal monsoon season and the continuation of the current benign trend in crude oil
prices.
On the growth front, GDP data for Q2 show that the economy grew slower at 5.3% (compared to 5.7% in Q1) with agriculture GDP
growing at 3.2%. In other sectors, relative to Q1, industrial GDP growth however, nearly halved to 2.2% in Q2, led by weakness in
the manufacturing sector. Early indicators for Q3 are not yet quite upbeat, leading us to reaffirm our 5.5% GDP growth forecast for

11

CRISIL Monetary Policy Review

FY15. In a recent CRISIL Research report Will a rate cut spur investment? we argued that the recent chorus for an interest rate
cut to revive the economy was pre-mature. The report shows that factors behind the recent slowdown in economic growth and
investment in India have little to do with high interest rates. While, the primary reason for the slowdown has been a sharp fall in the
expected return on investments due to policy uncertainty and slowing domestic demand. Thus a rate cut will yield little return.
We therefore believe that RBI will wait and see if the current fall in inflation is sustained. The first rate cut could take place post budget
in 2015. By that time there would be more clarity on the inflation trajectory as well as the fiscal health of the economy. Also, in the
coming months, the formal adoption of an inflation target by the government as per the recommendations of the Urjit Patel Committee
report will determine the course of action for monetary policy beyond 2016.

Figure 1: Inflation has slumped in recent months

Headline inflation

Food inflation

Figure 2: Key Policy rates

Marginal Standing Facility

Core Inflation

Repo rate

Reverse Repo Rate

17

11
15
13
9
11
9
7

RBI target of 6%

Cash Reserve Ratio: 4.0

Note : RBI target of 6% is for January 2016

Source: CSO, CRISIL Research

22

Source: CSO, CRISIL Research

Nov-14

Sep-14

Jul-14

May-14

Mar-14

Jan-14

Nov-13

Sep-13

Jul-13

May-13

Mar-13

Jan-13

Oct-14

Aug-14

Jun-14

Apr-14

Feb-14

Dec-13

Oct-13

Aug-13

Jun-13

Apr-13

Feb-13

Dec-12

Oct-12

7%

deterioration in asset quality of public-sector banks

5%

(PSBs), and higher financing through cheaper sources

such as commercial paper, which increased by 39 per

Overall credit

cent y-o-y as on October 31, 2014 as against a decline of

Oct-14

investment demand, increased risk aversion owing to

Aug-14

9%

Jun-14

Slower growth in bank credit was also due to sluggish

Apr-14

11%

Feb-14

13%

source of funds, which pushed up demand for bank credit.

Dec-13

15%

rupee depreciation led to higher interest rates on alternate

Oct-13

17%

cent growth last year, as the RBI's policy actions to control

Aug-13

19%

o-y as on October 31, 2014 from a high base of 16.4 per

Jun-13

Aggregate bank credit growth slowed to 10.9 per cent y-

Apr-13

21%

Dec-12

Figure 3: Credit growth (y-o-y)

Feb-13

Credit growth expected to improve in second half of

2014-15

Corporate segment

Retail segment

19 per cent last year.

Source: RBI, CRISIL Research

The slowdown in credit growth was visible in the corporate

(industry and services) segments, which rose by about

Figure 4: Commercial paper growth (y-o-y)

8.2 per cent y-o-y as of October 2014 as compared with

textiles, pharmaceuticals, iron & steel and telecom

80%

sectors.

60%

-40%

single-digit increase.

-60%

We expect credit growth in the banking sector to improve

Oct-14

per cent, with more than half of the banks recording

Aug-14

contrast, PSBs' advances growth was muted at 10

Jun-14

0%
-20%

Apr-14

because of growth in retail and SME credit. In

Feb-14

20%

Dec-13

advances increased by 18 per cent y-o-y, mainly

40%

Oct-13

As on September 2014, private sector banks'

Aug-13

100%

Jun-13

as of October 2014 owing to slow uptake by the

120%

Apr-13

Credit demand from industry lagged at 8 per cent

Feb-13

140%

Dec-12

17.9 per cent growth in October 2013.

Source: RBI, CRISIL Research

to about 15 per cent by end 2014-15, with growth

accelerating in the second half.

33

CRISIL Monetary Policy Review

Deposit growth to be 13-14 per cent in 2014-15

Bank deposits decelerated to 11.5 per cent y-o-y as on

Figure 5: Deposit growth, y-o-y

20%

October 31, 2014 as against 15.4 per cent growth last

year on account of a high base in the October-December

18%

2013 period due to surge in FCNR deposits.

16%

Bank deposits are forecast to increase by 13-14 per cent

14%

in 2014-15, a tad lower than that in 2013-14, due to

subdued GDP growth as well as expected issuance of

12%

infrastructure bonds.

10%

Source: RBI, CRISIL Research

Gross non-performing asset (GNPA), which stood at 3.9

per cent in March 2014, is expected to remain at elevated

(per cent)

6.0

5.6

5.7

3.9

4.0

March 15 F

Figure 6: Trend in asset quality

March 14

Asset quality to remain weak in 2014-15

levels in 2014-15.

As of September 2014, PSBs reported GNPAs of 5.2 per

cent (87 bps higher y-o-y). The asset quality of private

5.0
4.0

sector banks, though, remained relatively robust, with

GNPAs at 1.9 per cent of advances. Aggregate GNPAs of

4.3
3.7
3.3
2.9

3.0

the banking system were at 4.1 per cent.

of outstanding restructured advances (excluding state

power utilities) plus 75 per cent of investments in security
receipts] in the system to stabilise at 5.7 per cent as of

2.0

March 13

We expect weak assets [reported GNPA plus 30 per cent

March 12

Gross NPAs (%)

March 2015, post a sharp increase to 5.6 per cent as of

March 2014 from 4.3 per cent in March 2013
F: Forecast
Source: RBI, CRISIL Research

44

Weak assets (%)

Oct-14

Aug-14

Jun-14

Apr-14

Feb-14

Dec-13

Oct-13

Aug-13

Jun-13

Apr-13

Feb-13

Dec-12

8%

CD ratio to remain at current levels

The credit-deposit (CD) ratio stood at 75.8 per cent as of

October 31, 2014. Compared with October 31, 2013, the

Figure 7: Trend in CD ratio

110%
100%

current CD ratio is down by 40 bps. The drop can be

attributed to credit growth slowing down. Incremental CD

90%

ratio too fell to 72 per cent on October 31, 2014 from 80.8

80%

per cent on October 31, 2013.

70%

Incremental credit-deposit ratio

Oct-14

Aug-14

Jun-14

Apr-14

Feb-14

Feb-13

Dec-13

50%

cent) in 2014-15.

Oct-13

expect the CD ratio to remain at current levels (76-78 per

Aug-13

60%

Jun-13

15, deposits will grow at a moderate pace. We, therefore,

Apr-13

While credit demand will revive in the latter half of 2014-

Dec-12

Credit-deposit ratio

Source: RBI, CRISIL Research

3.5

applicable on fresh deposits, we expect only a marginal

3.4

reduction in the cost of funds on a y-o-y basis in 2014-15.

3.3

Despite easing short-term interest rates and liquidity, we

3.1

do not anticipate significant softening in lending rates as

3.0

credit demand is likely to pick up and overall cost of funds

2.9

3.2

2.8

Sep-14

Jun-14

Mar-14

Dec-13

Sep-13

Jun-13

Mar-13

Dec-12

Sep-12

14 bps, led by lower interest expenses on account of

Jun-12

2.5

Mar-12

stable y-o-y, NIMs of private sector banks expanded by

Dec-11

2.6

Jun-11

2.7

While net interest margins (NIMs) of PSBs' remained

Sep-11

remains firm.

(per cent)

due to easing liquidity. However, as these rates will be

Mar-11

Some banks have reduced deposit rates by 20-25 bps

Sep-10

Figure 8: Net interest margins

Dec-10

Lending rates unlikely to come down; NIMs to

improve marginally in 2014-15

favourable changes in the liability mix and higher CD ratio.

NIMs are expected to improve slightly in 2014-15 due to

gradual recovery in the economy, control over cost of

Source: Company reports, CRISIL Research

funds and better asset mix leading to higher yield on

advances.

55

CRISIL Monetary Policy Review

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Vidya Mahambare

Ajay Srinivasan

Chief Economist, CRISIL Research

Principal Economist, CRISIL Research

Director, CRISIL Research

Email: dharmakirti.joshi@crisil.com

Email: vidya.mahambare@crisil.com

Email: ajay.srinivasan@crisil.com

Sakshi Gupta
Junior Economist
Email: sakshi.gupta@crisil.com

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