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Citigroup - India Banks - CRR Hike

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Banks mull strategy after RBI hikes rates

A day after ICICI Bank upped its lending rates following RBI's key rate hikes, several lenders were mulling their response even as IndusInd Bank hinted at a possible rise this week.

Two private sector players - Yes Bank and ICICI Bank - hiked their prime lending rates (PLRs) over the weekend in response to RBI's move to hike repo and CRR rates on Friday.

"The days of absorbing increasing cost of funds are over. The RBI's move will definitely impact our cost of funds," IndusInd Managing Director Bhaskar Ghose told media here.

The bank will take a "balanced view" so that its business does not get affected by any sharp rise in its lending rates, he said.

"Some banks have already hiked their rates. We will see what the larger banks do," he said, adding "while we have no intention of absorbing the cost of funds, we will take our decision next week."

"You can certainly expect a minimum 0.25 per cent hike but it could go up to 0.50 per cent." IDBI Bank Deputy Managing Director Jitender Balakrishnan, while admitting that the cost of funds would go up, however, said the public sector lender would take a decision on hiking its lending rates only after "discussing the matter".

"The hike in repo and CRR will definitely impact our cost of funds. But whether we increase our lending rates or absorb the costs will be decided only at our board meet," he said.

Decisions to hike rates are taken at the Board level and IDBI Bank's Board is not scheduled to meet till end-April, he said, indicating that any possibility of an immediate response by the bank was remote.

Auto, housing sector to be hit most by rate hike

With the days of low interest rates that boosted demand for homes and cars behind us, real estate players and automakers fear that potential buyers would divert their rising wealth to savings instruments than spend it.

On the flip side, slumping sales could soon force housing and vehicle prices lower, but not just yet. "The rise in interest rate will put major strain on middle income buyers. They are really squeezed up as the EMIs have gone up by almost 50 per cent in last three years," said a real estate company official.

For instance, those who borrowed home loans in 2003 at an interest rate of 7 per cent are today paying over 11 per cent.

India's second largest lender ICICI Bank has already announced it would raise home loan rates by one per cent and other banks are likely to follow suit in the wake of RBI increasing its key short-term lending rate (repo) as also the percentage of mandatory bank deposits on Friday.

Real estate agents and bankers agree that potential buyers would postpone their decision to purchase a home or car after the hike in interest rates.

According to Hero Honda Chief Financial Officer Ravi Sud, hardening interest rates are going to slow down sales of two-wheelers as buying interest is getting negatively impacted owing to increasing interest rate.

"Our March sales are likely to be flat on a year on year comparison basis. Sales are being impacted primarily because of hardening interest rates, which makes monthly installments higher," he said.

Consumers who have surplus cash are also choosing to invest in various savings instruments rather then spending on purchases, he added. Bankers admit that interest rates on home and personal loans are set to shoot up further as a result of Reserve Bank's monetary policy decisions to cool inflation and temper the high demand for loans.

The central bank had made borrowing costlier, by hiking the inter-bank short-term lending rate by 0.25 per cent and the mandatory deposits banks with the RBI by 0.5 per cent.

RBI's measures are in response to inflation, which is now hovering around 6.46 per cent against this fiscal's target of 5-5.5 per cent.

In the last two years or so, banks have increased home loan rates from 6.5 per cent to 11 per cent, resulting in equated monthly installments rising by over 40 per cent.

Some economists, however, expressed doubt whether RBI's monetary measures to squeeze liquidity in the market will bring down "inflation pushed by supply-constraints" and when flow of capital through FIIs in the stock market is leading to rise in liquidity.

"RBI's measures seems to be just to balance the flow of liquidity through investment by foreign institutional investors in the stocks market, with little success to curb inflation," said a banker, adding that the Central bank was unnecessarily hurting borrowers and economic growth.

The Asian Development Bank last week forecast that India's economy would grow by a moderate 8 per cent this fiscal, as against the estimated growth rate of 9.2 per cent in 2006-07.

ICICI Bank hikes lending rates on consumer loans

India's largest private sector bank ICICI on Saturday hiked its floating reference rate by one per cent for consumer loans, including home loans, with effect from March 31.

It also announced an increase of one per cent in its Benchmark Advance Rate, a release here stated.

The revised FRR will be 12.75 per cent per annum as against 11.75 per cent at present and the revised I-BAR will be 15.75 per cent per annum payable monthly as against 14.75 per cent at present.

For existing floating rate customers, the increase in FRR by one per cent will be effective from April 1, 2007.

Existing fixed rate customers, whose loans are fully disbursed, will, however, not be impacted by the increase and their contracted rates will remain unchanged, the bank stated.

Budget Impact - Dhirendra Kumar

Last year, I thought that Budget 2006 was a 'low-impact' one as far as issues like savings and tax relief on savings went. The basic shape of taxes, both personal and capital gains, remained the same. In Budget 2007, things are much the same. This is yet another low-impact budget whose underlying message for savings and investments is that things are basically OK and there's no need to tinker too much. As I thought last year too, there's nothing wrong with a budget that's basically a do-nothing in these areas. Historically, Indian Finance Ministers have shown a tendency to do too much of the wrong things when governments are in some political pressure but Mr Chidambaram has stuck to his guns and basically emphasised that his policy on savings is just fine and I think that's a good thing. For individuals doing their tax-planning, stability of the tax regime has a great value.

Exemption: However, there are a few changes that will impact some segments. The increase in the basic tax exemption by Rs 10,000 means an extra Rs 1,000 a year for all tax payers. This kind of an increase should really be automatic and linked to some sort of an inflation index.

Dividend Distribution Tax: Some of the mutual fund industries' debt fund products will come under increased pressure as the Dividend Distribution Tax in liquid and money market funds has been hiked to 25 per cent. These are the kind of funds that most corporates use to park short-term cash. Of course, banks will benefit because their deposits will not be as relatively unattractive as they are now compared to income funds, but on the whole this will definitely mean a higher tax outgo (even though this tax outgo is invisible in their accounts) for cash-rich companies. It's difficult to calculate the exact impact at this stage but it is entirely possible that fund companies that have been hyperactive in these kinds of products could be severely affected.

New Regulations: In his speech, the FM said the government sought to 'promote the flow of investment to the infrastructure sector by permitting mutual funds to launch and operate dedicated infrastructure funds.' I'm not sure yet what this means. Funds are already free to launch any kind of sector-specific funds and some infrastructure funds already exist. Another point about funds he made is that the government would 'converge the different regulations that allow individuals and Indian mutual funds to invest in overseas securities by permitting individuals to invest through Indian mutual funds'. Here again, individuals can already invest abroad through mutual funds. I guess things will become clearer when the actual regulations detailing these changes arrive.

Exchangeable Bonds: Another interesting statement is that the government will 'put in place an enabling mechanism to permit Indian companies to unlock a part of their holdings in group companies for meeting their financing requirements by issue of Exchangeable Bonds'. In countries where they are permitted, exchangeable bonds are bonds that can be exchanged for the stock of a company other than the issuer, generally a subsidiary. I guess this would be mostly of interest to business houses that like to use innovative financing and restructuring strategies.

Markets' Fall: As far as stocks' steep fall on budget day goes, I think investors were basically nervous and were looking for any excuse (the budget or the global stock collapse over the last two days) to sell heavily. The general story seems to be that the market expected this or that benefit and since nothing materialised prices are crashing. It seems that whether it is corporate results or the Union Budget, stock players routinely build up great expectations unilaterally and then complain when these are not met.

Industry reacts: Some +ve, some -ve

Gautam Hari Singhania, chairman & managing director, Raymond, said: The Union Budget 2007 - 2008 has strived to continue the reform process so that overall growth can be sustained. The increased allocation to agriculture in terms of rural infrastructure will spur agriculture to move beyond its present unsatisfactory growth rate of 2.3% to the targeted 4 %, in turn improving the lives of the people dependent on this sector.

"A very welcome note in this budget is the greater focus on the soft infrastructure – education and training, health so very critical to our country if it has to continue on its high path of growth.

"For the textile industry, the budget has been generally positive. The TUF scheme has been extended till the end of the 11th plan period. Allocation under the TUF scheme for the next year has been increased which should expedite the release of the subsidy. Peak rates of the duty have been cut & import duties on polyester have been reduced. Increased allocation to textile integrated parks is very welcome as it will boost the set up of additional capacities to cater to the growing domestic market and export.

"The extension of service tax to cover rental of commercial properties is unwelcome as it will increase the cost of operations of the retail sector.

"Overall the budget continues with the financial prudence mandate and attempts to keep price stability.

Deepak Ghaisas, CEO – India Operations and CFO, i-flex solutions

The budget from long term perspective provides positive incentives to increase investment in the educations system - both in secondary and higher education. That is a vital requirement for the IT industry in the coming years as the shortage of talent is a major constraint. However, there have been no major signals on upgrading infrastructure especially as we need large investments in infrastructure. Some estimates put the requirements at over $100 billion and the IT industry need infrastructure if it is to continue to grow.

The planned expansion of expenditure on E Governance is a good signal for the IT industry. It will serve to expand the domestic market and IT companies will see government spending coming their way which is a good thing. However from short term perspective I believe the budget provides debits and no credit.

The IT industry had some expectations – I don’t think the finance minister has taken them in to account and if he has introduced any measures that affect the IT industry the impact of the these measures is negative. One of the hopes was the government would consider extension the Software Technology Park scheme and Section 10A of the Income Tax Act beyond 2009. This would be especially important for IT SME sector.

Most IT industries are already paying tax but the MAT imposition on the IT industry would negatively impact those of SME enterprises who are not paying any tax.

The imposition of fringe benefit tax on ESOPs is most surprising. This will make current ESOPs expensive and would also make it difficult for IT industry that uses ESOP as a major tool to attract talent.

There has been no further clarification of the SEZ scheme and this will continue to keep many IT companies from finalizing their capital expenditure plans.

Though there has been mention of public-private partnership to expand education there the budget does not provide any clarity on how exactly this is going to work.

Commenting on the Union Budget, Ashank Desai, Non-Executive Chairman, Mastek; said: “With regard to the IT sector, the Budget has come as a mixed bag. The increase in allocation for e-governance measures is a commendable measure and should result in benefits for both the sector and the nation as a whole in the longer term. At the same time, we believe that extension of MAT to companies that had earlier been promised 10A and 10B exemptions is likely to have an adverse impact on certain players. In addition to that, the inclusion of ESOPs under FBT will add to the challenges being faced by employers in knowledge-intensive industries in attracting and retaining world-class talent.”

Sheshagiri Rao, director (finance), JSW Steel, said: “The budget is more biased towards controlling inflation rather than stimulating growth. The reduction in excise duties for certain products used for infrastructure building, would not only reduce the inflation but also increase the demand quite substantially while simultaneously increasing the revenues to the Government due to higher volumes.

The thrust on social sectors by increased allocations on education, health and employment is a positive step for inclusive growth.”

Steel Industry: “The steel industry was expecting that the Government would take certain steps to stimulate demand by reducing excise duty user specific, particularly infrastructure, white goods and automobiles but no step have been taken in this direction. However, imposition of export duty on ore / ore concentrated exports is expected to higher availability. These critical raw materials at better prices to domestic steel producers.”

Concern: “The reduction of customs duties on import of secondary steel products which may result in opening of floodgates for entry of inferior quality steel products into the country. This provision is likely to be abused by importing prime quality steel products also.”

Madhur Bajaj, president, SIAM said that the Finance Minister presented a budget that sought to continue the growth momentum in the economy, but added that the auto industry had hoped for some more concrete steps in respect of the sector which have not been announced this year.

The budget focused on Agriculture, infrastructure and social sector, all of which will have positive impact on the economy. The proposals in the agriculture sector if implemented correctly would increase overall growth”. Mr. Bajaj said.

The positive features of the budget in respect to the auto sector according to Mr. Bajaj were the reduction of CST from 4% to 3%, the continuation of the weighted deduction of R&D expenditure under Income Tax Act for the automobile sector for the next 5 years, and the retention of current customs duty structure on cars and two wheelers was a welcome step and would encourage local value addition in the domestic economy and generate employment.

The other positives in the budget were the increase in spending on roads both national highways and rural roads. The increase in outlay for the Urban Renewal Mission and its focus on transport would help increase public transportation in the country according to Mr. Bajaj. The increase in funds for ITI’s and the introduction of a PPP model would also help in the long term, Mr. Bajaj added.

“However, reduction of customs duty on commercial vehicles from 12.5% to 10% is going to affect the industry negatively, specially as this applies to used commercial vehicles also” Mr. Bajaj said. “This would open up imports from low cost economies”. The additional education cess of 1% and the service tax on design services would have a negative impact on prices, he added. Also, some companies are likely to be adversely affected by Dividend Distribution Tax.

SIAM president said that industry was hoping that the high incidence of excise duty on cars and utility vehicles would be addressed in this budget. Moreover, utility vehicles are the only means of transportation for semi urban and rural people where public transport network has not developed.

Currently cars and utility vehicles, other than small cars attract 24% excise duty, which is one of the highest in the country. SIAM has been requesting for an across the borad reduction in excise duty for cars and MUVs to 16%. SIAM hopes that this would be corrected soon.

For enhancing road safety and addressing pollution, SIAM had suggested a programme to modernize vehicle fleet. SIAM hoped that the Government would soon come out with a suitable policy in this regard and this would be looked at by the committee on green house gases. Also, the recommendations outlined in the Automotive Mission Plan 2006-2016 should be taken up.

Madhavan Menon, MD, Thomas Cook India, said: Increase in allocation to development of tourism infrastructure from Rs.423cr to Rs.520cr is a good sign but the amount is inadequate given the constraints faced by the tourism infrastructure in the country. There was no mention about airports/ports development which is disappointing as these would be key to tourism promotion in the country. The five year tax holiday for development of different category hotels & convention centers in the NCR region is a welcome move as it will help meet the increasing demand of rooms for the Commonwealth Games especially in the economy category. VC participation in development of hotels & convention centers would also help meet the room shortage in hospitality industry."

Cellular Operators Association of India (COAI) Director General TV Ramachandran said: "The proposal to constitute a committee to study levy structure in telecom is a step in the right direction and it will help the industry in the long-term. Otherwise, the industry was left untouched, which is a cause of concern and disappointment. The industry was accepting a reduction in the license fee structure, however the FM did not make any indication in this regard.” " Glenn Saldanha, CEO & MD, Glenmark Pharmaceuticals: "Given that the pharma industry is one of the growth sectors for the Indian economy and that India is now respecting IPR which would create challenges for Indian companies in the future, we were hoping there would be significant incentives to stimulate Indian R&D. However while we expected more, we are glad that the R&D 150% tax incentive will continue for an additional five years."

Kapil Wadhawan, MD & Chairman, DHFL: "Creation of mortgage guarantee companies will improve alternative resources to housing finance companies at a lower cost, which will improve profitability of housing finance companies and will provide greater comfort to the lenders

"Introduction of reverse mortgage by National Housing Bank is positive for DHFL as we were the first to initiate this product and are ready with procedural aspects.

"Emphasis on Bharat Nirman Yojna and the 31% increase in the fund allocation to this scheme will generate employment in rural areas which will increase income levels of working people in these areas and increase the potential demand for housing finance."

CRISIL - Impact Analysis of Duty Cuts

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India Strategy - Lust & Dust - Implications of Democrats winning Senate & House

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Indian rupee: The fall and its impact...

2004 was a volatile year for the Indian rupee. While the elections and the subsequent elevation of the UPA government to the seat of power saw the rupee dip below 46 levels during the first half of the year, the sharp depreciation of the dollar against the euro and major Asian currencies led to the rupee appreciating to 43.50 levels during the second half of the year. The rupee once again touched a high of 43.28 on May 11, 2005 in tandem with other Asian currencies after the Chinese government took a small but significant step in appreciating the yuan. Since then, the rupee has considerably depreciated (by around 7%) and here we examine why.

High crude prices take their toll: One of the key factors that led to the depreciation of the rupee is the impact of the high crude prices on the merchandise account. In the period between May 2004 and September 2005, the average price of the Indian basket increased from around US$ 40 per barrel to around US$ 60 per barrel leading to the widening of the trade deficit (Source: RBI). Typically, in a trade deficit scenario, depreciation of the rupee makes sense as a weaker rupee will make exports more competitive thereby easing, to some extent, the pressure on the trade deficit. However, given the fact that the demand for crude oil is relatively inelastic, the value of the import bill rises leading to a vicious circle. However, what is interesting to note is that during the above-mentioned period, there was a rise in the value of the Indian currency, which was largely attributed to the surge in FII inflows. That said, since the start of 2006, while the trade account continues to be in the red, the rupee has depreciated leading to a correction in this anomaly.

The FII impact: The quantum of FII money in the Indian stockmarket has played a significant role in the movement of the exchange rate. In fact, as mentioned earlier, in the past couple of years, despite the trade deficit, the value of the Indian currency has been rising mainly due to the surge in FII inflow into the country. As can be evinced from the graphs, the value of the rupee between December 2004 and June 2005 was supported by large inflows on account of FIIs to the tune of US$ 6 bn (Source: SEBI). Pitted against this, in the period between January 2006 and August 2006, when the FII inflow of money into Indian equities was relatively at its lowest (US$ 3.8 bn), the rupee has also depreciated from 44 levels to 46.50 levels.

The reduced interest rate differential between the US Fed rates and the Indian interest rates could also be attributed to the fall in the FII inflows. To put things in perspective, while US Fed has hiked interest rates to 5.25% in 2006 from a low of 1% in June 2004, the extent of rise in the reverse repo rate in India has been much slower and currently stands at 6%.

To sum up...
Given the slowdown in FII inflows in the last few months and the trade deficit, we believe that the fall in the value of the rupee was inevitable. While this is a positive scenario for export oriented sectors such as software, pharma and textiles amongst others, a major drawback of the same is that it will increase the burden of servicing and repaying of foreign debt of companies that have raised dollar denominated debt. Also, oil companies are an exception, as India imports around 70% of the oil that it consumes (the only respite being a fall in the crude prices). That said, we believe that, in the long-term, the Indian rupee is likely to be weaker against the greenback. Therefore, in such a scenario, while it is not possible to completely eliminate forex risks, those companies that adopt prudent hedging strategies will have that extra edge over their peers.

Via Equitymaster