RBI Announcement: Reason for Cheer?
Mr. Pankaj Pathak, Fund Manager, Fixed Income, Quantum AMC shares his views.
In the monetary policy meeting held earlier today, the RBI announced a comprehensive monetary package comprising large rate cuts, liquidity infusion and regulatory changes to reinforce financial stability and support the economy. Some of the measures announced are as follows:
• Rate Cut – RBI cuts policy repo rates by 75bps from 5.15% to 4.40% and reverse repo by 90bps from 4.90% to 4.00%. Accordingly, the marginal standing facility (MSF) rate and the Bank Rate stand reduced to 4.65% from 5.40%
• Reduction in CRR - Reduced Cash Reserve Ratio (CRR) by 100 basis points from 4% to 3% of NDTL (Net Demand and Time Liabilities) for the period of 1 year till Mar 26, 2021. This would release primary liquidity of about Rs. 1.37 trillion in the banking system.
• Reduced daily CRR requirement - Reduced the minimum daily CRR requirement from 90% to 80% of total for 3 months till June 26, 2020.
• Increased MSF Limit - Increased the borrowing limit under Marginal Standing Facility from 2% to 3% of NDTL. This would allow banking system to avail an additional liquidity of Rs. 1.37 trillion under LAF window.
• Targeted Long Term Repos Operations (T-LTROs) – The RBI will conduct targeted term repos of up to three years tenor for a total amount of up to Rs. 1 trillion at a floating rate linked to the policy repo rate which has to be deployed in investment grade corporate bonds, commercial papers, and non-convertible debentures. Investments made by banks under this facility will be classified as Held To Maturity (HTM) even in excess of 25 per cent of total investment permitted to be included in the HTM portfolio. Exposures under this facility will also not be reckoned under the large exposure framework.
• Moratorium on Term Loans - All commercial banks, co-operative banks, all-India Financial Institutions, and NBFCs are being permitted to allow a moratorium of three months on payment of instalments in respect of all term loans outstanding as on March 1, 2020.
• Deferment of Interest on Working Capital Facilities - lending institutions are being permitted to allow a deferment of three months on payment of interest in respect to working capital facilities
• Easing of Working Capital Financing - Lending institutions may recalculate drawing power by reducing margins and/or by reassessing the working capital cycle for the borrowers without changing the asset classification
This was an unconventional monetary policy which looked beyond the RBI’s primary mandate of controlling inflation. It was completely directed towards tackling the negative consequences of the COVID-19 pandemic. Thus there were a lot of one-off & time bound measures to address the immediate concerns of the economy and the financial system particularly on the liquidity front.
The most significant was the announcement of directed Long Term Repo Operation for commercial papers and corporate bonds under which banks can borrow from the RBI for 3 years at variable Repo rate and invest into commercial papers or corporate bonds upto 3 year maturity. Corporate bonds and the money markets were under stress lately due to increased risk aversion and heavy outflows from the foreign investors and mutual funds. This led to a very sharp increase in market yields of even high rated PSU corporate bonds indicative of market dislocation and risk. This T-LTRO will get back liquidity into the corporate bond markets and also lead to a fall in short term bond yields of AAA corporates.
The RBI also reduced the Cash Reserve ratio by 1% of NDTL infusing Rs. 1.37 trillion of primary liquidity into the banking system. The prevailing surplus liquidity conditions along with these liquidity measures will keep the effective overnight rate close to reverse repo rate of 4% and thus will force banks to increase investments /lending. This will also enhance the transmission of earlier rate cuts into the real economy.
The RBI further assured the markets that they have number of tools – both conventional and unconventional - to inject another monetary stimulus, if needed. We acknowledge that large rate cuts and monetary stimulus will not have any material impact in terms of reviving growth under this crisis. But will definitely help in reviving confidence in the financial markets and will avoid any brewing financial crisis due to extreme risk aversion.
The bond and money markets celebrated the RBI’s actions with sharp drop in yields across the maturity curve. The 10 year benchmark government bond yield dropped by over 20 basis points (from previous day’s close of 6.22%) to touch 6.0% post the policy announcement but later gave up much of the gains to close the day at 6.14%. Corporate bonds and money markets witnessed larger impact as yield on 5 year AAA rated PSUs dropped by more than 100 basis points from ~7.5% to 6.25% and yield on 2-3 months PSU papers fell by over 250 basis points from 7.7% to below 5%.
Given the abundant liquidity and possibility of further rate cuts, short term bonds will likely remain supported. However the longer tenure bonds will be driven by potential fiscal measures by the government and possibility of further rate cuts from the RBI. In case government rolls out more fiscal stimulus that can put upward pressure on the long tenure bonds and will require the RBI to conduct aggressive OMOs.
The overall situation remains uncertain and despite these overwhelming measures by the RBI, we expect markets to remain volatile. If as an investor, you are uncomfortable with market volatility in these times, we would advise you to choose a safe bank deposit to park your money, for the moment.
We continue to advise investors in debt funds to choose funds which focus on keeping credit risks low and have liquid portfolios. India entered COVID having a weak economic background and the impact of COVID on companies and the economy is likely to be severe depending on how long the lock-down continues.