RBI might also conduct more OMO’s (including current twists and outright) to force transmission and in dynamic management of durable liquidity.
Murthy Nagarajan
Reserve Bank of India (RBI) had a complex situation of rising inflation, sub-par growth and transmission lagging. With inflation trajectory remaining high for near future, and many factors influencing in the medium term, RBI adopted caution and left the room available for use, when CPI inflation comes in the band of 3.2 percent in the third quarter.
RBI maintained an accommodative stance and chose more creative ways to address current issues and provide a boost to the banking system for onward support to the economy.
Going ahead, we see RBI on a pause mode till June 2020 as
i) near term inflation to remain elevated on high food inflation, and
ii) MPC wants to know the impact of previous actions by both the government and RBI on growth.
However, the regulatory measures prescribed by RBI is bringing the rates down and is expected to aid transmission and lower lending rates.
Regulatory measures:
1. Daily fixed repo and four 14-day term repo conducted every fortnight stand withdrawn. However, RBI will ensure adequate provision/absorption of liquidity as required by evolving conditions – unrestricted by quantitative ceilings.2. 14-day term repo/reverse repo operation at variable rate conducted to coincide with cash reserve ratio (CRR) maintenance cycle would be the main liquidity management tool for frictional liquidity requirements.
3. A further fine-tuning operation to support above to tide over any unanticipated liquidity changes during the reserve maintenance period.
4. If needed, RBI will conduct longer-term variable rate repo/reverse repo operation of more than 14 days.
5. Standing deposit facility (SDF) introduced in tool kitty to manage short term/transient liquidity.
6. RBI would also improve communication on liquidity management through press releases and periodic consultations.
Long term Repo Operations (LTRO’s) – Improving transmission: RBI would conduct term repo for one year and three years of appropriate sizes for up to a total amount of Rs 1 lakh crore.
No CRR maintenance by banks for incremental credit disbursed to MSME’s from January 31 to July 31, 2020.
Pricing of Loans to medium enterprises to be linked to an external benchmark.
Extension for One-time restructuring scheme for MSME advances to 31st Dec 2020.
Permit extension of date of commencement of commercial operations of project loans for commercial real estate, delayed for reasons beyond the control of promoters, by another 1 year
Providing boost through Regulatory and Liquidity (operational and framework) measures:
RBI has used its creativity and modified its operations on liquidity and regulations to boost the economy and provide banks with incentives to push credit flow/growth in the system.
LTRO’s will provide long term funds to banks at repo rate to match their loans books. These would be backed by government securities and hence we anticipate immediate downward shift on the shorter – medium end of the yield curve, followed by a corporate bond curve.
Doing away with daily fixed LAF window would force banks to have a greater eye on their liquidity position and carry their lending activity more aggressively. This would have an immediate impact on money market rates and push banks to meet short term credit requirements of corporates more aggressively.
Without using monetary tools, RBI has positively affected the credit transmission to MSMEs by providing banks incentives (no CRR maintenance on incremental lending).
Also, by proving time extensions for commercial real estates and one-time restructuring, RBI has eased pressure on the balance sheet of the banking system and this should provide headroom for further credit availability to this important part of an economy facing headwinds.
Outlook
We believe yield will come down and RBI actions could result in bull steepening of the yield curve. Corporate bond spreads are expected to compress (both RBI actions and commentary suggests that as a target) across the curve.
While shorter to medium part of yield curve looks like a clear beneficiary, Low duration funds, short term funds and Banking and PSU debt funds, is expected to provide good opportunity to invest.
RBI might also conduct more OMO’s (including current twists and outright) to force transmission and in dynamic management of durable liquidity. This would, in turn, bring the long term yields down and hence makes the case of investing in long-duration funds also.
It would be prudent to invest/stay invested in debt funds (duration as per risk appetite).
The Author is Head- Fixed Income, Tata Asset Management.
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