The Reserve Bank of India (RBI) on May 22 slashed the repo rate by another 40 bps and reinforced its image of a pro-growth institution. The RBI gave precedence to reviving growth despite uncertainties on the inflation front.
The RBI highlighted that headline inflation could remain firm in H1FY21 but could moderate thereafter. Rather than giving a projection on inflation, it stated that its forward guidance on inflation is directional.
The RBI acknowledged that challenging times for the economy on growth front lie ahead on account of demand compression and supply disruption, justifying the need for further accommodation.
The bonds rallied in a knee jerk reaction with the yield on the old 10-year benchmark falling to 5.88 percent. However, it finally ended the session at 5.96 percent on May 22 (Friday).
The 1-year overnight indexed swap (OIS) was unchanged as the cut was already priced in. Equities, especially banking stocks sold off sharply. However, they did stage a recovery towards the close, recouping significant losses from earlier in the session.
The rate cut theoretically is negative for Rupee. However, nationalised banks, likely on behalf of the RBI capped a run-away move higher with USD-INR ultimately ending the session at 75.90. The 12-month USD-INR forward premium ended 13 bps lower at 3.85 percent i.e. ~8p in absolute terms.
Besides the repo rate cut, it also announced regulatory and developmental measures on four fronts
Measures to improve market functioning
The RBI extended the special refinance facility extended to the Small industrial Development Bank of India (SIDBI) for refinancing and on lending by another 90 days.
Also, it extended the period within which foreign portfolio investors (FPIs) are required to invest 75 percent of their allotted limits under the Voluntary Retention Route (VRR) by three months to six months now.
Measures to support export and import
The RBI extended the tenor for which pre-shipment and post-shipment credit can be availed to 15 months from one year for disbursements made up to July 31, 2020
It also relaxed the time period for making payments for imports from six months to a year except in the case of import of gold, diamond, and jewellery.
Above measures are intended to give exporters and importers some relief in managing working capital
Measures to ease financial stress
The RBI had earlier granted a three-month moratorium on term loan installments and allowed deferment of interest on working capital loan by three months. These measures have been extended until August 31, 2020
Also, the group exposure limit for banks has been raised to 30 percent from 25 percent to enable corporates to meet their funding requirements from banks.
Measures to ease financial constraints faced by state governments
In order to ease the bond redemption pressure on states, the RBI relaxed rules governing withdrawal from Consolidated Sinking Fund (CSF). This is expected to help states meet 45 percent of the redemptions due in 2020-21.
The move has as such not resulted in any major compression in SDL spreads over government securities (G-secs).
The government has addressed the confidence issue by extending a guarantee for small and medium enterprise (SME) loans, the RBI decided to follow it up by further lowering the cost of funds.
The government fiscal measures were devoid of any specific stimulus for interest-rate sensitive sectors such as auto and real estate and this rate cut could help revive demand in those sectors once the lockdown ends.
Going forward, the domestic risk sentiment would be largely driven by global developments. The United States-China relations would continue to be in focus. It will also be important to closely track the leading high-frequency indicators as economies gradually open up. USD-INR may continue to drift higher.
We may see the range shift higher from 75.20-75.90 to 75.90-76.90 in the medium-term. In the absence of a steep USD up move globally, the central bank may continue to step in from time to time to keep volatility in check.
The author is Founder & CEO, IFA GlobalDisclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.