Trend reversal

Contrary to popular belief of a 50 basis points hike in key rates during April 2010 monetary policy review, the RBI stepped in decisively in the interim. It hiked key reverse repo and repo rates by 25 basis points each to 3.5 per cent and 5 per cent, respectively to smother the inflation concerns. A spurt in both food and non-food items contributed to inflation rising to 9.9 per cent in February, higher than RBI’s own year-end target of 8.5 per cent. With demand side pressures also creeping in from the manufacturing side, RBI was prompted to act than react. Going ahead, interest rates are seen moving up further and banks likely to see some asset quality pressures. Positively, economic growth is looking up. In this scenario, how will banks fare? Read on for cues.

The inflation effect
With the overall economic activity trending up, increases in the inflationary expectation are seen not only in food articles but also spreading to non-food articles. With domestic demand strong and crude oil prices firm, there is an expectation that inflation may cross double digits by March 2010. Rupa Rege, chief economist, Bank of Baroda, says, “We expect the inflation to see its peak in May, and we project a 10.5-11 per cent inflation rate by March end”. Some brokerages expect it to be higher at 11-12 per cent. Going ahead, the advent of south-west monsoon and global crude oil prices could be the key determinants that could decide where the inflation is headed.

With inflation management on top of RBI’s mind, the 75 basis points increase in the Cash Reserve Ratio (CRR; used for managing systemic liquidity) announced recently and short-term rate hikes only confirms the shift from a soft monetary stance to a tighter one. However, the monetary measures announced are unlikely to have a noticeable impact on banks in the very near-term as most of them are sitting on excess liquidity and pick-up in loans is expected to happen gradually. Further tightening is expected in the days to come, ASV Krishnan, analyst, Ambit Capital, says, “In the April monetary policy meeting, RBI is likely to increase both repo and reverse repo rates further by another 25 basis points each. We expect repo rates to stay sub-6 per cent during the next fiscal (2010-11), which could mean a further tightening of about 100 basis points during the fiscal”. So, where are interest rates headed?

Issues ahead
In the recent past, some banks like ICICI Bank (25-50 basis points) and BOI (50 basis points) have increased deposit rates that could push up cost of funds from the lows seen in December 2009 quarter. Indications are that banks are mobilising deposits for a possible increase in credit off-take as well as its relatively stable profile.

On lending rates, most of the banks are tight-lipped about an increase as the year-end is round the corner. However, banks could look at increasing rates after the next monetary meeting, wherein expectations are rife that the RBI could dish out another policy rate hike. Nevertheless, home financiers like HDFC are doing away with the teaser rate loans that would help margins. Overall, margins could come under slight margin contraction in the next few months.

In the medium-term though, the interest rate scenario would be influenced by the trend in credit off-take numbers, which so far is showing signs of improvement. With economic momentum gaining ground, the demand for credit from corporate and retail segments is expected to inch up. M Narendra, Executive Director, Bank of India, says that the incremental systemic credit disbursal growth rate should improve to about 22-25 per cent in 2010-11; currently, it is hovering at 16 per cent. This should provide banks pricing power to maintain margins going ahead.

With growth picking up, experts suggest that even with some hike in interest rates the impact on NPAs would not be major. However, interest rate sensitive sectors like real estate and infrastructure might face some heat. Rajesh Mokashi, Deputy Managing Director, CARE ratings, says “As per our estimates done last year, the level of gross NPAs was expected to reach 3.7 per cent of gross advances in 2009-10. Aided by the economic revival, as on December 31, 2009, gross NPA ratio stood at 2.6 per cent; we expect the ratio to reach around 2.8 per cent by March 2010. Assuming that 15 per cent of the restructured assets get converted into NPAs in 2010-11 in addition to the normal system NPAs, this ratio is expected to touch about 3.5 per cent by March 2011.” Needless to say, banks which see their NPAs rise will need to make higher provisions to maintain a healthy balance-sheet. For now, in terms of bad assets, banks like ICICI Bank and SBI have still a long road to go.
 

HEALTHY PROSPECTS
in Rs crore	Net Interest Income		Operating profit		Net Profit		Price (Rs)	P/BV* (x)	CASA (%)	Gross NPAs (%

FY10EFY11EFY10EFY11EFY10EFY11EFY10EFY11E Axis Bank 4,9506,1505,3505,9002,4903,1201,1923.646.02.12.9 Bank of Baroda 5,9757,1504,8405,6402,9903,3506361.837.01.41.7 Bank of India 5,8006,7604,6105,2301,8102,6003221.433.02.83.7 Canara Bank5,6506,5005,2505,4503,3203,4404131.729.01.92.3 HDFC 4,0405,0003,9504,6502,7643,2602,6115.7NA0.80.7 HDFC Bank8,41010,1806,5007,7302,9303,8201,9484.851.01.61.4 ICICI Bank 8,3209,4809,81010,9004,1505,2109482.139.05.14.5 PNB8,76010,3407,0407,9603,8804,5301,0012.438.52.03.5 SBI23,73027,690