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Monetary Policy Update

May 23, 2020

Repo Rate Cut by 40bps; Moratorium Extended

The Reserve Bank of India (RBI) in an unscheduled monetary policy committee (MPC) meeting today reduced the policy repo rate by 40bps to 4%, the lowest in last two decades. The MPC judged that the risks to growth are acute, while the risks to inflation are likely to be short-lived. Hence it was essential now to instil confidence and ease financial conditions further. In addition, the RBI also announced few measures to ease financial stress, support exports and imports and improve function of markets.

RBI’s Assessment of Current Economic Environment

The RBI’s assessment of global and local economy was grim as expected. The RBI believes the global economy is headed for a recession as indicated by sharp fall in global PMI data for April 2020. Emerging market economies face additional pressures in the form of capital outflows. Global trade is significantly impacted. The volume of world trade can shrink by 13-32 per cent in 2020, as projected by the World Trade Organisation (WTO).

Indian economy has also been severely impacted by the lockdown. High frequency indicators point to a collapse in demand beginning March 2020. Investment demand has also declined significantly across sectors.

However, there are few rays of hope. Food grain production has increased to a new record. The southwest monsoon in 2020 is forecasted to be normal by the India Meteorological Department (IMD). Kharif sowing was higher by 44% over last year as of 10th May 2020. These developments will support farm incomes, improve the terms of trade facing the farm sector and strengthen food security for the country according to the RBI.

Inflation Outlook

The MPC did not provide inflation forecast levels this time instead, said that inflation could remain firm in the first half of fiscal year (FY) 2021 and should ease in the second half, aided by favourable base effect. The supply shock to food prices in April may continue depending on the state of the lockdown. This could impact food inflation. If India could offload some part of its excess stocks, cereal prices could cool down. Commodity prices, including oil, are likely to remain soft given the demand outlook and thus core inflation could remain benign.

Growth Outlook

The RBI sees the GDP growth in FY 2021 to be in negative territory, with some pick-up in growth from second half of FY2021 onwards. The combined impact of demand compression and supply disruption will depress economic activity in the first half of the year. Economic activity could get restored in a phased manner in the second half of the year.

Major Announcements

Extension of Moratorium – The moratorium on interest payment on all term loans and deferment of interest on working capital facilities announced on 27th March 2020 is extended by another 3 months. The moratorium is now applicable till 31st August 2020.

Payment of Interest on Working Capital Facilities for the Deferment Period – The accumulated interest for the deferment period on working capital facilities can be converted to an interest term loan that can be repaid by 31st March 2021 rather than having to pay at one go once the moratorium period is over.
Limit on Group Exposure Relaxed – Banks can now increase exposure to a group company up to 30% up from 25% earlier. This is applicable up to June 30, 2021.
• The RBI had announced a special refinance facility of INR 15,000 crore available to SIDBI for 90 days that can now be rolled over for another 90 days.
• FPIs can now invest 75% of their allocated limits under Voluntary Retention Route (VRR) over 6 months rather than 3 months mandated earlier.
• A line of credit of INR 15,000 crore has been extended to Export-Import (EXIM) Bank for a period of 90 days with a rollover up to a maximum period of 1 year.
• Remittances for normal imports can now be completed over 1-year period compared to earlier mandate of 3 months.

Outlook

The RBI has now cut rates by a total of 115bps in last 2 months and provided significant amount of liquidity. However, this has failed to improve risk appetite as evident by a steep yield curve. The special liquidity window for NBFCs announced by the Finance Minister last week will buy bonds with a residual maturity up to only 3 months. While this may smoothen some amount of stress in the market it does not create risk appetite.

Lending stocks, Banks and NBFCs, declined in trade today with Nifty Bank index closing the day down by about 2.6%. While the moratorium is good move for end customers it creates elevated risk of NPAs on balance sheet of lenders. It also puts stress on NBFCs that do not have enough liquidity to tide over the coming few months.

Bond markets reacted positively to the rate cut, with the yield on the old 10-year benchmark (6.79% GoI 2029) down by 7 bps to 5.96% at the time of writing this. We believe liquid fund returns could track repo rate and may be lower over the next few days. PSU bond yields have declined by about 100 to 150 bps over the last two months. However, the yield on non-PSU AAA rated corporate bonds are attractive. Hence, we continue to recommend select corporate bonds and Corporate Bond Funds. Market dislocation could create some attractive risk reward opportunities among the better-quality AA rated corporate papers which investors could capitalise on. On the other hand, we continue to believe that companies with weaker balance sheet will still find it tough to raise money. Rate cut alone would not be enough to revive risk appetite for credit in our view.

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