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Monetary Policy Update

Mar 27, 2020

RBI Unveils Many Arms from Its Arsenal

‘Whatever it takes’ was given a whole new meaning today by the Reserve Bank of India (RBI). It fired from every barrel to support the economy in its fight against slowdown triggered by the Covid19 pandemic.

Interest Rates: The repo rate was slashed by 75 bps to 4.40% The MPC decided to keep the monetary policy stance unchanged as “accommodative”. Since the pandemic broke out, 38 central banks around the world have cut rates. Hence this move was widely anticipated, however the size of the cut took the markets by surprise.

Liquidity: The RBI decreased CRR to 3%, infusing ~ Rs 1.37 lakh crores of liquidity. It also enhanced banks’ ability to borrow overnight by increasing Marginal Standing Facility from 2% to 3%. It will be conducting TLTRO auctions of Rs 1 lakh crores. The liquidity thus created will have to be used by banks to buy commercial paper and investment grade corporate bonds. This will help tighten credit spreads in a targeted manner. Cumulatively, the three measures will inject a total liquidity of Rs. 3.74 lakh crore to the system.

Relief package: A moratorium of three months on payment of instalments on all term loans and deferment of interest on working capital facilities for three months have been permitted to mitigate the burden of debt servicing brought about by disruptions. These measures will provide a short-term relief to the businesses which are otherwise stalled and are battling with cash crunch.

Assurance: The governor talked up the markets with an assurance that they will do ‘whatever it takes’ to support the economy in such times of extreme uncertainty.

In addition to the above the RBI has also introduced few other policies to ease stress in the financial conditions.

Global Economy at a Standstill

As widely known, economic activities in most parts of the world have come to a near standstill as lockdowns and social distancing are imposed across affected countries. As a result, the global growth is expected to take a severe hit in 2020. However, the extent of slowdown will depend upon the intensity, reach and duration of the pandemic. A flight to safety triggered a sharp sell-off out of global equities and drove bond yields in developed markets to record lows.

Domestic Economy’s Fate No Different

The situation in India is no different with lockdowns posing serious risk to GDP estimates. GDP is estimated to grow at 5% in FY20 implying an asking rate of 4.7% in Q4FY20. This now doesn’t seem plausible with the entire country under lockdown for three weeks. High frequency indicators suggest that private final consumption expenditure has been hit hardest. Most service sector indicators for January and February 2020 moderated or declined. Since then anecdotal evidence suggests that several services such as trade, tourism, airlines, the hospitality sector and construction have been further adversely impacted by the pandemic. Amidst all the negativity, the only positive data point is growth in food grain production which grew 2.4% YoY.

Retail inflation fell almost a percent in Feb-20 to 6.6% from Jan-20 high led by softening onion prices. In the coming months, the shock to demand may keep the inflation under check. Further, the international crude prices have plunged over last few weeks which may bring relief to the extent benefits of lower prices are passed through.

In the external sector, after six months of de-growth, exports growth returned. However, imports also grew leading to widening of trade deficit.

Net FDI inflows saw a substantial increase to USD 37.8bn in the period from April-19 to Jan-20. The FPI outflows in YTD20 at USD 5.2 bn were lower than the previous year. India’s foreign exchange reserves stood at a very healthy USD487.2 bn as on March 06, 2020.

Market Reaction

• The short-term rates had shot up sharply and trade volumes plummeted in the past few days. This had created a lot of nervousness amongst market participants. Post the policy announcement, the stress eased almost immediately with yields going back to pre-stress levels.

• The yield on the 10-year government bond eased 8bps to 6.14%. The yield has fallen ~27bps in last one week.

• The Indian rupee appreciated 0.4% to 74.88 per US Dollar.

Outlook

RBI’s measures helped reinforce confidence that it will support markets through these challenging times. This is crucial in restoring normalcy in the debt markets even if it takes a few more days. Rolling into April we see conditions in the money markets ease. Investors who missed the move to money markets, should now stay put in liquid funds if the horizon is more than a fortnight.

The short—medium terms spreads of AAA papers have widened significantly past few days and we had recommended locking-in of yields. A lot of gains have now been upfronted. We expect the rates to continue to drift down over the medium term. Hence, we continue to recommend select corporate bond as well as Banking and PSU funds.

The relief package was much needed as lot of businesses and households will be severely impacted by the lockdowns and ensuing economic slowdown. Despite the measures, we think weaker balance sheets may continue to have challenges in raising funds and transmission of lower rates to them will be limited. We therefore put our call to invest in credit funds that was given prior to the pandemic break-out, on hold.

Our views on equity and gold remain unchanged at this point.

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