Mr. R Murali Krishnan

Head – Institutional Broking

Karvy Stock Broking

RBI POLICY

On first cut, the Central bankers (RBI) stance was more hawkish than anticipated. The monetary tightening is expected to suck the excess liquidity out of the system thereby reducing the demand pressure. This is expected to reduce consumption spending thereby pulling down the demand.

Impact analysis

1. Short term loans would become dearer for both corporate and individuals and will further discourage consumption.

1. Financing of interest rate sensitive sectors like automobiles, consumer durables, housing, Infrastructure etc, would be impacted

1. Going forward, high oil and other commodity prices and the impact of the anti-inflationary monetary stance may stress growth.

1. The pace of industrial activity has been slowing chiefly because of the impact of past monetary policy actions and high input prices. External demand too may slow if global recovery slackens.

1. There is a decline in business confidence and it is natural to predict a moderation in business expectations for the quarter ended June 2011.

1. Growth is expected to moderate in FY12 from its pace in FY11.

1. After this hike, we may see savings bank rate de-regulation to be implemented much before than the street expectation. In deficit liquidity situation it may hurt banks margin, but in times of access liquidity, the banks may lower the rates too, which can be beneficial for them. However, we also feel that there would be some cap & floor on the savings bank rate.

1. Higher provision coverage to impact banks that are below 70% as recommended by the central banker.

Silver lining - Hope

1. Preliminary indication of a normal monsoon during 2011.

1. Agriculture growth is expected to fall back to its trend growth from the higher base of last year.

1. The outlook for crude oil prices in the near future is uncertain, given the geo-political situation in the MENA region. The oil prices are unlikely to moderate RBI Policy Statement. But if see a serious pullback in oil/commodity prices it would abet the rising inflation and RBI stance will dilute.

Specific Impact on Banks

1. Immediate rate hike by bankers is unlikely as most of them have factored in the effects of inflation in their lending rates.

1. Impact of the saving rate hike on banks’ margins could be negative, unless banks pass on the higher cost to borrowers Banks may still see a net impact on NIM’s and profit in the short to medium-term until rates stabilize. A sensitivity analysis indicates that the impact on NIM’s could range between 11bps to 12bps for FY2012E.

1. Given the combination of savings rate increase and repo rate hike, banks would likely need to hike their prime lending rates and base rates by 50 bps in our view, to maintain margins.

1. Again with higher provisioning (as directed) may impact the profitability in a negative way especially for banks with lower PCR and higher restructured assets. In our view these steps will effect Banks margins and profitability negatively in near term (1-2 Quarters). However, if the banks passed on most of the effects to the end users, then we may see some slow down in credit demand going forward and more and more asset quality slippages.

View on markets

Next three months going to be tough on the market. Inflation remains at elevated levels. Investments cycle will slow down impacting demand and earnings growth rates. The central banker GDP growth of 8% looks ambitious given the current inflationary trends. This is a significant risk to growth and earnings revision for the markets for FY12 will have a downward bias. Banks and interest rate sectors will clearly take a knock. Banks have till now passed the interest rate upswing and manage their NIM’s. But a 50bps hike would make things tough given the slowing credit off-take. As the economy slows the NPA’s will start throwing up.

We expect markets to react on this steep hike. Secondly, there is definitely going to be a diesel/petrol price hike and this expectation is very realistic given the level of inflation. Liquidity drives markets and given the strong flows over the past month we need to see how investors react.