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| India Infoline Research Team / 08:15 , Apr 21, 2010 |
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The Reserve Bank of India in its annual monetary policy review today increased its key policy rates (repo and reverse repo rate) and CRR by 25bps each (in-line with our estimates). |
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The Reserve Bank of India in its annual monetary policy review today increased its key policy rates (repo and reverse repo rate) and CRR by 25bps each (in-line with our estimates). Given the risk of rising inflation, the central bank has placed focus on ensuring price stability while anchoring inflationary pressure. It has thereby increased the CRR ratio by 100bps to 6%, repo rate to 5.25% (up 50bps) and reverse repo rate to 3.75% (up 50bps) in a short span of 3-months. The Bank rate, however, has been left unchanged at 6%. Given the surplus liquidity, we do not foresee any increase in lending rates in near term. However, with pick-up in credit activities, we expect lending rates to increase by 100-150bps in FY11. The annual policy has targeted for a real GDP growth of 8% with an upside bias for 2010-11. With inflationary pressure expected to moderate by July, 2010, the central bank has set an inflation outlook of 5.5% by March-end. The policy statement has targeted for a system non-food credit growth of 20% for schedule commercial banks. Deposits growth is pegged at 18%, with money supply (M3) expected to grow at 17% levels for FY11.While a large part of the borrowing programme is front-loaded, with borrowings largely through fresh-issuance of securities, this is expected to create pressure on interest rates in short term. The policy placed focus on financial inclusion and customer services. It also provided sops to infrastructure sector in form of investment norms.
Main policy highlights
- After a prolonged period of accommodative policy stance, the central bank has gradually started unwinding its monetary and fiscal measures. While the central bank had refrained from raising its rates in its second quarter monetary policy review, it had increased the provisioning norm towards commercial real estate. Later, given the risk of rising inflation, the apex bank had shifted its focus from managing the crisis to managing the recovery. In its third quarter policy review, it thereby raised the CRR by 75bps to 5.75% (in phased manner), while keeping key policy rates unchanged. It further raised the repo rate and reverse repo rate by 25bps each to 5% and 3.5% respectively in the month of March, 2010.
- With a view to a) anchor inflation and inflationary expectations b) ensure sustainable recovery process c) enable government borrowing requirements while meeting private credit demand and d) aligning policy instruments in a manner consistent with the evolving state of the economy, the central bank, today raised the CRR and key policy rates (Repo and reverse repo rate) by 25bps each to 6%, 5.25% and 3.75% respectively. While the increase in CRR is expected to anchor inflation expectations, this increase will drain away over Rs125bn of funds from the system. Given the surplus liquidity, we do not expect interest rates to rise until Q2 FY11.
- The International Monetary Fund in its World Economic Outlook Update for January 2010 has projected for a GDP growth of (-) 0.8% in 2009 to 3.9% in 2010 and further to 4.3% in 2011 on a global bases. Given the recent uptick in industrial activities (IIP grew 15.1% for the month of February, 2010), sustenance of good performance of the industrial and services sectors on the back of rising domestic and external demand, the central bank has targeted a real GDP growth of 8% with an upside bias for FY11.
- While the surge in WPI inflation until December, 2009 was largely due to supply-side constrains, it has gradually spilt over to non-food manufactured items in recent times. The WPI inflation for the month of March 2010 stood at 9.9%, much ahead of the RBI comfort zone of 8.5% as articulated in third quarter monetary policy. The contribution of non-food items to overall WPI inflation has rose sharply to 53.3% by March 2010 (from (-) 0.4% in November 2009). Enhancement of excise duty and restoration of the basic customs duty on crude petroleum and petroleum products and the increase in prices of iron ore and coal had a significant impact on WPI inflation. Further, the firming up of global commodity prices also possess upside risks to inflation.
- While the apex bank expects the inflationary pressure to moderate by July, 2010 a) lack of clarity over prospects of the monsoon in 2010-11 b) continued volatility in crude prices and with c)evidence of demand side pressures building up, inflation is expected to haunt in coming period. Keeping in view domestic demand-supply balance and the global trend in commodity prices, the baseline projection for WPI inflation for March 2011 is placed at 5.5%.
- Given the tepid credit growth and comfortable liquidity conditions during the initial part of the previous year (FY 10), the central bank had raised over 70% of its market borrowing programme (until H1 FY10). Further, the unwinding of MSS securities and OMO purchases had resulted in fresh issuance of securities to the tune of only 63% of the total budgeted market borrowings. However, for the current year, almost the entire government borrowing programme is expected to be funded through fresh issuance of securities. While the system liquidity remains sufficient, given the pick-up in credit demand, managing borrowing programme is expected to challenging task. Also, the rising inflation has made it imperative for the reserve bank to absorb surplus liquidity from the system. We expect the central bank to raise its policy rates in coming quarters as its aims to tame down inflationary pressure.
- Given the improving economic environment as is indicated to pick-up in investment activities, the apex bank has increased its non-food credit growth target for schedule commercial banks to 20% for FY11. Deposits growth has been projected at a 18% rate with money supply growth pegged at 17% for the full year FY11.
The Annual monetary policy stance broadly highlighted:
- Anchor inflation expectations, while being prepared to respond appropriately, swiftly and effectively to further build-up of inflationary pressures.
- Actively manage liquidity to ensure that the growth in demand for credit by both the private and public sectors is satisfied in a non-disruptive way.
- Maintain an interest rate regime consistent with price, output and financial stability.
Slew of measures announced
| Key aspects |
Measure |
| At present, banks’ investments in non-SLR bonds are classified either under held for trading (HFT) or available for sale (AFS) category and subjected to ‘mark to market’ requirements. Considering that the long-term bonds issued by companies engaged in infrastructure activities are generally held by banks for a long period and not traded and also with a view to incentivising banks to invest in such bonds, it is proposed: |
To allow banks to classify their investments in non-SLR bonds issued by companies engaged in infrastructure activities and having a minimum residual maturity of seven years under the held to maturity (HTM) category. |
| In terms of extant instructions, banks’ investments in unlisted non-SLR securities should not exceed 10 per cent of their total investments in non-SLR securities as on March 31 of the previous year. Since there is a time lag between issuance and listing of security, banks may not be able to participate in primary issues of non-SLR securities, which are proposed to be listed but not listed at the time of subscription. In view of the above, it is proposed that: |
Investment in non-SLR debt securities (both primary and secondary market) by banks where the security is proposed to be listed on the Exchange(s) may be considered as investment in listed security at the time of making investment. |
| As part of the efforts to ensure convergence of the Indian Accounting Standards (IASs) with the International Financial Reporting Standards (IFRSs), the roadmap for banking companies and non-banking financial companies (NBFCs) has been finalised by the Ministry of Corporate Affairs in consultation with the Reserve Bank. |
As per the roadmap, all scheduled commercial banks will convert their opening balance sheet as at April 1, 2013 in compliance with the IFRS converged IASs. |
| Till June 2004, the Reserve Bank had prescribed a limit on banks’ unsecured exposures. As a step towards deregulation, the above limit was withdrawn to enable banks’ Boards to formulate their own policies on unsecured exposures. The provisioning requirement for unsecured sub-standard exposures, however, was increased to 20 per cent consequent to the withdrawal of limits on banks’ unsecured exposures (the provisioning requirement for secured sub-standard exposures stands at 10 per cent). In view of certain safeguards such as escrow accounts available in respect of infrastructure lending, it is proposed that: |
Infrastructure loan accounts classified as sub-standard will attract a provisioning of 15 per cent instead of the current prescription of 20 per cent. To avail of this benefit of lower provisioning, banks should have in place an appropriate mechanism to escrow the cash flows and also have a clear and legal first claim on such cash flows. |
| In the light of the comments/suggestions received, it has been decided to mandate banks to switch over to the system of Base Rate from July 1, 2010. |
Guidelines on the Base Rate system were issued on April 9, 2010. It is expected that the Base Rate system will facilitate better pricing of loans, enhance transparency in lending rates and improve the assessment of transmission of monetary policy. |
| The Interest Rate Futures contract on 10-year notional coupon bearing Government of India security was introduced on August 31, 2009. Based on the market feedback and the recommendations of the Technical Advisory Committee (TAC) on the Money, Foreign Exchange and Government Securities Markets, it is proposed: |
To introduce Interest Rate Futures on 5-year and 2-year notional coupon bearing securities and 91-day Treasury Bills. The RBI-SEBI Standing Technical Committee will finalise the product design and operational modalities for introduction of these products on the exchanges. |
| Tthe draft guidelines on the regulation of non-convertible debentures (NCDs) of maturity of less than one year were placed on the Reserve Bank’s website on November 3, 2009 for comments/feedback. The comments/feedback received were examined and also deliberated by the TAC on the Money, Foreign Exchange and Government Securities Markets. Accordingly, it is proposed: |
To issue the final guidelines on the issuance of NCDs of maturity less than one year by end-June 2010. |
| The Reserve Bank constituted an internal Working Group to finalise the operational framework for introduction of plain vanilla over-the-counter (OTC) single-name CDS for corporate bonds for resident entities subject to appropriate safeguards. The Group is in the process of finalising a framework suitable for the Indian market, based on consultations with market participants/experts and study of international experience. Accordingly, it is proposed: |
To place the draft report of the internal Working Group on the Reserve Bank’s website by end-July 2010 |
| The draft guidelines on OTC foreign exchange derivatives were placed on the Reserve Bank’s website on November 12, 2009 for public comments. The feedback received from stakeholders and industry associations was discussed in the meeting of the TAC on the Money, Foreign Exchange and Government Securities Markets. On the basis of the discussions, it is proposed: |
To issue final guidelines by end-June 2010. |
| Currently, residents in India are permitted to trade in futures contracts in four currency pairs on two recognised stock exchanges. In order to expand the menu of tools for hedging currency risk, it has been decided: |
To permit the recognised stock exchanges to introduce plain vanilla currency options on spot US Dollar/Rupee exchange rate for residents. |
| In order to promote transparency in the secondary market transactions for CDs and CPs, it is proposed: |
To introduce a reporting platform for all secondary market transactions in CDs and CPs. |
| Foreign banks already operating in India were also allowed to convert their existing branches to WOS while following the one-mode presence criterion. The WOS was to be treated on par with the existing branches of foreign banks for branch expansion in India. No foreign bank, however, applied to establish itself as a WOS or to convert to a WOS during the first phase. Furthermore, while there is a realisation that as international agreement on cross-border resolution mechanism for internationally active banks is not likely to be reached in the near future, there is considerable merit in subsidiarisation of significant cross-border presence. Apart from easing the resolution process, this will also provide greater regulatory control and comfort to the host jurisdictions. Drawing lessons from the crisis, it is proposed |
To prepare a discussion paper on the mode of presence of foreign banks through branch or WOS by September 2010. |
| The Finance Minister, in his budget speech on February 26, 2010 announced that the Reserve Bank was considering giving some additional banking licenses to private sector players. NBFCs could also be considered, if they meet the Reserve Bank’s eligibility criteria. In line with the above announcement, it is proposed: |
To prepare a discussion paper marshalling the international practices, the Indian experience as also the extant ownership and governance (O&G) guidelines and place it on the Reserve Bank’s website by end-July 2010 for wider comments and feedback |
Source: RBI, India Infoline Research
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