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India Focus Treasury Economic Research April 21, 2009 FY10 Annual Monetary Policy Review • RBI cuts

India Focus

Treasury Economic Research

April 21, 2009

FY10 Annual Monetary Policy Review

RBI cuts the repo and reverse repo rate by 25 bps to 4.75% and 3.25% respectively.

March-2010.

Announces GDP growth forecast of 6% for FY10 and WPI inflation target of 4% for end

Cautions against viewing possible negative WPI readings in 1H2009 as characteristic of

either deflation or significant demand destruction. Discusses role of sub-prime lending and provides estimate of effective lending rate.

Emphasizes need to factor in liquidity support (OMO and MSS unwinding) in gauging

impact of government borrowings. Continues to emphasize risks to growth from both global and domestic factors.

While the majority of market participants were prepared for status quo, the RBI went in for a token cut in policy rates of 25 bps. While this might not make a material difference to lending or deposit rates, the signaling effect is important. The RBI continues to be concerned about growth prospects (and less worried about inflation than even in the January policy) and sees enough growth risks around the corner not to take its feet off the monetary pedals.

Table 1: FY10 projections (% yoy)

   

RBI FY10

HDFC Bank

Variable

Current

projections

forecast

GDP growth *

7.1

 
  • 6.0 5.8

WPI Inflation

0.2

 
  • 4.0 3.7

M3

18.6

 
  • 17.0 17.0

Non-food credit

growth

17.5

 
  • 20.0 18.0

 

19.8

 
  • 18.0 17.0

Deposit growth Source: RBI & HDFC Bank Note:* FY09 CSO Advance estimates

 

However the fact that it cut rates by a quarter of a percentage point instead of the half that had become the norm over the past few months suggests that India’s policy rate configuration is close to a bottom. Specifically, we forecast average WPI inflation for FY10 to be around 2-2.5% and that should imply a floor of 2.5-3 per cent for the reverse repo rate. Thus for the rest of 2009 we see at the most two or three rate cuts of 25 bps each. Our sense is that we are returning to the more normal practice of announcing policy measures in the quarterly statements. It is quite likely that the reduction in rates would be announced in the next few policies rather than as interim moves responding to adverse events.

(%)

We have in the past emphasized the fact that managing the government borrowing programme remains the key challenge for the central bank in 2009-10 given the whopping borrowings that has come on the back of fiscal expansion. While there are no new initiatives from the RBI on this front, it does set the record straight by clearly enunciating the measures that it has already taken and the impact it has on the market.

The central bank has specified that it remains committed to ensuring that the government- borrowing programme is conducted in a manner that is non-disruptive to the fixed income market. Citing a buffer of close to Rs 1,20,000 crores likely to be provided by it through auction-based OMOs and MSS unwinding, the monetary authority has specifically drawn attention to the fact that borrowings net of this cushion are slated to be just around Rs 85,364 cr i.e much lower than the Rs 2,07,364 cr aggregate net borrowing figure targeted for H1FY10. Its accommodation of the government-borrowing programme is likely to be close to a 3% reduction in the CRR. We believe that conditions are ripe for a rally in government bonds and see a move in the 10-year yields to the 6 per cent level. However, we would recommend caution at levels below 6 per cent. There are risks around the corner, particularly those related to the yet unknown contours of the borrowing programme that will come with the new budget due sometime in June,2009.

Table 2:Central government borrowings: 1HFY10

 

(Amt. in Rs crores)

FY08

FY09

FY10

Gross market borrowings

97,000

1,06,000

2,41,000

Less: Repayments

30,554

44,028

33,636

Net market borrowings

66,446

61,972

2,07,364

 

0

0

80,000

Less: OMO purchases Less: MSS Unwinding

0

0

42,000

Add: MSS Issuances (net)*

69,077

5,263

0

Net supply of fresh securities

135,523

67,235

85,364

*Includes dated securities and Treasury bills

 

Source: RBI

Fig. 1: Bond yields ease on rate cut move

Domestic 10 year sovereign bond yield

9 8.5 8 7.5 7 6.5 6 5.5 5 Source: Reuters & HDFC Bank 10/1/2008 11/1/2008
9
8.5
8
7.5
7
6.5
6
5.5
5
Source: Reuters & HDFC Bank
10/1/2008
11/1/2008
12/1/2008
1/1/2009
2/1/2009
3/1/2009
4/1/2009

We were surprised and pleased with the extensive discussion on sub-prime lending rates as we were with the reasons for the stickiness of lending rates that the RBI has provided. The central bank has identified the block created by firm administered interest rates on small savings as an important factor behind keeping deposit rates high amidst aggressive monetary easing. Other reasons such as locking into high cost fixed rate deposits (in the wake of the financial crisis in October 2008) and competition for wholesale deposits during the credit boom of the last three years have also been cited as reasons for inflexible lending rates. Rigidities that link BPLRs of banks to concessional lending rates on agriculture and exports have been additionally highlighted as a reason for sticky lending rates.

Taking note of the fact that close to 75% of bank lending in recent months has been done at sub-prime rates, the RBI has compiled effective lending rates that point towards a distinct moderation. After climbing to 12.3% in 2007-08, effective lending rates are likely to have eased below 10.9% by the end of FY09. Nevertheless, the monetary authority has specified that the degree of decline in effective lending rates continues to lag behind key policy rate cuts. However, given the current policy rate configuration, receding inflationary pressures, slower credit growth and some normalization in bank cost of funds as high cost deposits locked into last year run off, we believe that lending rates are likely to decline by around 100 bps during the next three months and align more closely with policy rates.

Treasury economics research team

Abheek Barua,

Chief economist Phone number: +91 (0) 124-4664327 Email ID: abheek.barua@hdfcbank.com

Shivom Chakravarti,

Economist Phone number: +91 (0) 124-4664356

Email ID: shivom.chakravarti@hdfcbank.com

Jyotinder Kaur,

Economist Phone number: +91 (0) 124-4664338

Email ID: jyotinder.kaur@hdfcbank.com

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