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BIG NEWS – Aug 04th 2017


Posted on 08-Aug-2017 Comments  0

Monetary

Policy


Yes to rate cut, but monetary stance remains the same…



The monetary policy announced by the RBI on 04th August was largely along expected lines. The repo rate was cut by 25 basis points bringing it down to a level of 6%. The 25 basis point cut was largely factored into equity and bond markets and hence there was a sense of disappointment. Markets were expecting a 50 basis points cut, which was not to be. There are 3 key things to grasp about the rate cut and the monetary stance of the RBI…


Favourable macroeconomics…


There were two key factors that favored a rate cut. Firstly, the CPI inflation had dipped below the 2% mark on the back of negative food inflation. With a normal monsoon and a record Sharif output likely this year, the food inflation is likely to remain low. The RBI is now veering around to the view that the CPI inflation may stay well below 4% even in a worst case scenario. That surely created a positive environment for a rate cut. Secondly, there is the issue of growth.The recent data flow suggests that the IIP growth, core sector growth and the PMI have all suffered between May and July 2017. The implementation of GST effective July 01st had forced many industries to focus on inventory sales rather than fresh production. What was required was a boost and a rate cut would be the right option. Rates had been static since October 2016 and the time was ripe for a 25 bps rate cut. That is exactly what the RBI did.


But,the MPC prefers caution…


However,it is also interesting to understand why the Monetary Policy Committee (MPC) did not pursue an aggressive 50 bps rate cut. The MPC is still worried that food inflation may spike once the base effect shifts. Secondly, the MPC was also of the view that the risk of crude oil inflation was not entirely being factored into the CPI. Brent crude has stayed below the $50/bbl mark due to a glut of supply from the US, Libya and Nigeria. However, a sudden supply action from Russia and the OPEC cannot entirely be ruled out. Hence the MPC has chosen to err on the side of caution.


But stance remains neutral…


The most important take-away was that the monetary stance of the RBI has remained neutral. The RBI had shifted its stance from “Accommodative to Neutral” in February and that is where it has remained. The MPC has dwelt on the need to keep its options open considering that the global risk of central banks hardening rates was still a major possibility. Additionally, the Fed has already indicated that the tapering of the bond portfolio will commence sooner rather than later. The RBI would not want to be in a situation where low rates could make a case for FPIs to opt for risk-off investing. We saw the impact in 2013 and would not want a repeat. The RBI is, perhaps,justified in keeping the stance still open and flexible! ©


SBI Deposit Move


Will other PSU banks actually follow suit?



The move by SBI to cut rates on savings accounts by 50 basis points came as a surprise to many analysts. SBI still holds the largest share of CASA deposits but other private banks are fast catching up. Also,with the launch of small payment banks, the concept of deposit accounts has undergone a change. It has become more seamless and simpler. But SBI has been selective in this move. The rate of interest on savings accounts has been cut to 3.5% only for deposits up to Rs.1 crore. For deposits above that level, the rate of interest will continue to be at the original level of 4%. What are the key implications of this move?


Rates are headed down…


This move from the SBI came even before the RBI announced its monetary policy for August. The SBI move was, perhaps, the first clear indication that the RBI would be looking to cut repo rates. In fact,ever since the savings deposits rates were liberalized in 2011, most banks have pegged their rate on savings deposits at 4%. Of course,there are certain private banks that are even offering as high as 6-7% but that is more in case of banks looking to reduce their cost of funds with a greater share of CASA. For SBI, the message has been conveyed to its depositors that if they want lower rates payable on loans then they must also be prepared to accept lower rates of interest on deposits. After all, in the banking space rate cuts have to literally work both ways!


The demonetization effect…


To understand the logic behind the SBI move, one needs to go back to the aftermath of demonetization. When the old notes were withdrawn, the holders were required to necessarily deposit these notes in their bank accounts. That led to a surge in the deposit base of banks to the tune of Rs.7 trillion. The problem was that banks did not have the requisite credit demand to absorb these deposits. So banks were paying interest on deposits but not earning enough on loans. Banks had 2 choices. Firstly, they could raise the rates on loans, which was not feasible considering weak credit demand. Secondly, they could cut deposit rates, which is exactly what SBI has done!


It is actually about profitability…


The fact of the matter is that SBI has over 50% of the CASA deposits in India and therefore a 50 bps rate cut will make a substantial difference to them. According to estimates put out by CLSA, the cut in savings deposit rates could result in a 20-25% increase in the net profits of SBI. That could have huge implications for future earnings and the P/E discounting of SBI. While most banks are biding their time, they will have to follow suit, sooner rather than later. The spreads in case of PSU banks are acutely under pressure. The answer is to cut deposit rates. SBI has taken the lead; others will have to follow! ©



Indigo Airlines


Has Indigo finally discovered the profitability formula?



After a disappointing March quarter, Indigo Airlines appears to be back to its winning ways in the June quarter. With a 25% growth in top-line and in bottom-line, the company appears to have gotten over the twin pressures of competitive pricing and strong crude prices. There are three things that stand out in the latest quarter ended June. Of course, the overall market growth of 26% is going to be the macro story, but the real change is happening within.


A sharp boost to top-line…


To be fair, pricing pressure is very much there in the aviation sector.With stiff competition from 5 major players and 2 smaller players,the going was never going to be easy, especially on the pricing front. In the midst of all this, Indigo has managed to maintain its market share of a tad over 40%. But the real growth has come on the ASK (Average seat kilometer) front. The company has been able to substantially expand its flying capacity by adding more aircraft and also running more routes through better turnaround management of routes. Despite this increase in ASK, the airline has also managed to boost its RASK (Revenue per average seat kilometer). The rise in RASK shows that apart from an increase in capacity, the airline has also managed to improve its earnings run. That looks set to sustain for Indigo with the overall market expanding rapidly. The 25% growth looks set to continue.


A boot for profitability…


The big boost to profitability has come from two fronts. Firstly, Indigo has managed its operational metrics much better this quarter. The spread per ASK (which is the RASK-CASK) has improved by almost 40-50 paisa this quarter. That is a clear guarantee of the profit growth of Indigo sustaining. That also can be largely attributed to the subdued prices of ATF that has held spreads at a healthy level. The second factor is the debt management. The company has managed to reduce its overall long term debt by 25% post the IPO and that resulted in a sharp reduction in the interest burden. The operating metrics combined with the financial metrics have been responsible for the improved profitability of Indigo Airlines.


The big consumer story…


There all story of Indigo may be much bigger. India is already the 3rd largest domestic aviation market in the world after the US and China.It is likely to grow at 25% for many years to come and Indigo just needs to maintain its market share. At Rs.2400 crore, Indigo’s  debit substantially lower than Jet’s Rs.15,000 crore debt or Air India’s massive Rs.47,000 crore burden. That should provide substantial operating and financial leverage to Indigo. With a growing pie, the financials of Indigo look to stay robust. That is,of course, assuming that crude remains stable! ©


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