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India Strategy 29 July 2010

India Strategy 29 July 2010

Monetary Policy: Impact on Banking Banking sector performance (3M)

Tightening to continue – banks typically underperform in this 15%
11.3%
environment 10% 8.4% 7.9%
5.7% 5.6%
4.0% 4.6%
The RBI’s rate increase yesterday was along expected lines and we believe that 5% 2.4% -0.8%
-13.7% -0.6%
high systemic inflation would fuel continued rate hikes over the next few 0%
months. Given their sensitivity to rates, we analysed the historical performance
-5%
of banks in times of monetary tightening and found a pattern of
underperformance whenever rates move up. -10%

Despite the positive impact on net interest margins (NIM) in the near-term (due -15%

Banks

Goods

Metals

Telecom
Auto

IT

Oil &

Power
FMCG

Pharma

Estate
Gas
to immediate re-pricing of loans and a lag in deposit re-pricing), our analysis

Real
Cap.
over rate cycles shows that the BSE Bankex (12 stocks that represent ~90% of
banking sector market cap) is either flat or underperforms the Sensex during Source: RCML Research, Datastream
phases of rate tightening. Having said that, we do agree that the impact varies
across banks and that players with higher CASA ratios, higher balance sheet
liquidity or a greater percentage of floating-rate loans are better placed.
Relative performance of Bankex in rate cycles
Rate tightening cycle to continue: The RBI raised the repo/reverse repo rate by
Policy Stance Date -2M -1M 1M 2M
25bps/50bps yesterday, highlighting its increased focus on inflation (which has
now stayed in double-digit territory for five months) rather than growth (FY11 Tightening Sep-04 -5% 0% -1% 8%
GDP growth estimate upped from 8% to 8.5%). The central bank is also
Tightening Oct-05 -2% -5% -4% -4%
concerned about high credit and declining deposit growth, and wants banks to
either increase deposit rates or moderate loan growth. We believe that the rate Tightening Apr-08 -9% 0% -4% -9%
tightening cycle will continue (our economist Jay Shankar estimates another Easing (Sub-
Oct-08 12% 9% -1% -5%
100bps/125bps hike in repo/reverse repo rate in FY11). Prime Crisis)
Tightening Feb-10 0% 3% 4% 4%
Systemic liquidity is the key…: The last decade has seen four phases of policy
tightening and one of rapid easing: 1) Sep-Nov’04, 2) Oct’05-Apr’07,
3) Apr-Oct’08, 4) Oct’08-Apr’09 (easing during the sub-prime crisis), and
5) Feb’10-to date. The Bankex has suffered relative underperformance in each of
these phases. The extent of the underperformance varies, and ranges from less
than 2% over 6–9 months in Oct’05 to ~9% in Apr’08. Underperformance is
exacerbated when liquidity in the system is tight too, i.e., when there’s a CRR
hike, or when there’s heavy borrowing on the repo window.

…this time too: Daily borrowing at the repo window is at Rs 533bn, the highest
since Oct’08. We believe that the gap in deposit and loan growth rates will put
pressure on banks to increase deposit rates, putting stress on NIMs this time
around as well.

Performance of BSE Bankex relative to Sensex during earlier tightening by RBI

Tightening Easing Bankex Rel. Sensex (L) CRR Reverse Repo Repo (%)
2,500 10

2,000 9

1,500 8

1,000 7

500 6

0 5

(500) 4

(1,000) 3
Jan-02 Sep-02 May-03 Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10

Source: RCML Research, CMIE

Dr Tirthankar Patnaik Manoj Singla RCML: Winner of LIPPER-STARMINE broker award for “Earnings Estimates in Midcap Research 2008” |
(91-22) 6766 3446 (91-22) 6766 3401 “Honourable Mention” in Institutional Investor 2009 | Voted amongst Top 5 most improved brokerages
1
tirthankar.patnaik@religare.in manoj.singla@religare.in by Asia Money Poll 2009 | RCML Research is also available on Bloomberg FTIS <GO> and Thomson First Call
 Monetary Policy: Impact on Banking India Strategy 29 July 2010

Fig 1 - Performance of BSE Bankex relative to Sensex during earlier tightening by RBI

Tightening Easing Bankex Rel. Sensex (L) CRR Reverse Repo Repo (%)
2,500 10

2,000 9

1,500 8

1,000 7

500 6

0 5

(500) 4

(1,000) 3
Jan-02 Sep-02 May-03 Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10
 
Source: RCML Research, CMIE

Fig 2 - RBI in fire-fighting mode after double-digit inflation for five months now

Tightening Easing CRB Commodity Index (L) CRR Reverse Repo Repo WPI Inflation (%)
600 14
12
500
10
400
8
300 6
4
200
2
100
0
0 (2)
Jan-02 Sep-02 May-03 Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10
 
Source: RCML Research, CMIE

Fig 3 - Repo borrowing indicates lack of liquidity in the system

(Rs. Bn) RepoRaised (L) RevRepoPaid (L) Tightening Easing CRR Reverse Repo Repo (%)
1,000 10

9
500
8
0 7

(500) 6

5
(1,000)
4

(1,500) 3
Jan-02 Sep-02 May-03 Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10
 
Source: RCML Research, CMIE

2
 Monetary Policy: Impact on Banking India Strategy 29 July 2010

Coverage Profile

By recommendation By market cap (US$)

(%) (%)
60 54 80
50 61
37 60
40
30 40 33
20 9 20 6
10
0 0
Buy Hold Sell > $1bn $200mn - $1bn < $200mn

Recommendation interpretation

Recommendation Expected absolute returns (%) over 12 months

Buy More than 15%

Hold Between 15% and –5%

Sell Less than –5%

Recommendation structure changed with effect from March 1, 2009

Expected absolute returns are based on share price at market close unless otherwise stated. Stock recommendations are based on absolute upside (downside) and have a
12-month horizon. Our target price represents the fair value of the stock based upon the analyst’s discretion. We note that future price fluctuations could lead to a temporary
mismatch between upside/downside for a stock and our recommendation.

Religare Capital Markets Ltd

th
4 Floor, GYS Infinity, Paranjpe ‘B’ Scheme, Subhash Road, Vile Parle (E), Mumbai 400 057.

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