Spark Capital. Takeaways from RBI Annual Report - FY14. RBI FY14 Annual Report Analysis

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Alyson Johnston
6 years ago
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1 Takeaways from RBI Annual Report - FY14 Our analysis of RBI s annual report for FY14 revealed snippets of information which can have a significant bearing on the monetary policy - regulatory stance of the central bank in the near to medium term. From the monetary policy stand point, RBI has built a case for a return to growth accommodative mode, driven primarily by comfort on CPI inflation targets being met. Moderation in job creation across sectors, stability in exchange rate and lower international oil prices are expected to keep inflation low, although a deficient monsoon could play spoilsport on the food inflation front. Importantly, we see the first signs of a shift from physical to financial savings - net financial savings rate of the household sector saw a marginal uptick yoy to 7.2% of GDP, while savings in physical assets fell from 15.8% of GDP to 14.8%. From a prudential policy perspective, review of governance of bank boards, Counter Cyclical Buffer (CCB), effective financial inclusion, on-tap bank licensing policy are likely to top the central bank s agenda. On housing finance although the commentary looks encouraging, with long term bond funding being made available for affordable housing, we see headwinds remaining in a weak demand scenario (refer our note on Housing Finance); RBI s commentary on gold remains hawkish. We believe the PJ Nayak committee recommendations on governance of banks are likely to get implemented as RBI enjoys the backing of the finance ministry on the issue. On the structural front, RBI has already cut the SLR rate by 100bps since Jun 14, and we expect SLR cuts to continue, albeit at a slower pace (refer our note on India Banks: Undoing Financial Repression Structural Reset of Economics). From a banking supervisory perspective, though the systemic capital adequacy seems adequate at 13%, the core CRAR is only 10.1%, restricting capitalization comfort. On the asset quality front, restructured loans could rise further with the regulatory forbearance ending in FY15, though the improvement in the industrial & construction activity should reduce industry related slippages; weak monsoon trends could prove detrimental for agri asset quality. Overall, we expect delinquencies to inch upwards and peak out in FY15, accentuating the pain in the already weak credit cycle with the PSU banks bearing the brunt of the bad asset quality weak credit growth low capital quagmire (refer our note on PSU banks). 1) Household Financial Savings rise marginally, shift seen from physical to financial assets: Net Financial savings of the household sector as a percentage of GDP increased to 7.2% from 7.1% in FY13 and rose 13% in value terms. The preferred mode of savings continues to be deposits & currency held, but FY14 witnessed a shift away from shares & debentures (22% decline yoy), with mutual funds being the biggest loser (40% decline yoy). Insurance funds also declined on a relative basis with the additional quantum flowing into investment in deposits which rose 17% yoy, while currency held de-grew by 9%. The RBI s latest data adds credence to our view of the first signs of a shift from physical to financial assets, which we expect to gather pace of over FY14- FY16. Increase in retail credit driven by personal loans drove up financial liabilities, which was up 11% yoy, dampening the household financial savings on a net basis. Financial Savings of Household Sector Rs.bn FY11 FY12 FY13 FY14 Gross Financial Saving (A) 10,518 9,215 10,437 11,741 Change in Financial Liabilities (B) 2,804 2,870 3,213 3,555 Net Financial Saving of Household Sector (A-B) 7,713 6,345 7,224 8,186 Net financial savings as % of GDP

2 Break-up of Gross Financial savings FY11 FY12 FY13 FY14 Currency 13.0% 11.5% 10.7% 8.7% Deposits 49.9% 59.1% 56.6% 58.8% Shares and Debentures -0.4% -0.3% 4.1% 2.9% Claims on Government 2.7% -2.4% -0.8% 0.4% Life Insurance Funds 20.0% 21.2% 17.3% 17.0% Provident and Pension Funds 13.4% 10.3% 11.7% 11.6% Deposits Flow (FY11) Deposits Flow (FY14) SCBs, 93.1% Co-operative banks, 5.9% NBFCs, 1.0% SCBs, 90.2% Co-operative banks, 7.1% NBFCs, 2.7% Trade Debt, 1.3% Trade Debt, 0.7% Total deposits flow to Scheduled commercial banks (SCBs) has declined from 93.1% in FY11 to 90.2% in FY14, while deposits with NBFCs has risen 3.6x in absolute terms over the same period. 2) Household physical savings decline: The gross domestic saving rate deteriorated to 30.1% of GDP in FY13, from 31.3 in FY12, mainly on account of decline in household physical savings. The savings rate has reached a 9 year low, driven primarily by the fall in the household savings rate. The household savings rate which has hung around 23% of GDP for most part of the previous decade has fallen to 21.9% in FY13. Savings rate (as % of GDP) Household Financial savings Household Saving in physical assets Private corporate sector Public sector Average (FY06-08) FY09 FY10 FY11 FY12 FY13 3) Indian remains under banked: The Indian banking sector compares favourably with peers in terms of a being sound on capital with a low concentration ratio (market share of the 4 largest banks); however room for improvement in terms of inclusiveness, efficiency & size remains. Another glaring contrast is the disproportionately large share of public sector ownership in the banking sector, which dilutes the advantage of low concentration.

3 Structure of Banking sector across economies (as of 2011) Advanced Economies Emerging Market Economies France Germany UK USA Brazil China India Russia South Africa No. of banks (per 100, persons) Banking assets as % of GDP No. of bank branches (per 100,000 adults) % of public sector in banking assets % of foreign entities in banking assets Concentration ratio (%) NIM (%) Credit/deposit ratio (%) CRAR (%) ) Pricing power remains weak; competitive pressures intensify in SME & Vehicle segments: Median lending rates across sectors continue to reflect weak pricing power in the face of a tightening phase of monetary policy cycle & subdued economic activity. Home loan rates held up, as home loans are almost at base rates we believe home loan rates have bottomed out. The SME business on the other hand saw increased competitive pressures both on account of increasing focus on SME financing and the drying up of the big ticket loans market, in the face increasing asset quality pressures. Sector Median Lending Rates Month-end Home Vehicle Agriculture SME CC Education Mar Jun Sep Dec Mar Jun Variation (bps) ) Asset Quality PSUs remain a cause for concern: PSU bank GNPAs shot up to 4.7% from 3.8% in FY13 and also accounted for ~92% of restructured advances. RBI s stress tests under adverse macroeconomic conditions show that although the system level CRAR of SCBs remains healthy, there is a need for higher provisioning to meet expected losses, primarily through higher provisioning & Counter cyclical buffer. GNPA % NNPA % Restructured Advances Mar-13 Mar-14 Mar-13 Mar-14 Mar-13 Mar-14 Public sector banks Private sector banks Foreign banks Aggregate

4 Surat Chennai Nagpur Ahmedabad Hyderabad Raipur Lucknow Pune Kolkata Dehradun Mumbai Faridabad Guwahati Bhubneshwar Patna Delhi Bhopal Bengaluru Kochi Chandigarh Indore Coimbatore Jaipur Vijayawada Ludhiana Meerut Spark Capital System level GNPAs decreased from 4.4% in December 2013, to 4.1% in March 2014, but RBI remains wary of the cosmetic improvement on account of a spike in sales to Asset Reconstruction Companies (ARCs) during the March quarter. RBI views the increase in the level of restructured advances & sale to ARCs as a reflection of potential hidden stress in the quality of loan assets. Loan Sales to ARCs Rs.bn Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Public sector banks Private sector banks Foreign banks All Banks Industrial sector which forms 47% of credit, accounts for more than 58% of systemic GNPAs; on the other hand, retail credit which forms 19% of banking credit, had GNPAs falling to 2.0% from 2.3% in FY13. 6) Where is housing headed? The pace of housing growth slowed in with the all India index growing at 12.6% yoy from the 20%+ growth rates seen in FY12 & FY13. Markets remaining soft coupled with higher inventory levels and weak demand indicates further potential price correction. However, RBI continues to take a more favourable tone on housing as an asset class, compared to its hawkish stance on gold. RBI has allowed banks to avail long term bonds (exempt from CRR, SLR & PSL) for financing affordable housing, on the back of reduction in risk weights for residential housing projects. We do not see these long term bonds to be a game changer for banks especially for those with >40% CASA. Our analysis suggests that ROEs from using these bonds is ~16% which is sub-optimal for banks which have >40% CASA even after PSL exemption. Housing price change yoy (%) 20% 15% 18% 13% 10% 9% 8% 10% 5% 0% 6% 6% 5% 5% 4% 3% 1% 1% -5% -10% -15% -20% -1% -1% -1% -2% -2% -4% -6% -7% -8% -10% -13%-13%-14% 7) Curbs on gold, here to stay: RBI utilized a multi-pronged approach to discourage import of gold and to ease the pressure on CAD, by restricting imports & raising the customs duty on gold. These measures served their purpose resulting in gold contributing to ~58% of the overall reduction in imports in FY14. RBI views gold imports as a deterrent to the pick-up in the investment cycle for a recovering economy and is wary of easing gold import norms gold imports turned positive in June 2014 after 11 months of decline.

5 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Spark Capital 8) Pronounced asymmetry in Monetary Policy Transmission: Despite a 50bps increase in repo rates over Mar 13 Jun 14, lending rates were up only 10bps, reflecting inadequate pricing power on the lending side; deposit rates were up 32 bps during the same period. During the downward phase of the interest rate cycle, fixed rate high cost outstanding deposits prevent banks from reducing loan rates due to margin pressures, effectively translating into higher margins for the wholesale funded private sector banking pack vis-a-vis PSU counterparts. Asymmetry in Monetary Policy Transmission Quarter-ended Repo rate Term deposit WALR WALR (%) rate (%) (outstanding) (Incremental) Mar Jun Sep Dec Mar Jun Variation (bps) With credit growth falling drastically in the recent months, and lagging the deposits growth (the credit deposit wedge is currently -325bps) we believe that the asymmetry in policy transmission will continue. 15% C-D wedge 10% 5% 0% -5% -10% -15% 9) Borrowings to remain lower: The centre s net borrowings have risen 10x in the past decade from Rs. 460bn in FY05 to Rs. 4.68tn in FY14. However, both gross and net borrowings in FY13 & FY14 were lower than budgeted amounts, reversing the trend prevalent till FY12. With the GOI borrowing Rs.160bn lesser than budgeted in 1HFY15, we estimate actual gross borrowings to continue to be lower than the estimated Rs. 6tn in FY15. Central Government Borrowings FY12 FY13 FY14 FY15 Rs. Bn Budget Actual Budget Actual Budget Actual Budget Actual Net Borrowings 3,430 4,364 4,790 4,674 4,840 4,685 4,612 Gross Borrowings 4,171 5,100 5,696 5,580 5,790 5,635 6,000

6 10) Employment generation at 5 year lows, textiles the exception: FY14 witnessed a moderation in job creation across export oriented sectors, logging in a low 0.29mn jobs amounting to a yoy decline of 17%. Of particular concern to us was employment generation in the IT-BPO sector which at 0.06mn jobs was only a tenth of FY10 job creation, a negative for the housing finance industry. Job creation in the textiles sector (0.24mn) is at a 5 year high while the leather sector (0.03mn) is at a 3 year high, corroborating a recovery in these export oriented sectors. Unemployment rate in urban areas at 5.3% was much higher than the 3.5% in rural areas. Changes in employment (in million) Industry FY10 FY11 FY12 FY13 FY14 Textiles Leather Metals Automobiles Gems & Jewellery Transport IT-BPO Handloom - Power loom Overall On the Productivity front, the increase in capital-output ratios during recent years suggests that productivity improvement may not have continued at the same pace over the FY11-FY14 as compared to the previous decade up to FY09 (2.26% yoy growth in Total Factor Productivity). 11) Continuing decline in Capital formation: The Investment rate or the gross capital formation was down for the second consecutive year to 34.8% in FY13 as compared to 35.5% in FY12 and 36.5% in FY11. Within sectors, the private corporate sector has accounted for the largest share of the decline in the past 5 years, falling from 10.3 in FY09 to 8.5 in FY13. Public sector investment rate increased marginally from 7.1 in FY12 to 7.8 in FY13. Investment Rate (as % of GDP) Public Private Household FY09 FY10 FY11 FY12 FY13 12) Industrial Sector Contraction: Industrial sector declined in FY14 for only the third time in more than 6 decades, with the previous occurrences happening in the heights of oil crisis of the 80s & the external payment crisis of the 90s. However, recovery is insight with IIP growth during 1QFY15 coming in at 3.9%, which happens to be the highest in the last 11 quarters.

7 20 Index of Industrial Production (IIP) FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Jun '14 Mining Manufacturing Electricity Overall IIP 13) Agricultural NPAs worsen, recovery rates improve: Credit to the agriculture sector has been higher than targets in recent years with only 15 (10-PSU, 4-private, 1-foreign) out of 85 SCBs unable to achieve the PSL targets. This could improve further, with the interest subvention scheme for short-term crop loans (up to Rs.0.3 million) being made available to private sector SCBs with respect to loans originated in their rural and semi-urban branches. Though there was marginal increase in recovery of loans in FY13, the agri NPAs increased during the same period to 4.7% of advances. Recovery of Direct Agricultural Advances Rs.bn Demand Recovery Overdue Recovery % NPA % , ,822 1, ,918 1, ,596 1, ) Infrastructure Rethinking risk pricing: Infrastructure, iron and steel, textiles, mining (including coal) and aviation services which form 24% of banking credit, account for over half of stressed assets in the system. While share of advances to infrastructure grew 14.4% in FY14 from 13.5% in FY11; infrastructure s share of stressed assets spiked, from 8.4% to 29.2% over the same period; over a fifth of all infrastructure advances are currently stressed. RBI believes this to be the result of improper pricing of risk on the funding side (banks) and the nature of risk allocation on the operational side (contractual). In power generation for example, the bids allowed bidders to assume exchange rate and fuel cost risks, without enforcing suitable hedging leading to large scale renegotiation. 15) Electronic payment systems continue to gain traction: As the payment systems registered a growth in value of 14% during FY14, the volumes registered a healthier 23%, primarily due to the shift in the mode of transactions from physical to electronic, both in value & volume terms. Volume of Payment transactions Value of Payment transactions 100% 80% 60% 40% 20% 0% 27% 32% 35% 20% 24% 31% 53% 45% 35% FY12 FY13 FY14 100% 90% 80% 70% 60% 50% 1% 2% 2% 17% 24% 33% 82% 75% 65% FY12 FY13 FY14 Physical Payments Electronic Payments Physical Payments Electronic Payments Card Payments Card Payments

8 16) RBI at loggerheads with the recommendations of FSLRC: The commission s recommendations seek to significantly restrict the functional responsibilities of RBI to setting monetary policy & supervising banking sector. The other functions are proposed to be spun out into separate agencies, with Unified Financial Agency (UFA) supervising all financial firms (other than those under RBI). This according to the RBI, could be counter-productive from a regulatory point of view. The steadily increasing maturity profile of the central government borrowings is in line with RBI s stated objective of increasing the depth of the bond markets and also indicates an increase in demand at the longer tenures. Central Government - Incremental Borrowing Profile FY10 FY11 FY12 FY13 FY Weighted average Maturity Weighted average yield (RHS) 17) Monetary policy in place; fiscal consolidation need of the hour: Considering the asymmetry in monetary policy transmission, RBI noted that the current slowdown in investments was not solely interest rate linked, and that long term changes in output can only achieved by eliminating structural handicaps which are better accomplished by fiscal policy, than monetary policy. On the fiscal deficit side, RBI noted that expenditure cut led fiscal consolidation was an unlikely solution. In addition, the disinflationary momentum has reduced inflation to a much more manageable level, and has set the stage for growth to pick up led by revival in industrial & construction activity.

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Key estimate revision. Financial summary. Year FY14 391,088 45,198 34, FY15E 354,262 35,426 23,

Key estimate revision. Financial summary. Year FY14 391,088 45,198 34, FY15E 354,262 35,426 23, : price: EPS: How does our one year outlook change? We retain our negative stance on the stock. We expect s revenue to de-grow by 9% y-o-y on the back of muted execution (client side and clearance delays)