The COVID-19 epidemic has wreaked havoc on the global financial environment, causing unprecedented losses and isolation. In front of this, Reserve Bank of India { RBI } Governor Shaktikanta Das, in his Friday morning address, was correct to admit that “hard times never last; Only strict people and difficult institutions do it ”.
To mitigate the financial effects of shutdowns in economic and activity calls for spectacular and infallible status responses from both the Center and the Central Bank, both on a macro and micro level.
The government responded yesterday with the first part of its fiscal stimulus package and within 24 hours of that announcement, the Reserve Bank of India’s Monetary Policy Committee launched a series of instruments from its arsenal aimed at reviving growth and maintaining financial stability. Array received.
The RBI and Monetary Policy Committee (MPC) highlighted the severe impacts caused by demand and supply shocks, with force multipliers coming up with a comprehensive plan that included a combination of policy rate cuts, liquidity infusion measures, and easing.
Declarations of financial stress. Traditionally and rightly, the MPC also avoided providing estimates on growth and inflation for the Indian economy, making it clear that more attention was paid to responses to stress rather than forecasting numbers amid uncertainty must be given.
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The RBI MPC voted unanimously for a major cut in the policy repo rate but agreed to a 75 basis point reduction in the policy repo rate with a 4-2 voting pattern.
This rate cut means that the repo rate is now 4.4% and is at its lowest level since its introduction in 2000 and also 35 basis points lower than the lowest seen since the 2008 global financial crisis.
Further, to prevent banks from parking their surplus liquidity with the RBI, the MPC raised the reverse repo rate (the rate at which banks park their excess liquidity with the RBI) to its lowest level since April 2010. Reduced.
What these two measures have done is widen the monetary policy rate corridor (the difference between the reverse repo rate and the marginal standing facility rate) from 50 basis points to 65 basis points. This widening is the first time since April 2017.
In my previous articles, I have argued for providing continuous liquidity in the banking system and in the last one month, RBI has been doing this through long term repos.
However, the problem with RBI’s liquidity operations is that banks are parking close to Rs 3 lakh crore in the reverse repo channel. To discourage the system and make it less attractive, the RBI reduced the reverse repo rate from 90 basis points to 4%.
Not only on the one hand, RBI made this channel ugly, but on the other hand, it also ordered banks that the liquidity it receives from RBI is to be deployed as a part of its targeted long-term repo operations. Investment-grade corporate bonds, commercial papers, and non-convertible debentures.
Although both of these moves are welcome and will particularly benefit NBFCs and HFCs that are actively involved in raising funds from the bond and CP markets, the point to be monitored is whether in the midst of this lockdown, whether these Loans to various institutions will have to be lent by financial institutions.
In addition, the RBI reduced the cash reserve ratio for all banks from 100 basis points to 3% for a period of one year, its lowest level since 1962.
The cash reserve ratio (CRR) is the ratio of net demand and time liabilities. In simple terms, it refers to “deposits”, which banks have to park with the RBI without earning interest.
Even during the 2008 financial crisis, RBI took a similar measure when it reduced the CRR ratio from 9% in August 2008 to 5% in January 2009.
Also, banks will have to maintain a minimum daily CRR balance of 80% as against the current level of 90%. The RBI has calculated that its multi-dimensional approach to liquidity infusion since February 2020, accounted for a significant amount of 3.2% of India’s GDP.
Another widely expected announcement for leveraged entities was a moratorium on their loans. The RBI accepted this and announced measures to reduce the burden of debt servicing, including a moratorium on term loans, withholding interest payments on working capital, easing working capital financing, among others.
However, the description contained the devil. RBI has explicitly mentioned that all commercial banks, co-operative banks, All India Financial Institutions (AIFI) and NBFC / HFC have “permission” to allow 3 months deferment on payment of installments.
The idea is similar for monetary policy transmission where the RBI may decide to cut the policy rate but it is up to the individual financial institution whether it wants to pass on the benefits to the customer.
Therefore, although RBI has put the carrot in danger, the borrowers will have to wait for the decision of the banks concerned.
The first point of impact of the repo rate reduction should ideally be on deposit rates. With a cumulative rate cut of 135 basis points since February 19, scheduled commercial banks had reduced deposit rates by only 39 basis points, making it difficult to reduce lending rates.
The average fixed deposit rate weighted at 6.52% in January 2020 is lower than the interest rates on various small savings schemes of the government.
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Thus, the challenge would be to reduce deposit rates to maintain the interest rate spread. Lowering rates on small savings schemes makes possible feedback from the fiscal corner, without which interest rate transmission seems difficult.
This reaction will have an impact on the savings rate in the economy, but by the end of this challenging situation, it may be a temporary measure.
Although the RBI’s broad measures are welcomed and market expectations are met, the baton now passes into the most important component of the economy – the financial sector.
Monitoring the response of banks will be key to ensure replenishment of repo rate and replenishment of supply channels, to ensure credit flow to the economy and to rein in weakness in aggregate demand. Until that time, we can all remain optimistic.