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RBI Monetary Policy Review-250111


									                                                                                                 Monetary Policy Review| Banking
                                                                                                                      January 25, 2011

                                                                                          Vaibhav Agrawal
 Monetary Policy Review                                                                   022 – 3935 7800 Ext: 6808
 Back on the inflation trail
                                                                                          Shrinivas Bhutda
                                                                                          022 – 3935 7800 Ext: 6845
 RBI hikes repo and reverse repo rates by 25bp each
      Hikes repo rate by 25bp to 6.5%
      Hikes reverse repo rate by 25bp to 5.5%
      Keeps cash reserve ratio unchanged at 6.0%
      Additional liquidity support under the LAF window up to 1% of NDTL
      extended till April 8, 2011

 Focus on anchoring inflationary expectations
 The RBI in its third quarter monetary policy review raised the repo and reverse
 repo rates by 25bp each to 6.5% and 5.5%, respectively, with an objective to
 control inflationary expectations. The RBI stated that its current monetary policy
 stance is intended to:

      Contain the spill-over of high food and fuel inflation into generalised inflation
      and anchor inflationary expectations, while being prepared to respond to any
      further build-up of inflationary pressures.

      Maintain an interest rate regime consistent with price, output and financial

      Manage liquidity to ensure that it remains broadly in balance, with neither a
      surplus diluting monetary transmission nor a deficit choking off fund flows

 Upward bias for broader domestic interest rates
 With credit growth expected to sustain above 19–20% for FY2011 and deposit
 growth languishing at 16.5% yoy, almost all banks have already increased their
 retail fixed deposit rates (in most cases above 100bp) in 3QFY2011. However,
 the gap between credit and deposit has kept liquidity in the deficit since
 September 2010. Accordingly, over the course of the year, we expect deposit and
 lending rates to remain on an upward trajectory.

 Macro-fundamentals suggest possible rupee depreciation
 The gap between savings and investments is being plugged by the high current
 account deficit at present. The RBI has expressed its concern over India’s high
 current account deficit, which it expects would touch 3.5% of GDP in FY2011.
 In fact, combined with the fact that inflation is also likely to be as high as 7% for
 FY2011, both these macro parameters point towards a rupee depreciation
 in our view.

Please refer to important disclosures at the end of this report                                                                    1
                                                                                     Monetary Policy Review

                   Focus on anchoring inflationary expectations

                   In April last year, we had set a target of 7% for the repo rate, citing a need for a
                   front-ended increase in policy rates in this upcycle, following the sharp decline in
                   policy rates post the Lehman crisis. While the RBI had continued to increase policy
                   rates regularly up to 6.25% on the repo front, it took a pause in December 2010,
                   as tight liquidity was leading to a naturally tight monetary environment.

                   Exhibit 1: Natural tightening due to tight liquidity
                         (` bn)
                                                   Repo (-ve) / Reverse Repo (+ve)






                   Source: RBI, Angel Research

                   However, as of December 2010, the WPI climbed once again to a high level of
                   8.4%. The contribution of food and textiles to the 8.4% WPI was 47%, while oil’s
                   contribution to overall inflation increased to 19%. Contribution of other items
                   (having 55% weightage in the WPI index) increased to 34% in December 2010 due
                   to increased prices of coal, metals, electricity and wood products among others,
                   indicating that inflation is becoming more broad-based. In fact, the RBI itself has
                   hiked its inflation projection by the end of FY2011 to 7%, way above its comfort
                   zone. Moreover, while the RBI expects inflation to start moderating in 1QFY2012,
                   it has noted upside risks to inflation as food inflation has remained at an elevated
                   level for about two years and the prospect of it spilling over to the general inflation
                   process is rapidly becoming a reality.

                   Exhibit 2: WPI (food v/s non-food) for December 2010
                                                                           Weightage in         % contribution
                                                      Inflation yoy (%)
                                                                           WPI Index (%)        to current WPI
                   Food and textiles                             10.3                36                     47
                   Oil                                           15.8                 9                    19
                   Others                                           5.0              55                    34
                   Current WPI                                      8.4
                   Source: MOSPI, Angel Research; Note: Data as per 2004-05 series

                   Therefore, resumption of monetary policy tightening by the RBI to anchor inflation
                   expectations is appropriate at this juncture. Policy and broader interest rates are in
                   any case well below peak levels, leaving ample scope for gradual monetary
                   tightening, without adversely affecting the growth outlook.

January 25, 2011                                                                                            2
                                                                                                                  Monetary Policy Review

                                             Domestic supply-side inflation does not mean policy rates can be
                                             left unchanged
                                             Though the problem of inflation seems to be more affected on account of
                                             supply-side issues; internationally, central banks have historically raised policy
                                             rates in the scenario of rising inflation even if economic growth is not so high (as
                                             can be seen in Exhibit 3). For instance, during mid-1970s and early 1980s, crude
                                             oil prices jumped up sharply, which hampered economic growth and at the same
                                             time resulted in high inflation in the US. The US Federal Reserve (US Fed)
                                             aggressively resorted to monetary tightening despite the recessionary environment
                                             and essentially a supply-side inflation issue. Hence, considering the upward
                                             revision in inflation projection from 5.5% to 7.0% by FY2011-end, we believe the
                                             RBI will continue its gradual tightening of policy rates going forward, maintaining a
                                             hawkish stance.

                                             We believe that domestic monetary policy would indeed be ineffective in
                                             addressing increases in the prices of global commodities such as crude and
                                             metals. As far as this kind of inflation is concerned, we believe curbing domestic
                                             demand and growth would not be the answer and, in our view, the RBI would take
                                             cognizance of the same. Rising global commodity prices create a problem for the
                                             domestic economy as a whole, rather than creating adverse effects for different
                                             population segments in an inequitable manner. The country needs to find ways of
                                             meeting its global resource requirements more sustainably, rather than choosing to
                                             tighten monetary policy to tackle the same. However, at present, evidently, global
                                             commodities are only a small part of the problem and, at present, the fiscal and
                                             monetary policy challenge is clearly to address domestic-driven inflation,
                                             emanating from both the demand and supply side.

Exhibit 3: US Fed. aggressively increased discount rates in a rising inflation & benign growth environment

                                    GDP growth (%, RHS)          Discount rate (%)         Inflation (%)
   16.0                                                                                                                         10.0

   12.0        5.8
                                             5.4                     5.6
    8.0                                                                              3.1                                        4.0
                         (0.6)   (0.2)                                                        (0.3)
     -                                                                                                                          (2.0)
              1973       1974    1975       1976          1977      1978         1979        1980          1981        1982

Source: Angel Research

                                             Macro-fundamentals suggest possible rupee depreciation
                                             The gap between savings and investments is being plugged by the high current
                                             account deficit at present. The RBI has expressed its concern over India’s high
                                             current account deficit, which it expects would touch 3.5% of GDP for FY2011.
                                             In fact, combined with the fact that inflation is also likely to be as high as 7% for
                                             FY2011, both these macro parameters point towards a rupee depreciation in our

January 25, 2011                                                                                                                        3
                                                                                                            Monetary Policy Review

                   view. We believe this could provide the much-needed impetus to export growth,
                   leading to a more sustainable balance of payment situation. At the same time, this
                   should help normalise the liquidity situation to an extent, as one of the missing
                   sources of reserve money creation in this cycle so far has been net accretion in our
                   forex reserves.

                   Exhibit 3: Sources of accretion in forex reserves
                   (US$ bn)                                        3QFY2010          4QFY2010              1QFY2011          2QFY2011
                   Current account                                    (11.7)               (8.1)                 (13.7)             (14.2)
                   FDI                                                     2.4                3.2                    3.2              2.1
                   FII                                                     5.7                8.8                    4.6             19.2
                   ECBs                                                    1.6                0.2                    2.7              3.3
                   Banking capital                                         1.8             (0.8)                     4.0             (3.2)
                   Short-term credit                                       3.2                5.1                    5.6              1.1
                   Other capital inflows                                (2.5)              (4.8)                  (2.7)              (5.0)
                   Valuation change                                        0.4             (6.6)                  (7.0)              13.8
                   Net Annual Accretion                                    0.8             (3.0)                  (3.3)              17.1
                   Net Forex Accretion
                                                                           0.4                3.6                    3.7              3.3
                   (excl. valuation changes)
                   Source: RBI, Angel Research

                   Exhibit 4: Forex reserves position

                                                   Forex Reserves (USD bln)                        % yoy growth
                         310                                                                                                        12.0

                         300                                                                                                        10.0

                         270                                                                                                        2.0

                         260                                                                                                        0.0







                   Source: RBI, Bloomberg, Angel Research

                   Upward bias for broader domestic interest rates

                   As on December 31, 2010, the yoy growth rate in credit stood at 24.4% compared
                   to 18.0% in May 2010, much above the indicative projection of 20%. We expect
                   credit growth to sustain above 19–20% for FY2011. At the same time, deposit
                   growth has remained flattish at 16.5% yoy compared to 16.1% yoy during the
                   corresponding period last year.

                   Almost all banks increased their retail fixed deposit rates (in most cases above
                   100bp) in 3QFY2011, leading to a ~200bp increase in deposit growth post that
                   period. However, the gap between credit and deposit has kept liquidity in the
                   deficit since September 2010. Accordingly, over the course of the year, we expect
                   deposit and lending rates to remain on an upward trajectory.

January 25, 2011                                                                                                                          4
                                                                                                                  Monetary Policy Review

                   Exhibit 5: Hike in peak retail FD rates in 3QFY2011
                   Bank                                                              3QFY11                       2QFY11                 chg. (qoq)
                   UNBK                                                                       8.60                     7.00                       160
                   INDBK                                                                      8.50                     7.00                       150
                   PNB                                                                        8.50                     7.00                       150
                   SIB                                                                        9.00                     7.50                       150
                   J&KBK                                                                      8.50                     7.25                       125
                   DENABK                                                                     8.25                     7.00                       125
                   OBC                                                                        8.75                     7.50                       125
                   SBI                                                                        8.50                     7.25                       125
                   UCOBK                                                                      8.25                     7.00                       125
                   YESBK                                                                      8.50                     7.50                       100
                   AXSB                                                                       8.25                     7.35                            90
                   CRPBK                                                                      8.40                     7.50                            90
                   IOB                                                                        8.60                     7.75                            85
                   BOI                                                                        8.25                     7.50                            75
                   HDFCBK                                                                     8.25                     7.50                            75
                   ICICIBK                                                                    8.25                     7.50                            75
                   Source: Company, Angel Research

                   Exhibit 6: Deposits growth still lagging despite an increase in FD rates
                     (%)                                  Credit growth                         Deposit growth














                   Source: RBI, Angel Research

                   Banking sector outlook – High CASA banks to outperform
                   We expect the banking sector to be amongst the strongest performers over the next
                   two years, with at least 20% credit growth for the sector as a whole, driven by
                   strong GDP prospects, well-below-peak (albeit rising) domestic interest rates and
                   increasing risk capital inflows from abroad. Data from the last cycle indicates that
                   banking stocks gave negative returns, on an absolute basis, when interest rates
                   were falling post the Lehman crisis, since interest rates were merely symptomatic of
                   a declining economic environment when markets as a whole were falling. On the
                   other hand, the banking sector gave handsome returns during the upcycle from
                   2003, even though interest rates were rising–concomitant to strong GDP growth.

                   However, on a relative basis, given the rising interest rates, we prefer banks with a
                   high CASA ratio and lower-duration investment book. Broadly, this combination is

January 25, 2011                                                                                                                                        5
                                                                                                                      Monetary Policy Review

                                                     available in large banks, viz. ICICI Bank, Axis Bank and SBI. We expect these
                                                     banks to outperform on account of their strong core competitiveness and likelihood
                                                     of credit and CASA market share gains, driven by strong capital adequacy and
                                                     robust branch expansion. Generally, we expect mid-size banks to underperform on
                                                     the net interest income front from 4QFY2011 and expect stock returns to reflect the
                                                     same. Taking into account valuations, our top picks are Axis Bank, ICICI Bank and
                                                     SBI among large-cap banks. Amongst smaller banks, we like Indian Bank, Dena
                                                     Bank, Federal Bank and Jammu & Kashmir Bank.

Exhibit 10: Recommendation summary
                              CMP      Tgt. price    Upside      FY2012E         FY2012E     FY2012E          FY10-12E     FY2012E    FY2012E
Company      Reco.
                               (`)             (`)      (%)      P/ABV (x)   Tgt P/ABV (x)     P/E (x)   CAGR in EPS (%)    RoA (%)    RoE (%)
AxisBk       Buy             1,298         1,688       30.0           2.5             3.2        12.8              27.6         1.6       20.8
FedBk        Buy               375           505       34.8           1.1             1.5         8.3              29.1         1.4       14.2
HDFCBk       Buy             2,087         2,501       19.8           3.3             4.0        18.1              34.0         1.7       19.9
ICICIBk*     Buy             1,038         1,312       26.4           2.2             2.6        17.1              29.7         1.5       15.8
SIB          Neutral            22               -        -           1.3                -        7.8              16.9         1.0       17.4
YesBk        Accumulate        278           313       12.5           2.1             2.4        12.9              23.8         1.3       17.9
BOI          Accumulate        468           500        6.8           1.4             1.5         7.6              36.4         0.9       19.9
CorpBk       Buy               564           654       15.8           1.0             1.2         5.7              10.4         1.0       19.3
DenaBk       Buy               106           138       29.8           0.9             1.2         5.2                8.4        1.0       20.9
IndBk        Buy               229           285       24.5           1.0             1.3         5.4                9.6        1.4       21.2
IOB          Buy               128           166       29.4           0.9             1.2         6.6              22.2         0.6       14.3
J&KBk        Buy               740         1,063       43.7           0.9             1.3         5.6              14.4         1.3       18.1
OBC          Buy               352           437       24.2           0.9             1.1         5.0              24.5         1.1       19.0
PNB          Accumulate      1,137         1,259       10.8           1.5             1.7         7.6                9.8        1.2       21.9
SBI*         Buy             2,679         3,490       30.3           2.0             2.6        11.1              29.2         1.1       20.4
UcoBk        Neutral           109               -        -           1.1                -        5.0                8.5        0.8       29.5
UnionBk      Buy               336           389       15.8           1.4             1.6         7.2                6.3        1.0       20.8
Source: Company, Angel Research; Prices as on January 25, 2011

January 25, 2011                                                                                                                            6
                                                                                                                   Monetary Policy Review

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January 25, 2011                                                                                                                           7
                                                                                                                                                                                                                   Monetary Policy Review

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Research Team

Sarabjit Kour Nangra                                                        VP-Research, Pharmaceutical                                                          
Vaibhav Agrawal                                                             VP-Research, Banking                                                                 
Vaishali Jajoo                                                              Automobile                                                                           
Shailesh Kanani                                                             Infrastructure                                                                       
Rupesh Sankhe                                                               Cement, Power                                                                        
Param Desai                                                                 Real Estate, Logistics, Shipping                                                     
Sageraj Bariya                                                              Fertiliser, Mid-cap                                                                  
Paresh Jain                                                                 Metals & Mining                                                                      
John Perinchery                                                             Capital Goods                                                                        
Srishti Anand                                                               IT, Telecom                                                                          
Jai Sharda                                                                  Mid-cap                                                                              
Sharan Lillaney                                                             Mid-cap                                                                              
Naitik Mody                                                                 Mid-cap                                                                              
Chitrangda Kapur                                                            FMCG, Media                                                                          
Amit Vora                                                                   Research Associate (Oil & Gas)                                                       
V Srinivasan                                                                Research Associate (Cement, Power)                                                   
Mihir Salot                                                                 Research Associate (Logistics, Shipping)                                             
Pooja Jain                                                                  Research Associate (Metals & Mining)                                                 
Yaresh Kothari                                                              Research Associate (Automobile)                                                      
Shrinivas Bhutda                                                            Research Associate (Banking)                                                         
Sreekanth P.V.S                                                             Research Associate (FMCG, Media)                                                     
Hemang Thaker                                                               Research Associate (Capital Goods)                                                   
Nitin Arora                                                                 Research Associate (Infra, Real Estate)                                              
Ankita Somani                                                               Research Associate (IT, Telecom)                                                     
Varun Varma                                                                 Research Associate (Banking)                                                         
Vasant Lohiya                                                               Research Associate (Banking)                                                         

Shardul Kulkarni                                                            Sr. Technical Analyst                                                                
Mileen Vasudeo                                                              Technical Analyst                                                                    

Siddarth Bhamre                                                             Head - Derivatives                                                                   
Jaya Agarwal                                                                Derivative Analyst                                                                   

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Abhimanyu Sofat                                                             AVP - Institutional Sales                                                            
Nitesh Jalan                                                                Sr. Manager                                                                          
Pranav Modi                                                                 Sr. Manager                                                                          
Sandeep Jangir                                                              Sr. Manager                                                                          
Ganesh Iyer                                                                 Sr. Manager                                                                          
Jay Harsora                                                                 Sr. Dealer                                                                           
Meenakshi Chavan                                                            Dealer                                                                               
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 January 25, 2011                                                                                                                                                                                                                                              8

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