The rate cut and other liquidity facilities provided by RBI need to be enveloped in a package of macro and micro-prudential relaxations and regulatory forbearance.
The prospect of a grave global slowdown has increased from the unprecedented lockdowns, and isolation progressively put in place by the most important economic engines of the world. Global central banks have responded, often again at unprecedented lengths, supplemented by large fiscal stimulus measures. India’s economic environment is being shaped by a confluence of four Cs: Credit, COVID, Crude and Confidence. The last fortnight of March has been especially impacted, with a widening and deepening lockdown footprint, which will affect payments, transactions, credit flows and consequently increase market volatility to the point of severe financial stability consequences.
The first response of a central bank to a slowdown, particularly one as sharp, sudden, unexpected, made up of a mix of supply and demand, local and offshore, financial and real, is to cut the policy rate, whatever the expectations on the transmission to lending rates. The 0.75 percentage point (ppt) repo rate cut yesterday was one of the sharpest after the 2008 response to the global financial crisis which had seen three 100 ppt cuts in four months.
This was also the first mid review cycle policy cut since the MPC dispensation was enabled. The 1 ppt cut in the cash reserve ratio (CRR) was also the sharpest since 2008, to which was added a further relaxation on managing banking liquidity with the reduction in the average daily maintenance balance. The intensity of using lowcost durable liquidity to induce lending has increased relative to the incentives in the February policy. Progressing beyond the long term repo operations (LTROs) introduced in the February 2020 policy review, RBI introduced for the first time targeted LTROs.In February, the LTROs (of a similar magnitude) was implicitly meant to be viewed with the other “incentives” to lend to sectors with large forward linkages, like residential housing, retail auto loans, etc, and to stressed segments like MSMEs.The stress on sectors has increased multifold since then and spilt over into almost every other sector. This has necessitated targeting the end-use of lowcost liquidity, specifically instruments (investment grade (IG) bonds and commercial paper), mode of issuance (50% from primary issuance and rest from secondary markets) and issuers (including NBFCs and MFs). Lenders are also being nudged away from parking funds in RBI’s reverse repo corridor with an asymmetrically higher 0.9 ppt cut in the reverse repo rate. This rate cut and other liquidity facilities need to be enveloped in a package of macro and micro-prudential relaxations and regulatory forbearance.
An incentive to the above TLTRO drawals is permission to account these as held to maturity (HTM), thereby avoiding mark to market losses should volatility further increase, as well as exemption from the large exposure framework, which limits loans and investment beyond certain limits. On a broader credit canvas, all lending institutions have been permitted (note, not mandated) to allow moratoriums on payments of “instalments” (i.e., both interest and principal) on term loans forthree months as well as deferment of interest payment on working capital (WC) loans. Note that this is not a waiver, only deferment. The hope is that the lockdowns work, business and cash flows are restored, and loan amortisation payment capacities restored, although payments will have cumulated, and will need further spreading out over the next quarter.
Help for MSMEs, in particular, is provided by enhancing WC draw limits, by reducing margins or extending the WC cycle. Will the relaxations predominantly meant for IG bonds and loans not be overly restrictive? The real squeeze in lending was ostensibly for non-investment grade paper. This is not correct. In the recent weeks, investors had become averse to taking the risk of even the highest rated credit quality bonds. Bonds of some of the best rated issuers were trading at unusually high spreads; public sector institutional lenders have had to cancel issuance owing to lack of interest and subscription. Apart from the obvious downsides to, and arguments against, RBI becoming a commercial bank of last resort, the implied hope is that support for better rated paper would gradually percolate to weaker credit as the freeze dissipates, maybe with graded backstops and guarantees provided by the government, as has been earlier provided to NBFCs and last mile funding for residential real estate projects. Will these measures be effective? Since the proximate shock to an already weakened economic system was a medical and public health crisis, it is apposite to use the analogy of a trauma patient in the emergency ward. The first task is to stabilise the patient and staunch the wound.
Only thereafter are medicines to increase metabolism, strengthen immunity and fight infections started. The analogy is so apt that Governor’s statement included many phrases that the medical community would recognise. The effectiveness of the system’s response to policy measures, particularly monetary policy, depends on stakeholders perception of the credibility of the authorities’response functions. In this context, Governor’s emphasis on his forward guidance was particularly striking. In the idiom earlier introduced into central bank communication by ECB president Draghi, RBI Governoremphasised the “need to do whatever is necessary to shield the domestic economy from the pandemic”.
(The author is Senior VP, Business and Economic Research, Axis Bank. Views are personal)