RBI's Credit Policy (3rd May 2013) - Our Take

RBI’S CREDIT POLICY – 3rd May 2013…Repo Rate reduced by 0.25% from 7.5% to 7.25%... Other Key rates kept unchanged

· Cash Reserve Ratio – The cash reserve ratio (CRR) of scheduled banks has been retained unchanged at 4.0% of their net demand and time liabilities (NDTL).

· Repo Rate – The repo rate under the liquidity adjustment facility (LAF) has been reduced by 25 bps from 7.5% to 7.25% with immediate effect.

· Reverse Repo Rate – Reverse repo rate, determined with a spread of 100 bps below the repo rate, automatically stands adjusted to 6.25% with immediate effect.

· GDP growth - The baseline GDP growth for 2013-14 is projected at 5.7%. The RBI in its policy statement said that – “During 2013-14, economic activity is expected to show only a modest improvement over last year, with a pick-up likely only in the second half of the year. Conditional upon a normal monsoon, agricultural growth could return to trend levels. The outlook for industrial activity remains subdued, with the pipeline of new investment drying up and existing projects stalled by bottlenecks and implementation gaps. With global growth unlikely to improve significantly from 2012, growth in services and exports may remain sluggish”.

· Inflation projection - The baseline projection for headline WPI inflation for 2013-14 is expected to be range-bound around 5.5% during 2013-14. The RBI expects the imported inflation to be lower on expectations of some softening of crude oil and food prices (provided the exchange rate remains broadly stable). On the other hand, it expects food inflation to be the likely source of upside pressure because of persisting supply imbalances. Besides this, the timing and magnitude of administered price revisions, particularly of electricity and coal, to impact the evolution of the trajectory of inflation in 2013-14. The RBI said – “Keeping in view the domestic demand-supply balance, the outlook for global commodity prices and the forecast of a normal monsoon, WPI inflation is expected to be range-bound around 5.5% during 2013-14, with some edging down in the first half on account of past policy actions, although there could be some increase in the second half, largely reflecting base effects”. It further added that – “It is critical to consolidate and build upon the recent gains in containing inflation. Accordingly, the Reserve Bank will endeavour to condition the evolution of inflation to a level of 5.0% by March 2014, using all instruments at its command”.

· Monetary Aggregates - M3 growth for 2013-14 is projected at 13.0%. Consequently, aggregate deposits of SCBs are projected to grow by 14.0% and the growth in non-food credit of SCBs is projected at 15.0%.

Other Important Announcements

· Priority Sector Guidelines – Certain loan limits enhanced for being eligible to be classified as priority sector advances within the broad contours of the priority sector architecture:

1. Increased the loan limit for micro and small enterprises (MSEs) in the services sector, from `20 mn to `50 mn per borrower;

2. Increased the loan limit from `10 mn to `50 mn per borrower for bank loans to dealers/sellers of fertilisers, pesticides, seeds, cattle feed, poultry feed, agricultural implements and other inputs which are classified as indirect finance to agriculture; and

3. Raised the limit on pledge loans (including against warehouse receipts) from the current limit of `2.5 mn to `5 mn for classification as direct agriculture loans in the case of individual farmers and as indirect agriculture loans in the case of corporates, partnership firms and institutions engaged in agriculture and allied activities.

We believe that widening the definition of priority sector lending norms is likely to help private banks to meet priority sector targets to some extent.

· Un-hedged portion of the foreign currency exposure of corporate - In order to address the risks on account of un-hedged forex exposure of corporates, it is proposed to:

1. Increase the risk weight and provisioning requirement on banks’ exposures to corporates on account of the corporates’ un-hedged forex exposure positions.

Detailed guidelines will be issued by end-June 2013.

· Speedier branch expansion in unbanked rural centres - To facilitate speedier branch expansion in unbanked rural centres for ensuring seamless roll out of the DBT Scheme of the Government of India, banks are advised to:

1. Front-load the opening of branches in unbanked rural centres over a 3 year cycle co-terminus with the FIP. Credit will be given for branches opened in unbanked rural centres in excess of 25% in a year which will be carried forward to the subsequent year of the FIP.

Detailed guidelines will be issued by end-June 2013.

· Import of Gold - With a view to reducing the demand for gold for domestic use, it is proposed to:

1. Restrict the import of gold on consignment basis by banks only to meet the genuine needs of exporters of gold jewellery.

Detailed guidelines will be issued by end-May 2013.

Our Take

In line with the market expectations, the RBI has cut the Repo rate by 25 bps from 7.5% to 7.25% of NDTL with immediate effect. However, the cash reserve ratio (CRR) of scheduled banks has been retained unchanged at 4.0% as against the expectation of 25 bps cut. Commenting on managing liquidity going forward the RBI said – “The Reserve Bank will endeavour to actively and appropriately manage liquidity to ensure adequate credit flow to the productive sectors of the economy and to reinforce monetary transmission consistent with the growth-inflation balance”.

Commenting on guidance the RBI said – “Recent monetary policy action, by itself, cannot revive growth. It needs to be supplemented by efforts towards easing the supply bottlenecks, improving governance and stepping up public investment, alongside continuing commitment to fiscal consolidation. With upside risks to inflation still significant in the near term in view of sectoral demand supply imbalances, ongoing correction in administered prices and pressures stemming from MSP increases, monetary policy cannot afford to lower its guard against the possibility of resurgence of inflation pressures. Monetary policy will also have to remain alert to the risks on account of the CAD and its financing, which could warrant a swift reversal of the policy stance. Overall, the balance of risks stemming from the Reserve Bank’s assessment of the growth-inflation dynamic yields little space for further monetary easing.

Overall we believe, the policy action by the RBI to be neutral-to-negative for the markets. Expectations of a CRR cut was built up in the market, leading to an immediate disappointment. Besides this, the RBI’s guidance for limited space for further monetary easing further disappointed the markets. It warned that the risk of inflationary pressure persists despite a recent sharp decline in WPI inflation, and said a high current account deficit poses the biggest risk to the Indian economy. From equity market perspective, we advise investors to continue to stick to (1) sectors with visibility on growth – consumption and pharma, (2) interest rate sensitives like banking and auto, and (3) reform led sectors like oil & gas and media.