There is substantial liquidity in the banking sector, what is needed is the removal of risk averseness, say experts.
The Reserve Bank of India (RBI) on May 22 cut repo rate by another 40 basis points to 4 percent and reverse repo rate to 3.35 percent.Accordingly, the marginal standing facility (MSF) rate and the Bank Rate
reduced to 4.25 percent from 4.65 percent.
The central bank also extended the moratorium on all term loans by another three months to August 31, 2020, governor Shaktikanta Das said. The accumulated interest for the moratorium period can be converted into a term loan.
The monetary policy committee also decided to continue with the accommodative stance to revive growth and mitigate the impact of COVID-19.
Good for borrowers, bad for banks
The decision to extend loan moratorium was good for borrowers but it will put more pressure on banks as stress of non-performing assets (NPAs) stress is likely to increase, experts say.
"Extension of the moratorium announced earlier by another three months is a relief. A takeaway from the policy announcement is that the stress in the banking sector will continue," said VK Vijayakumar- Chief Investment Strategist- Geojit Financial Services.
The statement that monetary policy will continue to be accommodative was a positive signal. “The fact that the central bank has refrained from giving a GDP growth figure is a reflection of the complexity in giving projections with the present growth models," he said.
Deepthi Mathew- Economist- Geojit Financial Services, also said extended moratorium would bring relief to the borrowers but could put pressure on the banks’ balance sheets.
"The rising food inflation rate could be a challenge to the RBI as it is following the inflation-targeting regime," she added.
The central bank said the inflation outlook was highly uncertain. "Deficient demand may hold down pressures on core inflation (excluding food and fuel), although persisting supply dislocations impart uncertainty to the near term outlook. However, volatility in financial markets could have a bearing on inflation,"
The conversion of moratorium interest payment into a term loan can reduce NPA pressure for the next 12 months but overall, the stress will remain.
"The measure to convert the moratorium interest payment into a term loan payable in course of FY21 is the most important announcement. This can reduce NPA, at least in the next 12 month. The additional liquidity measures remain rather muted. The RBI also remains circumspect on growth and inflation outlook," Sujan Hajra, Chief Economist and Executive Director, Anand Rathi Shares & Stock Brokers said.
As per the RBI release, the MPC is of the view that the macroeconomic impact of the pandemic is turning out to be more severe than anticipated and various sectors are experiencing acute stress.
The impact of the shock has been compounded by the interaction of supply disruptions and demand compression. Beyond the destruction of economic and financial activity, livelihood and health are severely affected, it said.
Even as various measures initiated by the government and the RBI work to mitigate the impact of the pandemic, it was necessary to ease financial conditions further. It would facilitate the flow of funds at affordable rates and revive animal spirits, said the RBI.
Das said FY21 GDP growth was seen in negative territory.
Most analysts agree and foresee the full-year growth either flat or negative following the two-month long lockdown and the expected delay in recovery.
Risk-aversion still a problem
"By cutting the repo rate and reverse repo rate, the RBI aims to inject more liquidity into the system. However, more importantly, what is needed is to remove the risk averseness as there is substantial liquidity in the banking sector," Deepthi Mathew said.
KK Mistry of HDFC also told CNBC-TV18 that the rate cut is good, but the central bank needs to remove the risk aversion.
The repo rate cut is more or less in line with the expectations. The cut has been effected considering the fact that there is a growing economic and financial stress on account of the pandemic. This will help in bringing down the market rates as also lending rates mostly at the short end of the curve, said Joseph Thomas, Head of Research, Emkay Wealth Management.
The potential reduction in the cost of funds and the extension of moratorium will be supportive of financial stability, which is of extreme importance.
“We expect the rates across the curve to move lower from the current levels, though on a risk adjusted basis, the short to medium term would hold better value for long-term investor portfolios,” Thomas said.
The reduced reverse repo rate will serve as a disincentive to banks, which hold huge sums of liquidity to look at alternatives, including gilts.
Abhishek Goenka, Founder & CEO, IFA Global too flagged bank’s risk aversion as he hailed RBI’s decisions as good.
Extension of moratorium and converting the interest into term loans which essentially increases the payback cycle, swap facility for exim banks, extension of import payments and increasing the exporters length of credit to 15 months from one year are steps in the right direction and eases the liquidity situation with export and import companies, he said.
Rate cut and reverse repo rate cuts are moves in the right direction but risk aversion by banks is still there. Some restructuring of the loans news would have been a step in the right direction, which the market was awaiting.
Broadly it may be better for companies but banks may get hit in the short term. Overall, the bonds rallied with yield on old 10y benchmark falling 15bps in a knee jerk reaction.
“Rupee moves are fairly muted since we have huge selling interest by nationalized banks, likely on behalf of RBI at 75.85 levels. Of course the equities and banks initial reaction is negative,” he said.
Further cuts possible
The RBI’s decision continues to indicate that it remains proactive, said Suvodeep Rakshit, Vice President & Senior Economist, Kotak Institutional Equities.
With the indication that the growth would be negative, there is space for some further rate cut, though the efficacy will progressively be lower.
The extension of the moratorium bodes well. However, broader markets will focus on liquidity measures such as the path of OMO purchases (preferably a calendar) and regulatory measures to ensure both liquidity and solvency concerns are adequately addressed.
High-frequency indicators point towards collapse in demand during the lockdown, said S Ranganathan, Head of Research at LKP Securities.
Industrial production was down 17 percent and capital goods contracted 35 percent in March. A 40 percent rise in Kharif sowing raises hopes and forex reserves at $487 billion is robust and equals one-year imports. “Given a rather uncertain inflation Outlook, MPC forward guidance is more directional in nature," Ranganathan said.
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Check our complete coverage on RBI's May 22 announcements here