De-coding India’s Atmanirbhar Package: RBI Measures

The article has been co-authored by Chakshu Aggarwal & Prashant Jain

During third week of September 2019, overnight funding rate in US banking system had spiked to as high as 10% against US FED’s target rate range of 2%-2.25%. In simple terms, banks were not willing to lend even for overnight, indicating stress and liquidity squeeze in the system. Later, US FED pumped billions of dollars in banking system to revive confidence in overnight market. More importantly, US FED governor Powell mentioned – “We surveyed all the banks and said what’s your lowest comfortable level of reserves. We added that up, we put a buffer on top of it and we felt we were probably well above the level of scarcity. And then in early September, we had a situation where the liquidity – where banks had much more liquidity than they said they needed and yet it didn’t flow into the repo market”. This underscores the core-problem that in case of turbulence, markets participants tend to turn overtly cautious and refuse to lend to each other. On similar lines, Reserve bank has come to the forefront to address the liquidity challenges that are being faced by banking and corporate sector. In this post, second in a series of De-coding India’s Atmanirbhar Package, will try to decode RBI’s measures.

RBI Measures

In line with other central banks efforts to combat the adverse impact of pandemic on their respective economies, RBI’s Monetary policy committee (MPC) has cut interest rates(repo) by 115 bps to 4%. Reserve bank has also used other liquidity tools like Open market operations, Cash reserve ratio, Marginal standing facility, Long term repo operations, Targeted long-term operations, USD/INR Sell/Buy swaps, Operation twist and special liquidity lines for mutual funds and NABARD.

Below is brief on the steps taken by RBI to infuse liquidity into the system that forms the part of Atmanirbhar package:

Cash Reserve Ratio

RBI mandates banks to keep certain percentage(CRR) of their Net Demand and Time Liability (NDTL) with RBI in cash form. This cash does not earn any interest. RBI’s MPC has cut CRR by 1%, releasing nearly INR 1,37,000 cr of liquidity in the banking system.

Marginal Standing Facility

Apart from Repo facility, RBI also allows bank to borrow funds under MSF facility. Unlike Repo facility, borrowing banks can use bonds, earmarked for SLR requirement, as collateral under MSF borrowing. RBI has also increased borrowing limit under MSF facility by 1% of NDTL, nearly INR 1,37,000 cr.

Open Market Operations

Central bank uses open market operations as a tool to manage durable liquidity in the system. RBI tends to sell bonds, when it feels that system is flushed with too much liquidity and buy bonds, during liquidity crunch. As part of Atmanirbhar package, RBI has bought nearly INR 1,20,474 Cr worth of government bonds from market to increase liquidity.

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Long Term Repo Operations

Amid the backdrop of weaker transmission of monetary easing, RBI has started long-term repo operations to improve durable liquidity and transmission in banking system. Under LTROs(read more here), RBI infused INR 1 Lac Cr into the banking system by allowing banks to borrow from central bank at repo rate for tenor of 1 to 3 years by giving government securities as collateral. The operation was conducted in four tranches of INR 25K Cr each. On prima facie, LTROs should increase the durable liquidity of banking system and lead to better monetary transmission.

Targeted long-term Repo Operations

While the aim of LTRO was to improve overall liquidity in the banking system, RBI announced TLTRO 1.0 on 27th March 2020, and infused INR 1 Lac Cr into the system but this time it was targeted towards investment grade corporate bonds and commercial papers to improve availability of liquidity to corporate sector. RBI further announced TLTRO 2.0 on 17th April 2020 and infused INR 50k Cr into the system in order to address liquidity crunch faced by NBFCs and HFCs.

USDINR Sell/Buy Swap

Sell off in domestic equity and debt markets has led to a substantial outflow of foreign funds, leading to dollar shortage in on-shore USD/INR market. In order to address the dollar shortage, RBI announced USD/INR Sell/Buy swaps of USD 4 bn (equivalent to nearly INR 30,000 Cr). RBI has provided USD 4 bn in short end and taken out rupee liquidity of nearly INR 30,000 Cr. This move improved USD liquidity in onshore USDINR markets and reduced pressure on the rupee.

Operation Twist

In order to distribute the liquidity evenly across the yield curve, RBI simultaneously buys (longer term) and sells (shorter term) government security. Theoretically, this should increase duration of RBI’s portfolio and reduce duration of market participant’s portfolio and also result in flattening of yield curve (decrease in long term yields and increase in short term yields). Since March, RBI has conducted Operation twist of INR 10,000 cr.

Special Liquidity Facility for Mutual Funds

Under this facility, RBI conducted repo operations of 90 days tenor at then repo rate of 4.4% and banks were strictly required to use the funds for meeting the liquidity requirement of Mutual Funds. Recent sell-off in financial markets has led to an unprecedented outflow from mutual fund assets. Specially, Fixed income mutual funds have witnessed steep liquidity crunch amid lack of interest in low credit bonds and continued redemption request from the investors. Out of allocated INR 50,000 cr, only INR 2,430 cr is utilized till now.

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Extended lockdown has resulted in nearly zero operating income for company, negative cash flow, losses owing to fixed costs and erosion of equity in balance sheet. Moreover, few companies might find it difficult to service debt and fixed costs. Thus, RBI announced the loan moratorium (Should you opt for it?) for 6 months period.( Initially it was extended for 3 months). EMI holidays are much needed relief for companies, that are short on cash. Moreover, this will lead to reduction in new NPAs recognition, providing breathing space to banking sector.

One of the key challenges for RBI has been to facilitate better transmission of monetary easing to the end borrower. Banking system has been very reluctant in passing interest rate cuts to the low rated corporates. For instance, WALR (Weighted average lending rate) on outstanding rupee loans declined by 29 bps during October 2019-March 2020, against RBI interest rate cut of 135 bps. Perhaps because of this, RBI has been quite proactive in using different tools like LTRO, TLTRO, Operation switch and special liquidity facilities for Mutual funds. At last, given limited fiscal space available for fiscal policy, monetary policy needs to continue with the heavy lifting. Although, this part of atmanirbhar package will do little to stimulate demand in the economy but will certainly aid in survival of corporate India and they will live to fight another day.

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