Banks may cut rates after FM’s push

Banks are expected to reduce interest rates in the days ahead after Finance Minister Arun Jaitley prodded them to ease rates to ensure that there was a better transmission of RBI's rate cuts.

"The Union finance minister Arun Jaitley asked the chief executive officers (CEOs) of both the Public Sector Banks (PSBs) and private sector banks that why the banking system, in response to RBI's rate cut of 75 basis points since January 2015, effected a corresponding rate cut of only 25 basis points," a statement from the finance minister  said after Jaitley's meeting with bank chiefs.

CMDs of both state run and private banks said full transmission would not be viable till the time the cost of funds and deposits for the banks, as reflected in the re-pricing of their liability book at the new rate, comes down and liquidity level at the new lower cost, is tested. "However, all banks unanimously expressed that in a period of two to three months, greater transmission of lower rates could be seen," the finance ministry statement said.

The government and the central bank are keen to ensure that there is better transmission of the interest rate cuts to support growth. The finance ministry is keen to ensure that the growth engines roar again and rate cuts would help drive investment and consumption. RBI governor Raghuram Rajan had also expressed his disappointment with the slow pace of monetary transmission as banks have been slow to respond to RBI's rate cuts.

"Some part of it (rate cut) has been passed on to customers, while some banks have not passed on. I feel over the next few days ...some of the bankers felt that over the next few weeks, they would be in a position to work out greater cuts," Jaitley told reporters after the review meeting.

Jaitley also expressed his concern over the modest domestic credit growth of 7% over the previous year registered by state-run banks and took stock of the sectoral profile of the total domestic credit flow of Rs 49 lakh crore during 2014-15. The agricultural credit grew by 17.3% over the previous year, which came as a silver lining. The FM urged the bankers to achieve the target of 20% growth in educational loans.

Jaitley noted the robust credit growth of 16-18% in the housing sector, and advised the banks to achieve 30% growth in priority sector housing loans, which are required to provide a stimulus to overall growth.

The government also discussed the issue of growing non-performing assets with banks, which is a matter of concern. The increase in bad loans is due to some stalled infrastructure projects, slowdown in the global economy and continuing uncertainty in the global markets.

Jaitley said the RBI, government departments and the financial institutions should collectively examine solutions that work, to de-bottleneck critical projects of economic value. The FM suggested that the secretary, department of financial services (DFS) obtain a list of all major projects stalled purely due to financial reasons and attempt to sort out the sticky issues along with the concerned banks.

He also suggested that DFS and the RBI should interact to examine and sort out the regulatory issues in bad loans and the scope for their modification to ease the pressure on banks. Minister of state for finance Jayant Sinha said banks should sell off their non-core assets. Jaitley said he would like to sort out issues which relate to state governments and other ministries with regards to stalled projects.

Jaitley also shared his concern over the low participation of private banks in government promoted schemes, especially the three social security schemes where private bank participation is only 4 %.

Jaitley told banks that grievance redressal ought to be a serious pursuit and constructive effort should be made towards disposal of pending grievances within banks, without allowing them to escalate to higher government levels.

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RBI UNVEILS POSTBUDGET RATE CUT

Less than a week after the Union Budget, RBI governor Raghuram Rajan reduced the repo rate - the rate at which RBI lends to banks - by 25 basis points, to 7.5%, citing improved government finances. However, the burden of home and auto loans on borrowers is expected to ease only in April, the beginning of the new financial year. This is RBI's second rate cut in the last two months but only three of 45 banks - Union Bank, United Bank, and Karur Vysya - have so far lowered the benchmark rates.

Banks are yet to pass on the benefits of the earlier midterm cut in rates on January 15. “Since there is a lag effect for the monetary transmission to take place, effect of previous 25 basis points cut together with the present rate cut would encourage banks to review their base rates,“ T M Bhasin, chairman of Indian Bank, said.

Although banks have seen a marginal dip in cost of funds, they are reluctant to lower rates now due to earning pressure on account of rising bad loans. Also, the financial year end is the time banks try to beef up their balance sheet by aggressively mobilizing deposits and often offer better deals.

An immediate rate cut would reduce interest income for banks. Although some economists did forecast a rate cut given the improvement in the quality of fiscal deficit in the Budget, the timing of the rate cut took markets by surprise. Apart from announcing the cut midweek, this was also the first time that RBI announced its decision before markets opened for TRADING.

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Infra, realty companies stand to gain from rate cut

The Reserve Bank of India’s (RBI’s) surprise 25-basis point cut in the repo rate, much before its next month’s meeting, is good news for infra and realty companies, which have been reeling under pressure for long. Most banks had not cut their base rates after the RBI cut repo rate by 25 basis points last month, which signalled the start of the rate-cut cycle. But now, experts believe it is only a matter of time before lending rates inch lower.

Infrastructure companies such as L&T, NCC, HCC, GMR, GVK, Sadbhav Engineering, Ashoka Buildcon, and many more are expected to gain from the rate cuts. While the gains should translate into lower interest costs, bigger gains will accrue when the business cycle picks up (estimated from around the second half of FY16).

Given the government’s focus on adding new infrastructure and clearing bottlenecks, companies, especially from the construction and engineering space, should benefit. In fact, road construction players are already seeing higher orders as compared to 2013-14.

In the Budget, the government has raised the infrastructure allocation by Rs 75,000 crore for 2015-16. It is also infusing Rs 20,000 crore as seed capital into National Infrastructure Fund (NIF) and working on a hybrid system whereby it will provide 40 per cent of the equity for select infrastructure projects.

Says Ajay Bodke, Head (investment strategy & advisory), Prabhudas Lilladher, “The rate cuts are important, but these should be seen in conjunction with the government’s attempt to revive the investment cycle, which is equally crucial. The railway minister is also in talks with LIC for Rs 100,000 crore of projects for long-term innovative funding methods. The ‘plug and play’ route for projects across infra segments is another positive. Projects have been stuck due to a lack of clearances. A government that is making ministries sit together and solve problems in itself is money saved. These measures are helping avoid time and cost overruns, which is half the battle won.”

He adds that if the top line growth improves, operating leverage comes into play, which along with savings in interest costs will boost return on equity (RoE) of companies, leading to a sharp increase in their market value.

For instance, theoretically, GVK Power’s equity can be bought for only Rs 1,526 crore, which is equal to just a tower in South Mumbai, for a company that has significant assets. Although there is debt of over Rs 22,000 crore taking the enterprise value (EV) to Rs 23,500 crore, if over two-three years the top line inches up gradually and interest rates come down, there can be a change in the mix of equity value and debt. Even if the ratio changes by 20-30 per cent, then there will be a significant impact on market value. The case is the same for GMR and many other companies.

On the other hand, real estate companies, especially those reeling under debt, will also gain. But, don't expect any significant gains in the short term.

Experts say once RBI cuts the rate further, companies could see visible reduction in interest costs. Expectations are that the central bank will cut rates by at least 75 basis points more this year. So, there is hope for at least another 50 basis points of a rate cut in the coming months.

“In our view, the framework for a monetary policy response remains unchanged, with RBI likely to target real rates of around 175 basis points. We believe that inflation will decelerate to 4.75 per cent by end-2015 in our base case and 4 per cent in our bull case scenario. This inflation outlook and the real rate policy framework followed by RBI therefore means that the central bank will cut the rate by a further 100 basis points through CY2015, with the next move happening during the April 7 meeting,” wrote Chetan Ahya and Upasana Chachra of Morgan Stanley in a note on Wednesday.

IIFL Research shares a similar view. “In our view, further rate cuts to the tune of 75-100 basis points are possible in the current calendar year.”

Like infra plays, realty companies would also stand to gain more from an increase in business (higher demand for houses). However, the affordability factor (cost of owning a house) is still pretty low and will keep demand in check in the medium term.

Bodke says, “In the first phase, infra (construction) companies will benefit; then cement, steel, capital goods and banking companies will gain; then wages will rise and only then when gains from a pickup in investment cycle reflect on consumption will realty companies gain.”

The share price of many infra and realty companies, which gained in the first half of trading on Wednesday, declined on profit-booking and a weak sentiment globally. Given the positive longer-term implications, the stocks should also rise but not in a hurry. So, use corrections for selective buying, say experts. Companies such as DLF, Prestige, Oberoi and Sobha stand to gain. Overall, experts suggest that only those companies that are better placed in terms of execution (in their business) and have sufficient operating profits currently to service their debt should be considered.

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