In less than 2 months and in an unscheduled monetary policy meeting, the RBI announced another fairly steep rate cut along with regulatory measures to further ease the financing conditions in the domestic economy which has been severely impacted by the shutdown in the last 2 months. Today’s policy announcement was the RBIs second monetary policy review for the fiscal year 2020-21.
The MPC reduced the repo rate by 40 basis points to 4% while maintaining its accommodative stance. The MSF, bank rate and reverse repo rates which are linked to the repo rate has also been lowered accordingly. The repo rate and reverse repo rate now stands at a near two decadal low.
The RBI also extended the earlier announced relaxation (announced in the last 2 months) for debt servicing and compliances. It also announced measures to support exports and imports including providing a line of credit for EXIM banks, increased the group exposure limit and measures to ease the stress of state governments.
The MPC took note that the two months of COVID-19 induced lockdown has had severe ramifications on economic activities and financing conditions across all segments and this called for an easing in financing conditions and a reduction in policy rate. While all members of MPC voted for a reduction in repo rate, 5 were in favour of a cut of 40 bps while one member voted for a reduction in repo rate by 25 bps
The MPC stated that there still remains policy space for future actions. The RBI only gave directional guidance on inflation and economic growth and refrained from giving any numerical projections amidst high uncertainty surrounding the pandemic. Though the outlook of inflation is highly uncertain the headline inflation is expected to remain below target in H2. Economic growth is expected to contract in FY21 with prominent downside risks.
We had lowered its GDP growth projections for FY21 to -1.5-1.6% earlier this week in our Report – Road to Recovery.
RBI’s Assessment on global and domestic economy
- Global economic activity stagnated due to lockdown and social distancing
- • Volatility in financial markets ebbed after fiscal and monetary policy response
- • Revival in foreign fund flows to EMEs • Weakness in US dollar with gradual improvement in risk appetite
- • Crude oil prices firmed up. Gold prices remained elevated
- • Subdued CPI inflation across advanced and emerging market economies. Pick up in food inflation due to supply disruptions
- • Global trade to contract this year as per WTO projections.
- Server impact on domestic economic activities on account of 2 months of nation-wide lockdown
- • Depressed rural as well as urban demand.
- • Decline in private consumption as well as investment activity
- • Sizable contraction in service activities
- • Improvement in agriculture and allied - Kharif sowing is higher and Rabi procurement is under progress
- • Uptick in retail inflation led by supply shocks in food component • Abundant systematic liquidity
- • Narrowing liquidity premia in various markets segments
- • Increase in FDI and FPI inflows in equity segment. Outflows from debt segment
- • Sizable foreign exchange reserves
RBI’s outlook on inflation and economic growth
The RBI has given only directional guidance on the inflation trajectory and economic growth due to high uncertainty surrounding COVID-19 pandemic.
Headline inflation could be below 4% target in Q3 and Q4 FY21
- Favourable base effect, expectations of gradual relaxation in lockdown, moderation in food inflation, forecast of normal monsoon, low input costs with subdued metal and raw material prices globally, deficient demand will dampen inflationary pressures going ahead.
- However, upside to the inflation could emanate from likely firming up of global crude oil prices, persistent supply dislocations and volatility in financial markets.
- Risk to inflation is anticipated to be short lived. With inflation expected to remain benign there remains a policy space to address growth concerns.
MPC noted that the macroeconomic impact is more severe than earlier anticipated. Various sectors are under stress due to supply disruptions and low demand.
GDP growth in FY21 is expected to remain in a negative territory
- Depressed economic activities barring agriculture, expectations of subdued economic activities due to continuation of social distancing norms post lockdown easing and temporary shortages of labour will weigh on economic growth.
- Gradual revival in activity in H2 with recovery in Q3 and increase in growth momentum in Q4 is expected.
- There is high uncertainty regarding duration of pandemic and thus, downside risks to the economic growth are significant.
Developmental and regulatory policies
The statement of regulatory and development policies includes measures which broadly focuses on improving the functioning of the financial markets, support to export and imports, ease financial stress caused by COVID-19 and steps to ease financial constraints faced by the state governments.
I. Measures to improve functioning of the markets:
- Refinancing facility for SIDBI: The special refinancing facility of Rs 15,000 crs which was provided to SIDBI for onlending/refinancing to small industries for a period of 90 days will be rolled over by another 90 days from the end of the 90th day.
- Additional duration to meet investment limits by FPIs under VRR: From the current level of 3 months, additional 3 months is to be allowed to FPIs to fulfill the requirement of meeting atleast 75% of the allotted FPI limits.
II. Measures to support export and imports
Export credit: The RBI has permitted an increase in the maximum permissible period of pre-shipment and postshipment export credit sanctioned by banks from existing 1 year to 15 months for all the disbursements made up to July 31, 2020
Liquidity facility for EXIM banks:
The RBI has decided to extend a line of credit of Rs 15,000 crs to EXIM bank for 90 days (with a rollover of maximum 1 year) with a view to enable the bank to avail US dollar swap facilities to meet its foreign exchange requirements.
Extension of time for payment for imports:
The RBI has extended the period for completion of remittances against normal imports into India (except in cases where amounts are withheld towards guarantee) from 6 months to 12 months from the date of shipments made on or before July 31, 2020.
111Measures to ease finance stress
- Moratorium on term loan installments: The RBI has permitted commercial banks, cooperative banks, small finance banks, AIFIs and NBFCs (termed as “lending institutions”) to allow a further 3 month moratorium i.e from June 1 to August 31, 2020 on the payment of installments in respect of term loans outstanding as on March 31, 2020. Consequently, the repayment schedule may be shifted by additional 3 months.
- Deferment of interest in working capital facilities: The lending institutions are permitted to allow a deferment of another 3 months from June 1 to August 31 for the working capital facilities sanctioned in the form of cash credit / overdraft.
- Conversion of accumulated interest rate into funded interest term loan: The lending institutions are permitted to convert the accumulated interest on working capital facilities over the deferment period into a funded interest term loan facility. This loan facility has to be repaid by March 31, 2021.
- Asset classifications: The moratorium / deferment availed by the borrowers will not result in an asset classification downgrade. The 90 day NPA norm for all standard accounts (as on March 1, 2020) which have been granted moratorium/deferment shall exclude the period of moratorium. Thereafter, the normal ageing norms shall be applicable.
- Easing working capital financing: The lending institutions are permitted to recalculate the “drawing powers” for working capital financing by reducing the margins till August 31, 2020. The margin requirements are to be restored to the original level by March 31, 2021.
- Extension of Resolution Timeline: The lending institutions, which have an additional provision of 20% in the case of large default accounts (for which resolution plan has not been implemented within 210 days), shall exclude the entire period of moratorium (i.e March 1, 2020 to August 31, 2020) from the calculation of resolution period.
- Limit on Group Exposures under the Large Exposure Framework: The RBI has permitted to increase bank’s exposure to a group of connected counterparties from 25% to 30% and this limit will be applicable till June 30,2021.
IV. Ease financial stress of state governments
Relaxation in the rules governing the withdrawals of funds from the CSF of states, which is maintained by states as a reserve fund for the amortization of their debt obligations. The relaxation offered (till 31 March 2021) will release an additional amount of Rs 13,300 crs is expected to help States meet about 45% of their redemption for FY21. As of end March’20, a total of Rs.1.34 lakh crores was being maintained by different states/UTs with the RBI. Among states, Maharashtra has the highest reserves at around Rs.40,000 crs, followed.
CARE Ratings View
- While these measures are aimed at easing the funding pressures and make available bank funds for distressed segments it needs to be seen if bank credit offtake sees a noteworthy increase, given the underlying heightened risk aversion among banks to lend on fears of the lending turning bad in the future. The credit guarantee provided by the central government for lending to MSMEs, NBFCs, HFCs and MFIs in the special economic package in conjunction with the relaxation offered by RBI would help moderate the risk aversion to an extent. Banks could continue to prefer to park funds in the reverse repo facility of the RBI. The reverse repo rate has now made it very unattractive for banks to deploy their surplus funds. But they could be waiting to invest them in GSecs and SDLs which would be higher this year and offer better and safe returns.
- The present rate cut and other facilitation should be more as measures aimed to help firms to survive and will not really bring about revival in economic activity in the next few months. Further support through TLTROs may still be required once the lockdown ends and companiesrequire funding to enhance investment and hence growth. This is probably the reason the RBI Governor also spoke of possibility of more rate action in future if required.
- A rate cut may not prompt significantly higher borrowing as given the lack of economic activity and expectations of weak prospects, businesses could be reluctant to borrow and add to their liabilities. Therefore, a lot depends on when the shutdown ends and a move to normalcy begins.
- The extension of moratorium was expected and provide more time for the borrowers to adjust to their debt servicing commitments. However, such interest and loans have to be repaid as there is no waiver involved and hence it is imperative for economic activity to re-commence so that production increases and they are able to earn their revenue to meet these commitments.
- The allowance made to states to dip into their CSF is encouraging as those which have created this fund will now be at an advantage. In future, more states would opt to maintaining this fund as ‘the rainy day’ argument works.
On the whole the measures of the RBI are extremely supportive of the ‘revival’ process that was sparked by the government last week with a series of reforms announced. The policy lowers the cost of funds and also points out that the transmission has been quite satisfactory of late. As activity has come to a virtual standstill companies would still not be able to service their debt and hence the moratorium has been extended. The same has been done for the earlier announced measures on working capital limits. All this will provide support to firms in these challenging times. The response of banks and borrowers would be interesting and determine how quickly the revival takes place. Further we could expect another rate cut during the year as conditions evolve.
Kavita Chacko, Senior Economist
Dr. Rucha Ranadive, Economist
Sushant Hede, Associate Economist
Rachna Gupta, Manager – Training