The COVID-19 pandemic has wreaked havoc on the global financial environment, leading to a situation of unprecedented loss and isolation.
In the face of this, Reserve Bank of India governor Shaktikanta Das was right to acknowledge in his Friday morning address that “tough times never last; only tough people and tough institutions do”.
The onerous and intractable situation both at the macro and micro levels does call for responses, both from the Centre and the central bank to mitigate the proliferating financial implications of the shutdown in economic activity. The government responded yesterday with the first part of its fiscal stimulus package and within 24 hours of that announcement, the Reserve Bank of India’s monetary policy committee unleashed an array of instruments from its arsenal with an objective to revive growth and preserve financial stability.
The RBI and the monetary policy committee (MPC), highlighting the severe implications on account of a mixture of demand and supply shock, came up with a comprehensive plan with force multipliers which included a combination of policy rate cut, liquidity infusion measures and easing financial stress announcements. Unconventionally and rightly, the MPC also refrained from providing projections on growth and inflation for the Indian economy making it clear that the focus should be more on responses to address the stress rather than forecasting numbers amidst uncertainty.
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The RBI’s MPC voted unanimously to a sizeable reduction in policy repo rate but with a 4-2 voting pattern agreed upon 75 basis points cut in the policy repo rate. This rate cut means that the repo rate is now at 4.4% and is at its lowest level since its introduction in 2000 and also 35 basis points lower than the lowest level seen during the aftermath of the 2008 global financial crisis. In addition, to discourage the banks from parking their surplus liquidity with the RBI, the MPC reduced the reverse repo rate (the rate at which the banks park their excess liquidity with the RBI) to its lowest level since April, 2010.
What these two measures have done is widened the monetary policy rate corridor (the difference between the reverse repo rate and the marginal standing facility rate) from 50 basis points to 65 basis points. This widening has happened for the first time since April 2017.
Two welcome moves
In a number of my previous articles, I have argued for providing sustained liquidity into the banking system and in the past one month, the RBI has rightly been doing so via long term repos.
However, the issue with RBI’s liquidity operations is that the banks have been parking close to Rs 3 lakh crore in the reverse repo channel. In order to discourage this arrangement and make it less attractive, the RBI lowered the reverse repo rate by 90 basis points to 4%.
Locals throng a market to buy vegetables, during day-3 of a nationwide lockdown, imposed in the wake of the coronavirus pandemic, in Kanpur, Friday, March 27, 2020. Photo: PTI
Not only on one hand did the RBI made this channel unattractive, but also on the other hand it mandated the banks that the liquidity which is availed from the RBI as a part of its targeted long term repo operations has to be deployed in investment grade corporate bonds, commercial papers and non-convertible debentures. Although both these moves are welcome and would benefit especially NBFCs and HFCs who are actively involved in raising money from the bond and CP market, the point which will have to be monitored is that amidst this lockdown, whether there will be on-lending of these funds by financial institutions to various industries.
An ‘out of the box’ CRR cut
In addition, the RBI slashed the cash reserve ratio for all banks by 100 basis points to 3% for a period of one year, its lowest level since 1962. Cash reserve ratio (CRR) is a proportion of the net demand and time liabilities. In simple terms, it refers to “deposits” which the banks have to park with the RBI without earning interest. Even during the 2008 financial crisis, the RBI had undertaken a similar measure when it had reduced the CRR ratio from 9% in August, 2008 to 5% in January 2009.
Also, the banks will have to maintain a minimum daily CRR balance of 80%, lower than the current level of 90%.The RBI has computed that its multi-pronged approach of liquidity infusion since February 2020, accounts for a sizeable quantum of 3.2% of India’s GDP.
Can borrowers breathe a sigh of relief?
Another widely expected announcement for leveraged entities was the moratorium on their loans. The RBI did acknowledge this and in order to mitigate the burden of debt servicing, announced measures which included moratorium on term loans, deferring interest payments on working capital, easing working capital financing among others.
However, the devil lies in the details. The RBI has explicitly mentioned that all commercial banks, cooperative banks, all-Indian financial institutions (AIFIs) and NBFCs/HFCs “are permitted” to allow a moratorium of 3 months on payments of instalments.
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This idea is akin to monetary policy transmission where the RBI can decide to cut the policy rate but it is upon the individual financial institution whether it wants to pass on the benefits to the customer.Therefore, though the RBI has dangled the carrot, but borrowers will have to wait for the decision of the respective banks.
Transmission concerns surrounding deposit rates
The first point of impact of a repo rate cut should ideally be on the deposit rates. With a cumulatively rate cut of 135 basis points since February, 19, the scheduled commercial banks had slashed deposit rates by only 39 basis points which made reducing lending rates difficult. The weighted average term deposit rate at 6.52% in January 2020 is lower than the interest rates on different small saving schemes of the government.
Thus, the challenge will be to reduce the deposit rates in order to maintain the interest rate spread. What can help here is probably a response from the fiscal corner by reducing rates on small saving schemes, without which interest rate transmission looks difficult. Through this response will impact the savings rate in the economy, but this could be a temporary measure till the end of this challenging situation.
Passing on the baton to the financial sector
Though the RBI’s comprehensive measures are welcome and meet most market expectations, the baton now passes on to the most critical component of the economy – the financial sector.
Monitoring the response of banks in transmitting the repo rate cut and ensuring credit flows in the economy to rebuild supply channels and reinvigorate the weakness in the aggregate demand will be the key. Till that time, we can all remain optimistic.
Sushant Hede is Associate Economist CARE Ratings Views expressed here are personal. Rucha Ranadive, Economist CARE Ratings also contributed to this article.
