RBI Governor Shaktikanta Das (PTI)
Some of the measures announced by the Reserve Bank of India (RBI) last Friday were on expected lines; the extension of loan moratorium scheme for example. This had to come because the lockdown was extended until May 31. In a locked-down economy, it is impossible for most borrowers to start repaying their EMIs beginning June.
Firms have suffered massive cash flow issues on account of a prolonged shutdown. In the initial phase, the RBI had announced the moratorium for March 1–May 31. Since then, in multiple meetings with the RBI top brass, banks and non-banking finance companies had apprised the central bank about the need for continuation of the moratorium scheme. That has been announced now.
Besides this, the central bank announced a series of small steps mainly to cushion the impact of COVID-19 on the economy. These were mainly to encourage banks to keep the funding channels open for struggling industries. These include permission to lending institutions to convert the accumulated interest on working capital facilities over the total EMI deferment period of six months into a funded interest term loan, hiking the group exposure limit to 30 percent from 25 percent for enabling corporates to meet their funding requirements from banks, relaxing export credit rules and permission for Sidbi to roll over Rs 15,000 crore refinance beyond the earlier permitted 90 days.
All the above schemes are to help stressed corporate borrowers and is welcome at a time there is a huge uncertainty on the economic front. A higher group exposure limit would mean banks can lend more to the same group if it needs money. Earlier, the RBI had put a cap on group exposure fearing concentration risk. The question is whether industries, barring a few, will have the appetite to borrow more with no business activity on the ground.
Demand scenario plays a crucial role
What came as a surprise was the 40 basis points rate cut that brought down the repo rate to 4 percent. The RBI has clearly front-loaded its rate cuts to give a leg up to the economy. Combined with the 75 bps rate cut in March, in just two months, the RBI has cut repo rates by 115 bps. If one looks at the rate cut beginning this rate cut cycle, the RBI has cut rates by a total of 250 basis points. The banking system has passed the rate cuts partially to the end borrowers on account of low demand for loans. Lower rates are appealing for small borrowers but are not a deciding factor to take more debt on their books. The demand scenario plays a crucial role. Unless there are consumers to buy services and goods, there is no point in investing in capacity expansion.
Having said that, the third round of RBI measures are more incremental in nature, these measures are very critical for immediate assistance for stressed borrowers. For example, in the absence of a moratorium extension, liquidity facilities for stressed borrowers, banks would have started witnessing a massive spike in bad loans in the distant future. Already, there are about Rs 9 lakh crore NPAs in the banking system. This would have gone up further by a significant quantum. Even after the lockdown is lifted, it will take a few more months for industries to restore normalcy and get their workforces back in factories. Considering all these factors, the RBI’s regulatory measures make perfect sense.
Deterioration in economic conditions expected
What is the RBI’s rationale for pressing too many rule changes back to back? The central bank, going by the language of Shaktikanta Das’ statement on Friday, is convinced of a sharp deterioration in economic conditions going ahead. It expects fresh asset quality issues to emerge in a slowing economy wrecked by the pandemic. The RBI has now projected a negative growth for FY21 and is of the view that that the macroeconomic impact of COVID-19 is turning out to be more severe than initially anticipated. “Beyond the destruction of economic and financial activity, livelihood and health are severely affected,” the governor said in his statement.
What more could the RBI do in the present economic environment? It will have to keep supporting the system with rule relaxations till normalcy is restored in the economy. These will be mere band-aid solutions since the real issue is with lack of demand on the ground. Even then, given that there is no visibility of economic revival in the remaining part of the year and there are no major policy initiatives from the government so far to boost demand, the RBI will have to possibly come up with more such band-aid solutions to help the banking system avert a sudden spike in NPAs.
Additional measures could come in the form of a one-time restructuring facility for all corporate borrowers or further relaxation in NPA recognition norms. Banks may be asked to lend more with less stringent rules. The desperation may push banks to overlook the creditworthiness of some of the weaker borrowers. So far, the RBI’s liquidity shots have not reached the small-sized borrowers. The biggest disadvantage the central bank faces right now is the lack of support from the government in the form of effective fiscal side measures to boost demand. Monetary measures cannot alone lift the economy from the mess it is in now. Much of the economic package announced by the government is also loans and interest subventions. Loans aren’t free money. It needs to be paid back to lenders and in the absence of demand, the RBI will be forced to come up with more band-aid measures.