RBI delivered more than expected—cutting the repo rate by 75bps, widening the corridor, infusing liquidity, and easing regulatory norms.
By PRANJUL BHANDARI & AAYUSHI CHAUDHARY
In a surprise press conference earlier today, RBI unveiled a detailed stimulus plan, ticking all the three boxes, namely, rates, liquidity, and regulatory easing. It arguably exceeded market expectations, given bond yields rallied by 30-35bps on the short end, and 15bps on the long end after the announcement. Policy repo rate cut by 75bps; effective easing even higher.
RBI brought forward its MPC meeting (which was to be held in early-April) and cut the policy repo rate by 75 bps to 4.40%. Four members of the MPC voted for this quantum of cut. The remaining two voted for 50bps easing. The interest rate corridor was widened from 50bps to 65bps. At 4.65%, the MSF rate remains 25bps above repo rate. But, the reverse repo rate was lowered by 90bps to 4.00%.
The reverse repo rate will now be 40bps below the repo rate (instead of the previous norm of being 25bps lower). This step was taken to incentivise banks to lend out to the market, rather than park excess liquidity with RBI.
Given abundant banking sector liquidity, the reverse repo rate could become the more effective one, and as such, the de-facto easing was more than 75 bps, perhaps between 75 bps and 115 bps (if the effective lending rate falls from the previous repo rate of 5.15% to the current reverse repo rate of 4.00%). Given the uncertainty around COVID proliferation in India, RBI refrained from providing forecasts of inflation and growth, which it generally does after the MPC meets.
Impact: The repo rate was cut by 75bps. But the effective easing could be of a higher quantum, between 75 bps and 115 bps.
Liquidity infused, both targeted and system-wide
- Targeted Long Term Repo Operations (TLTRO) of up to Rs 1tr, for a c3- year tenor, at the overnight policy repo rate, was announced. Banks will have to deploy this in investment-grade corporate bonds, commercial paper and nonconvertible debentures. These can be both from the primary or secondary markets, including from mutual funds and non-banking finance companies. Investments made by banks under this facility will be classified as held to maturity (HTM).
- Cash reserve ratio cut by 100bps to 3.0%, for a period of one year. This will infuse primary liquidity of Rs 1,370bn across the banking system.
- Marginal Standing Facility was increased from 2% of the statutory liquidity ratio (SLR) to 3%, for up to June 30, 2020. This amounts to Rs 1,370bn of additional liquidity.
Impact: The three measures relating to TLTRO, CRR and MSF will inject total liquidity of Rs 3.7tr into the system. The HTM status given for the TLTRO investments are likely to take away the fear of mark-to-market losses of domestic banks,making this intervention successful, in our view. The CRR cut will help bank profitability (recall that funds parked under the CRR requirement earn no interest income).
Regulatory forbearance likely to help banks and borrowers alike
- A 3-month re-payment moratorium for all term loans outstanding, as on March 1,2020, was announced.
- Deferment of interest to be paid on working capital loans (cash credit/overdraft) outstanding as on March 1,2020 for three months, was also announced.
- Working capital financing norms were eased. Lending institutions will be allowed to recalculate drawing power by reducing margins and/or by reassessing the working capital cycle for the borrowers.
- Implementation of Net Stable Funding Ratio (NSFR) norm has been deferred by six months to October 1, 2020.
- Last Tranche of Capital Conservation Buffer has also been deferred by six months to September 30, 2020.
Impact: RBI clarified that the regulatory forbearance steps on loan and interest payment will neither result in an asset class downgrade, nor have an adverse impact on the credit history of the beneficiaries. Pushing forward the last tranche of the capital conservation buffer will free-up capital for the banking system.
Steps to curb select financial market volatility
(i) Domestic banks will be permitted to deal in offshore rupee NDF markets with effect from June 1, 2020.
Impact: This will provide liquidity to the NDF market, and help curb volatility.
As mentioned earlier, we think the RBI delivered more than was expected, and touched upon each of its functions – setting rates, infusing liquidity, and overseeing regulation. Some benefits of these steps are likely to show up immediately while others could help in the reconstruction process once the 21-day lockdown, and more broadly the COVID proliferation is behind us. We expect growth to halt in 1HFY21, but rise sharply in 2H as inventory restocking demand kicks in.
If the stress in the financial sector continues, there are a few exceptional instruments that RBI can still use. For example, giving liquidity directly to certain sectors as per Section 18 of the RBI Act.
Over the next few months, the fiscal picture will become clearer. We believe that the welfare measures announced yesterday were only a part of the overall fiscal package. We believe that a combination of a fiscal stimulus, lower tax buoyancy and weak disinvestment receipts will lead to a substantial widening of the fiscal deficit.
The markets will keenly eye the OMO programme that the central bank unveils for FY21. It would also look for indications whether the RBI will resort to direct monetization of the deficit (i.e. buying bonds in the primary market), given these unprecedented times.
Edited excerpts from HSBC Global Research’s India’s RBI thunders, March 27,2020