In News: The latest monetary policy statement of the Reserve Bank of India (RBI) is proactive, forward-looking and path-breaking indeed. The monetary policy committee (MPC), meeting off-cycle amidst the corona pandemic, has opted to further lower the cost of funds in the banking system by duly factoring in weak macroeconomic trends.
The RBI has also announced a series of measures to ease financial stress, which are most welcome.
The Goals of the measures:
To keep the financial system and financial markets sound, liquid and smoothly functioning
To ensure access to finance to all, especially those that tend to get excluded by financial markets
To preserve financial stability
Measures to Improve the Functioning of Markets
Refinance Facility to SIDBI extended for another 90 days: In order to enable increased supply of affordable credit to small industries
Relaxation of Rules for Foreign Portfolio Investment under Voluntary Retention Route: The VRR is an investment window provided by RBI to Foreign Portfolio Investors, which provides easier rules in return for a commitment to make higher investments. The rules stipulate that at least 75% of the allotted investment limit be invested within three months; considering the difficulties being faced by investors and their custodians, the time limit has now been revised to six months.
Measures to Support Exports and Imports
Exporters can now Avail Bank Loans for Higher Period: The maximum permissible period of pre-shipment and post-shipment export credit sanctioned by banks to exporters has been increased from the existing one year to 15 months, for disbursements made up to July 31, 2020.
Loan facility to EXIM Bank: The Governor has announced a line of credit of ₹15,000 crore to the EXIM Bank, for financing, facilitating and promoting India’s foreign trade.
More time for Importers to Pay for Imports: Extended from six months to twelve months from the date of shipment.
Measures to Ease Financial Stress
Extension of Regulatory Measures by another 3 Months: These measures will now be applicable for a total period of six months (i.e. from March 1, 2020 to August 31, 2020). The aforesaid regulatory measures are:
(a) 3-month moratorium on term loan instalments;
(b) 3-month deferment of interest on working capital facilities;
(c) easing of working capital financing requirements by reducing margins or reassessment of working capital cycle;
(d) exemption from being classified as ‘defaulter’ in supervisory reporting and reporting to credit information companies;
(e) extension of resolution timelines for stressed assets; and
(f) asset classification standstill by excluding the moratorium period of 3 months, etc. by lending institutions. The lending institutions have been permitted to restore the margins for working capital to their original levels by March 31, 2021. Similarly, the measures pertaining to reassessment of working capital cycle are being extended up to March 31, 2021.
Provision to convert Interest on Working Capital into Interest Term Loan: Lending institutions have been allowed to convert the accumulated interest on working capital facilities over the total deferment period of 6 months (i.e. March 1, 2020 up to August 31, 2020) into a funded interest term loan, to be fully repaid during the course of the current financial year, ending March 31, 2021.
Increase of Group Exposure Limit to Increase Fund Flow to Corporates: The maximum credit which banks can extend to a particular corporate group has been increased from 25% to 30% of the bank’s eligible capital base.
Measures to ease financial constraints faced by State Governments
States allowed to borrow more from Consolidated Sinking Fund: The Consolidated Sinking Fund is being maintained by state governments as a buffer for repayment of their liabilities. The rules governing withdrawal from this Fund have now been relaxed, in order to enable states to enable them to repay their borrowings from the market, which become due in 2020-21.
What will the impact be?
Impact on Deposit Rate and Small Saving rates –With the latest repo rate cut, the deposit rates of the banks may come down further. The same story plays out with small savings schemes whose interest rates are revised on a quarterly basis. Those investing in FDs, especially senior citizens who are mainly dependent on the interest income from these deposits, are likely to see a reduction in their income.
Loans will become Cheaper –The rate cut is expected to reduce EMIs (equated monthly instalments) of borrowers and also make it cheaper to take new loans. Now with the external benchmarking of floating rate loans from October 1, 2019 these loans compared to those linked to MCLR will become cheaper. So, for borrowers looking to take loans, they will get even more attractive rates.
Shorter end of the curve will generate lower yields –Those investors who invest in short duration paper in debt market like overnight fund will see fall in the return. Even the return of liquid funds can fall amidst flush of liquidity in the system.
Moratorium on Loan payment –RBI’s decision to further extend the moratorium on loan for the 3 months will ease the pressure on cash flows of the common people in a time when their income has fallen or is uncertain. However, this move along with the fear of rising NPAs, may put pressure on the banks’ balance sheet and cash flows.
Economic Activity to get a boost –These measures are designed to help businesses stay afloat till the time the situation improves and there is more clarity on the areas in which support is required. Once clarity emerges on the areas that need support and the extent of support required, the government can then provide targeted support. But it is important to ensure that the businesses survive till then.
Conclusion
Indian GDP will shrink in 2020-21. This means everything will shrink – from incomes, to consumption to output. With this as the headline worry, the RBI set into motion a big change in stance from a hard inflation targeting to a directional approach and a sharp focus on getting growth back.
However, while the monetary policy measures announced are certainly necessary, they can hardly be deemed to be sufficient, in the face of severely weakened demand conditions economy-wide, following two entire months of severe economic lockdown.
The way forward is for government to set up one or more special purpose vehicles (SPVs) to buy bonds issued by non-bank finance companies (NBFCs), and back-to-back, RBI can purchase the bonds of such State-owned vehicles to channel funds to economic agents, say in manufacturing, retail and services sectors, and as debt and equity.
“It is when the horizon is the darkest and human reason is beaten down to the ground that faith shines brightest and comes to our rescue.”
Connecting the Dots:
Implications of negative GDP on the economy
The crisis right now is growth and not inflation. Discuss.
