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Opinion | After repo rate cut, RBI can focus on bond yields, sectoral incentives

If CPI inflation falls below 4%, it could allow another 50bps reduction in policy rate

The Reserve Bank of India (RBI) has announced a new set of measures to mitigate the impact of the covid-19 pandemic on the economy.

Incentivizing banks to lend, rather than depositing excess liquidity with the RBI, the reverse repo rate has been further reduced by 25 basis points to 3.75%. Banks deposited 4.9 trillion net surplus liquidity with RBI on 16 April. Lower rates incentivize banks to lend rather than keep deposits with RBI.

Liquidity injections of 1 trillion under Targeted Long-Term Repo Operations (TLTROs), part of RBI’s earlier 3.74-trillion liquidity enhancing measures for banks, were largely accessed by public sector enterprises and large corporates. RBI has now announced a 500 billion targeted liquidity injection for Non-Banking Financial Company (NBFCs) and Microfinance institutions (MFIs). Given that Scheduled Commercial Banks have lent NBFCs over 7 trillion, more may be required. In addition, 500 billion of refinance facility has been extended to Nabard, Sidbi and NHB, which will be used for on-lending to regional rural banks, Ministry of Micro, Small & Medium Enterprises (MSMEs) and housing finance companies (HFCs).

States are facing challenges in collecting revenues. Markets anticipate states to borrow to meet their spending needs. Last year, states borrowed 5.7trillion, an increase of 23%, from the bond markets. This has led to an increase in yields with the spread between 10-year central and state government securities now increasing to 130bps. RBI has further increased the ways and means advances (WMA) limit for states to 60%, from 30%, over March 2020 levels. This will give states room to pace out borrowings and bring yields lower.

On 27 March 2020, RBI had announced a moratorium for all standard loans as on 29 February 2020. Now, RBI has allowed customers availing moratorium to be exempt from the 90-day asset classification norm, which is extended to NBFC borrowers also. Borrowers will now have room to manage their cash flows, which will increase only gradually as the economy opens up. However, certain sectors may take time to see normal level of economic activity for which some form of restructuring may have to be announced later.

For the commercial real estate sector, RBI had earlier allowed banks an additional year of moratorium before classifying these loans as non-performing. The same has been extended to borrowers of NBFCs as well. Banks and NBFCs are at par now and this will give real estate developers time to finish their projects.The RBI governor also alluded to the fact that growth is likely to be far lower than last year. IMF expects growth at 1.9% in FY21. In India’s case, we have seen a large dip in trade volumes and values, with exports falling 34.6% and imports by 28.7%. Non-oil-non-gold imports, a demand barometer, fell by 30.5%. Thus, growth for FY20 will also be revised lower from NSO’s estimate of 5%.

CPI inflation has now fallen to 5.9% from 7.6% in January 2020. We are seeing some dip in food inflation and more is anticipated once supply restrictions and logistic issues are sorted out.

In between, crude prices have fallen to less than $30/bbl. As a result, PDS kerosene and LPG prices have fallen by 24% and 8% in April. Core inflation is at 4% and is unlikely to see any upside risk as aggregate demand is expected to be muted. So, CPI inflation is likely to fall below 4%, RBI’s target. This will allow another 50-bps reduction in policy rate. As new retail and MSME loans are linked with an external benchmark, consumers will see quick transmission in their EMIs. RBI may have to continue with more measures such as OMOs to bring down the gap between overnight and 10-year yields, liquidity support to sectors impacted by covid-19 and regulatory dispensation to sectors where demand may remain muted with continuing cash flow mismatches.

Sameer Narang is chief economist, Bank of Baroda.

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