RBI’s second booster shot: Key policy rates cut

Assessing the risks to growth to be acute due to the impact of the Covid-19 pandemic, the Monetary Policy Committee (MPC) of the Reserve Bank of India voted for an off-cycle repo rate cut of 40 basis points from 4.40 per cent to 4 per cent. With the latest cut, the RBI has cumulatively reduced the repo rate by 115 basis points in a span of two months.

Simultaneously, the central bank announced a host of measures, including extension of the moratorium on debt servicing for three more months up to August 31, to prevent the transmission of financial stress to the real economy.

The six MPC members voted with 5:1 majority to cut the repo rate, which is the interest rate at which the RBI provides liquidity to banks to help them overcome short-term mismatches. At 4 per cent, the repo rate is at an all-time low.

The MPC meeting, which was originally scheduled during June 3-5, was brought forward as the recent release of macroeconomic data revealed the damage wrought by Covid-19.

Following the repo rate cut, the reverse repo rate (the interest rate that RBI pays banks when they deploy their surplus liquidity with it) stands reduced from 3.75 per cent to 3.35 per cent.

The reverse repo rate cut will push banks to lend instead of taking the easy way out of deploying funds with the RBI. Fearing the possibility of bad loans, banks have turned conservative in lending due to the sequential slowdown, which set in from Q1 (April-June) 2018-19, and the lockdown since March 25.

RBI Governor Shaktikanta Das, in a televised address, said: “Judging that the risks to growth are acute, while the risks to inflation are likely to be short-lived, the MPC believes that it is essential now to instil confidence and ease financial conditions further.

“This (repo rate cut) will facilitate the flow of funds at affordable rates and rekindle investment impulses…If the inflation trajectory evolves as expected, more space will open up to address the risks to growth.”

Following the repo rate cut, bank deposit and lending rates are expected to fall further.

Pallav Mohapatra, MD & CEO, Central Bank of India, said loans linked to the external benchmark (repo rate) will become cheaper by 40 basis points. Deposit rates could go down by about 10-20 basis points.

The RBI painted a grim picture of GDP growth in 2020-21, estimating it to remain in negative territory, with some pick-up from H2 (October 2020 - March 2021)s.

Depressed economic activity

Das observed that the combined impact of demand compression and supply disruption will depress economic activity in the first half of the year.

Much will depend on how quickly the Covid curve flattens and begins to moderate, he added.

Referring to food inflation, which suddenly reversed and surged to 8.6 per cent in April as supply disruptions took their toll, the MPC assessed that the inflation outlook would be highly uncertain.

The MPC is of the view that headline inflation may remain firm in the first half of 2020-21, but should ease in the second half, aided by favourable base effects.

Easing financial stress

Measures taken to ease financial stress among businesses and households include permitting lending institutions to extend the moratorium on term loan instalments and deferring interest on working capital (WC) facilities by another three months — from June 1 to August 31 — for all term loans and WC facilities outstanding as on March 1.

Lending institutions have been permitted to convert the accumulated interest on WC facilities over the deferment period (up to August 31, 2020) into a funded interest term loan which will be repayable not later than the end of the current financial year (March 31, 2021).

To facilitate flow of resources to corporates, the RBI, as a one-time measure, has allowed an increase in a bank’s exposure to a group of connected counter parties from 25 per cent to 30 per cent of the bank’s eligible capital base. The increased limit will be applicable up to June 30, 2021.

The raising of the limits comes in the backdrop of the difficulty many corporates have been facing in raising funds from the capital market, which is witnessing heightened uncertainty owing to the pandemic, and are depending mainly on funding from banks.

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