We now project 10-year yields of 6.5% by end FY16 (previous forecast 7%), down from 8.5% currently. This may precede policy rate cuts of similar magnitude as the inflation risk premium comes off, the report added.
UBS also said that the key policy repo rate may be slashed by 100 bps, if the Reserve Bank of India (RBI) gets comfortable with a surplus liquidity and yet muted growth, moderating inflation thus the effective clearing policy rate will become the reverse repo rate.
The biggest beneficiaries of the 100 bps policy rate cut will be banks and financial entities and UBS estimates this will have a 26% positive impact on profit before tax for public-sector banks. However, this would be largely offset by pension provisions, the report added. Lower bond yields could significantly increase pension related provisions for public sector banks given 8-10 years mismatch between duration of assets and liabilities.
Asset financing companies such as Shriram Transport Finance, Mahindra Finance and LIC Housing Finance would benefit the most from the rate cut as they would reduce finance costs dramatically.
The report also added that the stressed loans in the economy could decline by 20% if borrowing costs come down by 100 bps. Analysis of 2,079 companies with total borrowings of $ 400 billion (~40% of total bank credit) indicates that stressed assets with an independent cost review less than one could decline by 20% if borrowing costs declined by 100 bps, the report explained.