We expect lending rates to come off by 50bps cut by March 2020 in contrast to 2018’s 30bps hike. Also, Budget 2019 should retain February’s 3.4% of GDP fiscal deficit target.
We grow more confident of our call that lending rates will come off by 50bps by March 2020. This is critical for recovery as our India Activity Indicator signals weakness for the next 1-2 quarters. What’s changing? The RBI MPC changed its stance to accommodative supporting our 50bps rate cut-by-March call. Second, RBI is expectedly infusing durable liquidity of $2-3 billion a month. Our liquidity model estimates that this should fund 16% loan demand in FY20. Third, the reversal of poll/summer rabi harvest cash demand has pushed the money market into reverse repo mode. We expect RBI to allow this till the slack season ends in September to assure the market of sufficient funding in the October-March ‘busy’ season. It takes six months for Re 1 of RBI liquidity to ‘multiply’ into Rs 5.1 of bank credit. A 0.25% CRR cut should be sufficient to fund credit worthy borrowers should the NBFC concerns worsen. Fourth, yields are coming off with RBI OMO ($19 billon BofAMLe, $5.7 billion done) set to clear the G-Sec market. Finance minister Nirmala Sitharaman will likely retain the Interim Budget’s 3.4% of GDP fiscal deficit target in her July 5 Budget. Finally, the MoF/RBI are taking measures to de-stress banks. The MoF will likely use the $14-42 billion of excess RBI capital to be identified by the Jalan report to recapitalise PSU banks. In sum, the MoF/RBI are all set to win the battle of monetary transmission.
1. 125bps of RBI rate cuts signal lower yields/lending rates: Our expected 125bps of RBI rate cuts by March (75bps done) send a powerful signal for lower yields/lending rates. We expect the RBI MPC to cut 25bps on August 7 if rains are normal, pause as inflation goes up on base effects in end-2019, and cut again by 1Q20 . Our US and China economists expect the Fed/PBoC to cut 75bps by early 2020.
2. $35 billion of durable liquidity funds 16% loan demand: We expect RBI to continue to infuse durable liquidity of $2-3 billion a month via OMO and/or FX swaps. Our liquidity model estimates that $35 billion of RBI liquidity ($10.7 billion) will generate sufficient deposits to fund 16% loan growth in FY20. A Re1 of RBI liquidity ‘multiplies’ 5x into credit over, say, six months. The primary reason for hardening of lending rates in the past few years was inadequate injection of RBI liquidity fuelling excess loan demand. Although loan growth is picking up, this is being driven by a shift to bank funding from NBFC/commercial paper funding.
3. Reverse repo mode assures liquidity in ‘busy’ season: RBI’s comfort in allowing reverse repo mode in the April-September ‘slack’ season should assure the market of sufficient liquidity in the October-March ‘busy’ season. We calculate that a 0.25% CRR cut should fund, say, Rs 1,500 billion of credit-worthy borrowers in case the NBFC situation worsens further.
4. Lower risk free allows lending rate cuts: Yields are coming down with RBI OMO ($19 billion BofAMLe, $5.7 billion done) set to clear the G-Sec market. The Narendra Modi regime has surely demonstrated its commitment to fiscal discipline when it did not compete with the Congress’s NYAY plan of 1.9% of GDP even in the heat of polls. We expect finance minister Sitharaman to retain the Interim Budget’s 3.4% of GDP fiscal deficit target in the upcoming Budget.
5. De-stressing banks: Jalan committee: Policy measures to de-stress banks will ease lending rates: PSU bank recapitalisation, rationalisation of Bankruptcy Code through the June 7 NPL circular, deferral of tighter-than-Basel III CRAR and IndAs norms. We expect the MoF to recapitalise PSU banks with $14-42 billion of excess RBI capital to be identified by the Jalan committee.
50bps cut positive for rate sensitivity
We expect banks to cut lending rate cuts by 50bps by March 2020 in contrast to 2018’s 30bps hike. After all, real lending rates have virtually doubled since 2014. Not surprisingly, our BofAML India Activity Indicator is signalling weakness for 1-2 quarters. Governor Shaktikanta Das’s proactive liquidity operations have calmed markets. The real economy, however, is still hurting from the end-2018 liquidity crunch that is pulling GVA growth down to 6.3% (along with base effects) in October 2018-September 2019. If lending rates ease in response to policy initiatives, growth will likely rebound to 7.5% by March.
What can the MoF/RBI do to defuse fears of a NBFC ‘crisis’? Provide sufficient liquidity to ensure that (1) healthy NBFCs are able to raise funds, and (2) banks are able to fund credit-worthy borrowers impacted by failing NBFCs, if any. In case, say, NBFC failures impact Rs 1,500 billion of credit-worthy borrowers, RBI should inject an additional Rs 300 billion/$4 billion, given the credit multiplier of 5.1, by a 0.25% CRR cut.
RBI liquidity/reserve money drives M3/deposit growth, not deposit rates. Can banks step up deposit growth to fund higher loan demand without raising deposit rates? Deposit growth, essentially, is driven by reserve money/durable liquidity injected by RBI. Our liquidity model estimates that M3/deposit growth will pick up to about 13% from 9.7% if RBI injects $35 billion via OMO/FX purchases/CRR cuts in FY20.
But how will RBI liquidity generate bank deposits and credit? Suppose it buys Rs 100 of G-Secs from a bank. The bank will prefer to lend the Rs 100 to borrower X rather than keep it idle. As X needs only Rs 10 in cash, she will put the remaining Rs 90 into the bank as CASA. The bank then lends this Rs 90 to another borrower Y. As Y only needs Rs 9 in cash, he puts Rs 81 in his bank account. A Rs 100 of RBI liquidity has thus already generated Rs 171 of deposits and Rs 190 of credit in these two rounds.
But won’t deposit/lending rate cuts, driven by RBI rate cuts, dampen deposit growth? Not really, in our view, as the 1881 Negotiable Instruments Act restricts the power to issue cheques to banks. Bank deposits are actually neutral to any redistribution of household investment between fixed deposits, mutual funds and real estate/gold purchases by cheque as monies simply flow to the current account of the MF/seller.
(Excerpted from BofAML India’sEconomic Viewpoint report ‘5 reasons lending rates set to fall 50bp’ dated June 14, 2019.)