The liquidity situation in the market is quite fascinating. The situation is quite diverse. Growth in bank deposits is higher than change in credit (which was negative in first fortnight of the month). This means that credit is not growing relative to deposits. Next, the RBI has cut the CRR by 1 per cent which releases around ₹1.45 lakh crore in the system. There have been a series of LTROs and TLTROs of over ₹2 lakh crore over the last two months or so. It is not surprising that banks have been putting around ₹7 lakh crore in the reverse repo auctions of the RBI.

The basic question raised is why are we releasing so much money into the system at a time when demand is low? The RBI has brought in a moratorium of loans for three months, which most likely is to be rolled over selectively for some sectors. Any which way when a company is not in a position to repay old loans, it is very unlikely that it would be seeking fresh loans for productive purposes. It is more likely that it could be using cheaper finance to repay old loans. While some companies will be going in for expansion, it is unlikely to be in the first quarter when there is a lockdown. Therefore, demand for funds for expansion and growth would be limited.

The RBI has also asked banks to enhance the working capital limits by 10 per cent which is good for firms which are stretched. The question is whether or not all companies will opt for it as even today the ratio of outstanding credit to sanctioned credit limits for the industry as a whole is around 70 per cent. But increasing the limit provides a lot of comfort.

Abundance of liquidity

As far as banks are concerned, liquidity has been in abundance. Money from TLTRO can be used for subscriptions in the bond market, but it makes sense for them to go for the better-rated instruments which would tend to be the blue-chip companies in the private sector and public sector units. The money from the regular LTRO has been churned through the LAF window and while the RBI has made it commercially non-viable to invest money lent at 4.4 per cent in reverse repo of 3.75 per cent, it is still preferable given the banks’ reluctance to lend right now and the limited demand for funds. Such rollovers can be used when the economy recovers and deployed at the MCLR of 7.1-7.75 per cent. Quite clearly banks are waiting for the better performing companies to come in for borrowing.

The last TLTRO auction on April 23 meant for NBFCs did not quite get the enthusiastic response as in the earlier auctions with only a little over 50 per cent being bid for. It does appear that the earlier TLTRO funds have already gone into the blue-chip NBFCs and with banks cherry-picking their investments there is less interest in the lower-rated companies.

Banks will be cautious

One takeaway from this entire exercise of the RBI is that banks are going to be doubly cautious about lending as the last NPA episode has caused substantial turmoil in all banks with several controversies being ignited. The moratorium has to be extended logically because all borrowers who have opted for the same have been out of production or income (the retail part) for one month for sure and probably a longer period given the certainty of further extensions of lockdown in different forms. Hence those who have not been able to service debt in March cannot do so in July and have to be given an extension.

Also banks are cognisant of the fiscal deficit target being breached for certain. This will mean a larger amount of government paper coming into the market and the non-TLTRO funds can be used to get a return of around 6 per cent or higher from these auctions. There is talk of the RBI lending directly to the government (which is not allowed post 1997 when there were the 4.6 per cent ad-hoc T-Bills).

How can banks be nudged to lend? First, if the RBI announces that it will directly lend to the government by changing all the Acts due to extreme conditions, banks may perforce have to use their funds for lending. Second, the RBI can put curbs on the amount that will be absorbed under reverse repo auctions just like the rule on repo earlier which was restricted to 1 per cent of NDTL. This may just help the cause.

The writer is Chief Economist, CARE Ratings. Views are personal