The RBI’s credit policy is directed at combating the COVID-19 impact by working towards improving the flow of credit to the commercial sector. In this process, the repo rate has been reduced by 75 bps which in turn should also help to reduce the cost of funds.
While the broader goal of inflation management will run the background, the attempt here is to ensure that the slowdown in growth process which is a certainty now is contained. Quite prudently there are no projections made on what the numbers will look like as it is hard to guess how long the virus shutdown will stay and affect individuals and industry. Therefore, the development agenda which is a part of the policy is directly linked to making the system work towards augmenting the flow of credit.
The RBI had brought in the concept of LTRO (Long Term Repo Operation) in the February policy to provide fixed cost funds for longer tenures to banks which were well received. However, the funds did not get translated to higher lending either because of the reluctance of banks to lend or absence of demand for credit.
To counter this chain the RBI has done several things. First, the reluctance of banks to lend has been addressed by extending the period for classification of NPAs for both term loans and working capital by three months. This should assure banks that it is safe to lend to corporates -- especially the smaller ones.
Second, the reverse repo auctions have been popular with banks as they got 4.9 percent interest. Now they will get only 4 percent which should dissuade them to go in for such options and instead stick to the normal lending operation where higher returns can be earned while helping units in need of funding. Also with a lower repo rate, there should be some reduction in lending rates though it may be less than proportional.
Third, the new series of LTRO will be for specific use in the market and as it will be provided at the repo rate of 4.4 percent will bring down the yields of corporate bonds, debentures and CPs (commercial papers). As half would be in primary and the other part in secondary markets, there would be harmony in the yield movements. Companies wanting to raise funds can seriously do so now in the bond market.
Therefore, the effort is really on to improve the flow of credit. This will be useful for all companies. Those that have borrowed for investment would witness their projects getting stalled due to the shutdown especially in construction, real estate and engineering.
The threat of increasing NPAs is real and opening these windows of lending as well as a moratorium on repayments will make them feel better. The smaller companies have seen their supply chain getting affected as well as output where there is a total shutdown. Their working capital limits need to be reworked and they would not be able to service their loans. As the RBI has unclogged these impediments, they will be better placed to carry on business once normalcy returns.
Right now the major focus has been on providing liquidity which is estimated at 1.8 percent of GDP which combined with the operations post-February are 3.2 percent that is quite substantial. The question is whether this will work? This remains to be seen because the banks need to respond appropriately so that these benefits get passed on. They would first be evaluating their asset quality as this is the yearend to gauge what would be the level of impairment and would then take a call on how much to lend.
An interesting part of the development doctrine is to allow banks to take part In the NDF (Non-Deliverable Forward) market which is the derivative market for the NDF in offshore markets which largely guides movements in the domestic market. This will help to lower the volatility in the market which is required in the currency segment where the virus impact has caused rates to move away from fundamentals.
The policy is quite timely and coming earlier than expected without any ‘noise’ being made about the MPC meeting, fits well with what the government has been announcing. The major actor from now onwards would be the banks and how they respond to these measures.
As a regulator, the apprehensions of banks have been addressed and the conditions have been made congenial for lending at a lower cost. Savers, however, would be at the other end getting lower returns on their deposits, which is the unfortunate mirror image of lower lending rates. The decision has been taken that reviving the economy or rather ensuring no collapse of the structure should take precedence.
The author is Chief Economist CARE Ratings.
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Updated Date: Mar 27, 2020 20:01:05 IST