Strong case for a CRR cut on Monday, if not a rate cut By INDRANIL SENGUPTA, BANK OF AMERICA MERRILL LYNCH Incoming data support our call that the Centre's fiscal deficit, at 5.7 per cent of GDP in FY13, will overshoot the Budget's 5.1 per cent target. This factors in the long-awaited 12% hike in diesel prices. By the way, this supports our case for a 25 CRR cut – if not a rate cut – in Monday’s RBI policy. That said, we reiterate that crowding out risks are overdone. Although we expect the Centre to borrow an additional Rs 500 billion, the 10-year should persist in our expected 8-8.5% range belying fears – ever so fashionable last year - of piercing 9%. After all, the RBI will likely have to absorb the excess gilt supply via OMO to generate 15-16% M3 growth to fund 7-8% growth. We have raised our OMO forecast by Rs200bn to Rs1800bn - Rs815bn done - in FY13 assuming 75bp of CRR cuts and US$14bn of FX outflows. Further, we continue to expect lending rates to come off by another 50bp atop 25-50bp done. As we have often argued, banking expansion has cut crowding out risks by pulling down the fiscal deficit to 72% of M3 growth in 2009-12 from 129% in early 2000s. Do find our last fiscal report here. We continue to expect that the Centre's fiscal deficit, at 5.7% of GDP in FY13, will overshoot the Budget's 5.1% target. This will primarily emanate from a higher-than-budgeted oil subsidy, even after factoring in today’s 12% diesel price hike and capping subsidised cooking gas cylinders to 6 a year. We have also hiked our direct tax forecast to 15.6% from 12.3% as they have gone up 34.1% in April-July. We have also cut our indirect tax forecast to 12% from 22.4% given 5.4% run rate. RBI OMO to keep 10y 8-8.5% though Rs 500bn extra issuance We continue to expect RBI OMO to absorb excess gilt supply to contain the 10y in the 8-8.5% range. The Center will likely borrow an additional Rs 500bn with its fiscal deficit likely to overshoot. Our liquidity model estimates that this would result in an excess gilt supply of about Rs2101bn. At the same time, we expect the RBI to OMO Rs1800bn (Rs815bn so far) in FY13 to generate 15-16% M3 growth to fund 7-8% growth. This assumes 75bp of CRR cut and US$14bn of FX sales. Given that the US$14bn of FX forwards that the RBI has contracted neutralizes OMO done, we expect it to resume OMO by end-September. We continue to highlight that the rapid expansion of the banking system has cut crowding out risks by pulling down the fiscal deficit to 72% of M3 growth in 2009-12 from 129% in early 2000s. This fiscal cushion has pulled down the share of industrial loans advanced at 14+% to 15% from 87% in the 1990s, although the Centre's fiscal deficit has been relatively sticky at 5.5-6% of GDP across both downturns. Note banks have been growing at a faster pace than the economy because rural India is still shifting to money from barter. This process of financial maturity will likely run its course in 5-10 years.