Macro-economic environment and its effect on the
banking sector in 2008-09
Background
The global financial meltdown has had far reaching consequences for
economies worldwide. International credit markets tightened considerably as a
result of rising defaults and foreclosures. Although financiers in India
In the first half of 2008-09, growth in bank credit continued to be
strong on account of limited avenues for corporate credit. From the third
quarter, however, the signs of global meltdown were visible in the form of
liquidity constraints and a slowdown in demand for corporate credit. In the
interim period, the Reserve Bank of India (RBI) has taken a host of monetary
easing measures such as reducing the Cash Reserve Ratio (CRR) and repo rate to
release liquidity in the system. However, it will be some time before demand
for credit from the corporate sector picks up. This is expected to hamper the
overall growth story of the banking industry in the second half. Accordingly,
CRISIL Research expects moderation in credit growth in 2008-09 and even more
subdued growth in 2009-10. The banking sector is likely to face pressure on
profitability, given the continued high cost of funds and the inability to pass
on the full increase in the same to borrowers. The banking sector is also
expected to face some pressure on asset quality, on account of loans to the
retail segment and to small and medium enterprises (SMEs).
Monetary policy and banking trends in 2008-09
RBI's stance in 2008-09 so far has changed from a reversionary monetary
policy in the first and second quarter to an expansionary monetary policy in
the third quarter. This was because of high inflationary pressures and severe
liquidity constraints coupled with slowdown in economic growth in the first
half.
Tight monetary policy in first quarter 2008-09 to
combat inflation
During the first quarter of 2008-09, inflation edged up in major
emerging markets, reflecting the combined impact of higher commodity and crude
oil prices as well as strong demand conditions. This rising inflation
emerged as the biggest concern for the RBI. Inflation based on the wholesale
price index (WPI) increased from 4.8 per cent in July 2007 and 7.7 per cent at
end-March 2008 to 11.82 per cent in June 2008, signalling the impact of higher
crude oil prices as well as surging global commodity prices.
Further, the M3 (money supply) growth, on a y-o-y basis, was 20.5 per
cent as on July 4,
2008 , as against the 16.5-17.0 per cent range set for 2008-09 by
the RBI in April 2008. This further highlights the high inflationary pressures
that the Indian economy faced in the first quarter of 2008-09. The high growth
in money supply during the said period can be mainly attributed to rising
capital inflows and credit expansion at a relatively higher rate of around
28-30 per cent.
During April-May 2008, keeping in view the liquidity conditions and
inflationary pressures in the economy, the CRR was raised by 75 basis points
(bps) to 8.25 per cent in three stages of 25 bps each effective from April 26,
May 10, and May
24, 2008 . Further, the RBI increased the repo rate first by 25 bps
and then by another 50 bps to 8.5 per cent effective from June 12 and June 25, 2008 ,
respectively. The CRR was further increased by 25 bps each on July 5,2008, and July 19, 2008 ,
to 8.75 per cent.
High inflation leads to further tightening in second
quarter of 2008-09
In August 2008, inflation reached a level of 12.82 per cent, the highest
in the last 4-5 years. The regulator responded by further tightening the
monetary policy. In view of the overall monetary conditions, the RBI increased
the repo rate by 50 bps from 8.5 per cent to 9.0 per cent with effect from July 30, 2008 ,
and CRR by 25 bps to 9.0 per cent with effect from August 30, 2008 .
Although money supply growth decelerated in the second quarter of
2008-09, it was placed at 19.0 per cent as on September 26, 2008 , as against the
RBI's comfort level of 17.0 per cent set out in July 2008.
