RBI Announcement: Reason for Cheer?

Posted On Friday, Mar 27, 2020


In the monetary policy meeting held earlier today, the RBI announced a comprehensive monetary package comprising large rate cuts, liquidity infusion and regulatory changes to reinforce financial stability and support the economy. Some of the measures announced are as follows:

RBI cuts policy repo rates by 75bps from 5.15% to 4.40% and reverse repo by 90bps from 4.90% to 4.00%. Accordingly, the marginal standing facility (MSF) rate and the Bank Rate stand reduced to 4.65% from 5.40%

Reduced Cash Reserve Ratio (CRR) by 100 basis points from 4% to 3% of NDTL (Net Demand and Time Liabilities) for the period of 1 year till Mar 26, 2021. This would release primary liquidity of about Rs. 1.37 trillion in the banking system.

Reduced the minimum daily CRR requirement from 90% to 80% of total for 3 months till June 26, 2020.

Increased the borrowing limit under Marginal Standing Facility from 2% to 3% of NDTL. This would allow banking system to avail an additional liquidity of Rs. 1.37 trillion under LAF window.

The RBI will conduct targeted term repos of up to three years tenor for a total amount of up to Rs. 1 trillion at a floating rate linked to the policy repo rate which has to be deployed in investment grade corporate bonds, commercial papers, and non-convertible debentures. Investments made by banks under this facility will be classified as Held To Maturity (HTM) even in excess of 25 per cent of total investment permitted to be included in the HTM portfolio. Exposures under this facility will also not be reckoned under the large exposure framework.

All commercial banks, co-operative banks, all-India Financial Institutions, and NBFCs are being permitted to allow a moratorium of three months on payment of instalments in respect of all term loans outstanding as on March 1, 2020.

Lending institutions are being permitted to allow a deferment of three months on payment of interest in respect to working capital facilities

Lending institutions may recalculate drawing power by reducing margins and/or by reassessing the working capital cycle for the borrowers without changing the asset classification

This was an unconventional monetary policy which looked beyond the RBI's primary mandate of controlling inflation. It was completely directed towards tackling the negative consequences of the COVID-19 pandemic. Thus there were a lot of one-off & time bound measures to address the immediate concerns of the economy and the financial system particularly on the liquidity front.

The most significant was the announcement of directed Long Term Repo Operation for commercial papers and corporate bonds under which banks can borrow from the RBI for 3 years at variable Repo rate and invest into commercial papers or corporate bonds upto 3 year maturity. Corporate bonds and the money markets were under stress lately due to increased risk aversion and heavy outflows from the foreign investors and mutual funds. This led to a very sharp increase in market yields of even high rated PSU corporate bonds indicative of market dislocation and risk. This T-LTRO will get back liquidity into the corporate bond markets and also lead to a fall in short term bond yields of AAA corporates.

The RBI also reduced the Cash Reserve ratio by 1% of NDTL infusing Rs. 1.37 trillion of primary liquidity into the banking system. The prevailing surplus liquidity conditions along with these liquidity measures will keep the effective overnight rate close to reverse repo rate of 4% and thus will force banks to increase investments /lending. This will also enhance the transmission of earlier rate cuts into the real economy.

The RBI further assured the markets that they have number of tools - both conventional and unconventional - to inject another monetary stimulus, if needed. We acknowledge that large rate cuts and monetary stimulus will not have any material impact in terms of reviving growth under this crisis. But will definitely help in reviving confidence in the financial markets and will avoid any brewing financial crisis due to extreme risk aversion.

The bond and money markets celebrated the RBI's actions with sharp drop in yields across the maturity curve. The 10 year benchmark government bond yield dropped by over 20 basis points (from previous day's close of 6.22%) to touch 6.0% post the policy announcement but later gave up much of the gains to close the day at 6.14%. Corporate bonds and money markets witnessed larger impact as yield on 5 year AAA rated PSUs dropped by more than 100 basis points from ~7.5% to 6.25% and yield on 2-3 months PSU papers fell by over 250 basis points from 7.7% to below 5%.

Given the abundant liquidity and possibility of further rate cuts, short term bonds will likely remain supported. However the longer tenure bonds will be driven by potential fiscal measures by the government and possibility of further rate cuts from the RBI. In case government rolls out more fiscal stimulus that can put upward pressure on the long tenure bonds and will require the RBI to conduct aggressive OMOs.

The overall situation remains uncertain and despite these overwhelming measures by the RBI, we expect markets to remain volatile. If as an investor, you are uncomfortable with market volatility in these times, we would advise you to choose a safe bank deposit to park your money, for the moment.

We continue to advise investors in debt funds to choose funds which focus on keeping credit risks low and have liquid portfolios. India entered COVID having a weak economic background and the impact of COVID on companies and the economy is likely to be severe depending on how long the lock-down continues.

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.

Mutual fund investments are subject to market risks read all scheme related documents carefully.

Please visit – www.QuantumMF.com to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.

Above article is authored by Quantum.

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