DBS sees CD ratio remaining high for long

Written by Press Trust of India | Mumbai | Updated: Oct 5 2013, 00:15am hrs
The credit deposit ratio is likely to remain at an elevated level for the next 6-8 months on account of higher credit growth and slower deposit creation, among other things, a report said today.

"The credit-deposit ratio is poised to remain above comfort levels at least in the next six-eight months," a research report by DBS said.

As on September 6, the credit-deposit (CD) ratio in the banking sector stood at nearly 78 per cent, which later shot up to a record high of 83.34 per cent year-to-date.

The report attributes increase in the CD ratio to elevated inflation levels leading to negative real rates, liquidity tightness created on account of slower deposit creation and higher credit demand, which of late has been clipping at over 18 per cent, while deposit has been growing much lower at 14 per cent.

"Firstly, negative real rates on the back of high and sticky inflation have led depositors to seek sources other than bank deposits," the report said, adding, the scale of negative real rates is starker when measured against CPI inflation, thus leading to a shift out of financial savings.

"Secondly, slower deposit creation has aggravated the tightness in liquidity conditions, with its own pitfalls hinders transmission of changes in the monetary policy rate, leads to balancesheet stress and keeping rates elevated," the report said.

With sources of funding becoming scarce in the face of high borrowing costs and volatile financial markets, private sector players are increasingly likely to rely on bank funds.

The report further said that slowing growth and resultant stress on the labour market also impinges on the purchasing power and ability to build-up savings.

"Thus even as deposits slow, credit growth could hold-up, resulting in a further rise in the CD ratio," the report said.

As of end last fiscal, the CD ratio stood at 78.1 per cent significantly higher than the pre-global financial crisis level of 60.5 per cent.

The ratio has hardened above 75 per cent in the past two years as weak investment activity and high persistent inflation have dented both deposit and lending activity. The report said the Reserve Bank's decision to raise repo rate last month and target CPI inflation would help lower the CD ratio.

"The central bank's decision to raise the repo rate and possibly target CPI inflation is expected to narrow negative real rates and spur deposit mobilisation," the report said, adding that it sees another 50 bps (0.5 percentage point) hike in the repo rate before the end of the fiscal.

The likelihood of pegging the next tranche of inflation- indexed bonds to retail inflation, rather than WPI, will also be timely, the report said. "The attractive and positive, if inflation eases, real returns could also help channel interests back into financial savings."

Down the line, pick-up in deposits will thaw liquidity conditions, helping to calm borrowing costs, the report said.

"This positive chain of developments, however, is contingent on other domestic and global factors as well and unlikely to pan out in the near-term."

DBS sees banks to raise lending rates first before the deposit rates, thus delaying the transmission process.