RBI’s liquidity bonanza will make sure there is no immediate cash squeeze in the system and huge spike in NPAs on account of the adverse environment. This will help to avoid short-term panic
If Finance Minister Nirmala Sitharaman confined her March 26 presser to a largely modest welfare package targeting the vulnerable segments, the Reserve Bank of India (RBI) governor Shaktikanta Das’ March 27 presser was nothing short of a bonanza to the middle class and small entrepreneurs in times of the COVID-19 crisis. But, the question here is whether banks will respond with enough aggression to RBI cues.
There are three components to the RBI announcement. A significant rate cut, three-month moratorium on term loans coupled with relaxation on interest payments on working capital loans and a slew of liquidity measures that’ll release a combined Rs 3.74 lakh crore liquidity into the banking system. Together, with the Rs1.7 lakh crore economic stimulus announced by FM Sitharaman, India has started off its fight well against the global virus scare.
At the first glance, these RBI measures will help avert an immediate liquidity shock in the financial system. Over the last few weeks, banks have largely stayed away from any significant lending or refinancing activities. This is largely because of fears of an economic backlash and lack of clarity on the unfolding liquidity scenario. The confusion was evident. Till last week, even some of the top rated companies were paying a higher rate to raise money in money markets.
Let’s look at each one of these announcements and understand the implications:
The rate cut of 0.75 percent is significant. The last time a rate of this magnitude happened was more than a decade ago when a 100 bps cut happened in October 2008 and in January 2009. In fact, given that the RBI has created an asymmetrical repo-reverse repo corridor (reverse repo has been cut by 90 bps to 4 percent), the effective impact of repo rate cut will be higher. That’s because banks now have no incentive to put money at 4.4 percent at the reverse repo window.
The rate cut of this magnitude should push banks to lower their lending rates. But, to what extent this will happen depends on individual banks. In a normal scenario, given that most of the loans are now linked to repo, a 50 to 75 bps rate cut should not be an unrealistic assumption. This rate reduction should benefit both retail and corporate borrowers, mainly small and medium-sized companies. But, a lot will depend on how margin-hungry banks will ultimately respond.
The second measure — the moratorium on term loans by all lending institutions and interest payment waiver — will be huge relief to borrowers in times of COVID-19 lockdown and job losses. According to the RBI, all types of term loans will get this benefit. With the RBI permitting banks to reschedule interest payments on working capital loans, banks need not worry about terming these loans as NPAs. Given the impact of COVID-19 on the economy, The demand for EMI waivers has been strong. That is addressed.
For companies, the RBI’s liquidity bonanza will be a blessing. The RBI has done three things here. It has announced to continue the targeted Long term repo operations (LTRO) for three years making available about Rs 100,000 crore to the banks , a cash reserve ratio (CRR) cut releasing Rs 137,000 crore and an increase the limit of Marginal Standing Facility (MSF) from 2 percent to 3 percent to the tune of Rs 137,000 crore. In total, liquidity to the tune of Rs 374,000 crore will be infused.
The RBI has made sure banks will use this money for productive lending purposes by insisting that they have to deploy this money in investment grade corporate bonds, commercial paper, and non-convertible debentures over and above the outstanding level of their investments in these bonds as on March 27. According to bond dealers, banks can make a decent 200 basis points spread if they invest in corporate papers at around 6.6 percent.
The RBI has made these instruments reasonably attractive for banks by saying that investments made by banks under this facility will be classified as held to maturity (HTM) even in excess of 25 percent of total investment permitted to be included in the HTM portfolio. This takes care of banks’ fear for mark-to-market losses. Also, exposures under this facility will also not be reckoned under the large exposure framework.
“Given that there is no demand for fresh loans in a slowing economy, banks are most likely to use this money for extending refinancing of loans of NBFCs and companies. Fresh loan demand may pick up later,” said Kumaresh Ramakrishnan, Chief Investment Officer - Fixed Income at PGIM India Mutual Fund.
In short, RBI’s liquidity bonanza will make sure there is no immediate cash squeeze in the system and a huge spike in NPAs on account of the adverse environment. This will help to avoid short-term panic.
But, three key questions remain.
One, how will the RBI ensure that banks take up the RBI concessions in the required spirit and pass on the benefit to the customer? For instance, although the RBI has provided the provision to waive off EMIs and defer interest payments, final implementation will have to happen between the bank and the borrower. In the time of lockdown, how proactively banks take this up remains to be seen.
Second, even after what RBI has done, fiscal response remains critical. The government’s Rs 1.7 lakh crore package is too little considering the massive hit on the economy. The government will have to let go of its fiscal deficit concerns for now and expand the scope of stimulus.
Third, post the lock-down period, there could be uncertainties in the market. The impact of the near-paralysis in the industry on account of the lockdown is likely to continue for a longer period. There could be a spurt in demand from companies for survival capital post the moratorium period. This will be a challenging situation even though the RBI has indicated that it will continue to offer assistance.
Over to the government now.