India Economy - Monetary Policy - Pleasing easing - Anand Rathi

With today's 25bps cuts in repo rate and CRR, RBI has accelerated the pace of monetary easing Today's measures are likely to result in 15-20bps reduction in the base rates. With probability of softer inflation continuing, the central bank is likely to frontload monetary easing. We expect: (1) Repo rate to be cut by another 50bps by Jun'13 and at least 100bps in 2013; (2) continuation of open market operation; and (3) no further cut in CRR.

- RBI accelerates easing. In line with expectations, RBI today cut the repo and reverse-repo rates by 25bps each, to 7.75% and 6.75%, respectively. In line with our expectation, RBI cut the cash-reserve ratio (CRR) by 25bps to 4% of net demand and time liabilities (NDTL), which would add Rs.18,000cr liquidity to the banking system. Since Jan'12, RBI has cut CRR 200bps, injecting around Rs.120,000cr liquidity.

- Cutting CRR 7x more effective. A 25bps cut in CRR currently means~Rs.1,800cr additional yearly income for banks (yield @10%). A similar amount of repo cut leads to Rs.250cr annual cost reduction (on Rs.100,000cr LAF borrowing) for the banking sector. Therefore, for banks' profit and loss account, cutting CRR by 25bps is currently 7 times more effective than the similar amount of cut in the repo rate.

- Liquidity remains tight. Liquidity in the system has been in a deficit mode for the past two years. Banks' daily average borrowings under the liquidity adjustment facility has been above ~Rs.100,000cr since Nov'12. RBI injected Rs.200,000cr through open market operations (OMO) in 2012. Till the time deposit growth revives, RBI could continue with OMO, although the quantum is likely to be less than half of 2012.

- Base rate cut by 20bps likely. The pass-through of additional income due to 25bps CRR cut and cost reduction due to 25bps repo rate cut would enable banks to reduce base rates 20bps, without impacting net interest income. Continuation of OMO could boost treasury income of banks.

- Policy outlook. As inflation softens to 6.1% by Apr'13e, we expect RBI to frontload its monetary easing and cut repo rate by another 50bps till Jun'13. In CY13, we expect at least 100bps cut in the repo rate. Further, we expect RBI to keep CRR unchanged at 4% in CY13. With fiscal consolidation in the forthcoming budget, we expect considerable reduction in net government borrowing in FY14 over FY13. This, with continuation of OMO, could reduce the 10-year G-sec yield to below 7% by Mar '14.

Source : Equity Bulls

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