RBI cuts rates to mitigate COVID-19 impact

India’s economic growth is likely to decline on account of the impact of coronavirus pandemic and the consequent lockdown.

Various financial institutions have been cutting India’s economic growth forecast. The rating agency Moody’s slashed India’s GDP growth rate estimate for the year 2020 to 2.5 % from 5.3% estimated just 2 weeks back. Foreign brokerage Barclays cut India’s GDP forecast to 2.5 % for the calendar year 2020

Also, the RBI said in its statement that the GDP estimate of the National Statistics Office (NSO) for the Jan-March quarter of 2020 is at risk.

Therefore, the RBI announced a slew of measures in its monetary policy review to curtail the fall-out of COVID19 on the economy. These measures will unleash liquidity worth Rs.374000 crores in the financial market.

The RBI’s monetary policy was initially scheduled to be announced on 3rd April, but it was brought forward to 27th March

Before you continue reading, I highly recommend you to go through this post explaining Repo, CRR, SLR, MSF, Bank rate, OMO and MSS

Highlights of the RBI’s monetary policy statement

Cut in the repo rate by 75 basis points

The RBI slashed the repo rate by 75 basis points; from 5.15% to 4.4%, the lowest ever
Repo rate is the rate at which a bank borrows from the RBI on an overnight basis.
A reduction of 75 bps in repo rate will reduce the cost of borrowings for the banks.

Reduction in the reverse repo by 90 basis points

The RBI cut the reverse repo rate from 4.9% to 4 %.
Reverse repo is the rate at which a bank keeps its funds with the RBI.
There has been a higher cut in the reverse repo rate than the repo rate
Hence, the gap between repo and reverse repo has increased from 0.25% to 0.4 %
This will reduce the incentive for banks to park excess funds with the RBI and instead lend more.

A massive expansion in Long Term Repo Operations (LTRO)

LTRO is an unconventional measure to inject liquidity into the banking system and boost credit growth. (Read: LTRO explained)
RBI will conduct auctions of long term repos of 3-year tenor for a total amount of upto 1 lakh crores.
These will be issued at a floating rate linked to the Repo rate.
The liquidity acquired by the banks through LTROs will have to be deployed in instruments like investment-grade corporate bonds, Commercial Papers, and non-convertible debentures.
These instruments are used by the corporate sector to access working capital.
The first auction of long term repos of Rs.25000 crores was conducted on the day of announcement of the rate cuts on 27th March.

Reduction in CRR to lowest since 1962

The cash reserve ratio (CRR) has been reduced from 4 % to 3 %
This reduced CRR is available for one year.

Moratorium on all term loans for 3 months.

Banks and NBFCs can allow borrowers a 3-month moratorium or holiday on repayment of installments of all term loans outstanding as of March 1, 2020
(Term loans includes all loans other than for working capital)
It implies that the borrower will get extra time (3 months) to repay their loans.
Their credit scores will not get affected even if they don’t repay and their accounts will not be tagged as Non-performing assets (NPAs)
This will help borrowers who are not able to repay their loans due to cash disruptions caused by Covid-19

Deferment of interest rate on Working capital loans

The RBI also deferred interest payment on working capital loans by 3 months
The accumulated interest will be paid after the expiry of 3 months.
These steps have been taken to ensure the continuity of viable businesses even if they are not able to repay their loans due to Covid related disruptions.

Marginal Standing Facility (MSF) raised from 2 % of SLR to 3% of SLR

Banks can borrow money from the RBI through MSF by dipping 2 % into their Statutory Liquidity Ratio (SLR).
This borrowing limit has been increased to 3 % of SLR.
This will be applicable up to June 30, 2020
Also, MSF rate has been reduced from 5.4 % to 4.65 %.

Deferred the implementation of Net Stable Fund Rate (NSRR) by 6 months

Under Basel 3, banks are required to maintain NSFR of 100 %.
[You may read: What is meant by Basel norms?]
It was supposed to be implemented from April 2020
NSFR requires banks to fund their activities with stable sources of finance.
Banks are required to maintain a stable funding profile in relation to their off-balance-sheet assets and activities.
This implementation has been deferred by 6 months.

Deferred the implementation of Counter-cyclical buffer

Under Basel 3, banks are required to maintain Counter-Cyclical Buffer (CCB) of 2.5%
These buffers have to be built normal times to be used in case of an economic emergency.
India has been implementing this guideline in tranches of 0.625 %.
The implementation of the last trance of 0.625% has been deferred by 6 months

The above measures are intended to enhance liquidity in the financial system, ensure that rate cuts of RBI are passed to the borrowers and help people who are facing cash disruptions due to the coronavirus pandemic

This monetary policy announcement has come a day after FM’s 1.7 lakh crore package for the most vulnerable sections of the society.

To conclude, the RBI has taken laudable steps to help the economy in these desperate times. We can’t comment on the efficacy on the ground though as there are no precedents to fall back on.

References:

RBI notification