A Balanced & Prudent Policy

Today's Monetary Policy is absolutely balanced and in the right direction. While conserving the "rate reduction space" for later use, the Monetary Policy Committee (MPC) has continued to provide support on the liquidity front. Doing away with the loan moratorium and announcing a responsible scheme for one-time loan restructuring is both prudent and wise from the perspective of financial stability.

The highlights of today's policy are as follows.

• The MPC has kept key policy rates unchanged but retained the policy-stance at "accommodative" to strike a balance between growth and inflation. All six members of the MPC voted for this action. The reasons offered are as follows.

1. While reimposition of lockdowns in several cities and states, led by surges of fresh infections has dampened the growth outlook, inflationary risks too have increased (at least in Q2, FY21) due to supply chain disruptions & higher domestic taxes on petroleum products.
2. In an environment of unprecedented stress, the RBI wishes to use the space for monetary policy action more judiciously to maximise the beneficial effects of monetary policy stimulus.
3. The MPC remains conscious of its medium-term inflation target.
4. The cumulative reduction of 250 bps since February, 2019 is working its way through the economy, lowering interest rates in money, bond and credit markets, and narrowing down spreads.  

• The RBI's liquidity measures have lowered the borrowing costs and improved financial conditions.

1. Spreads of 3-yr AAA-rated corporate bonds over similar tenor government securities have declined from 276 bps on March 26 to 50 bps on July 31st. Spreads on AA+ rated bonds softened from 307 bps to 104 bps; spreads on AA bonds narrowed from 344 bps to 142 bps points over the same period. Even for the lowest investment grade bonds (BBB-), spreads have come down by 125 bps by July 31st. 
2. Mutual Funds have stabilised since the Franklin Templeton episode. The AUM of Debt MFs, which fell to Rs 12.20 trillion as on April 29, recovered and improved to Rs 13.89 trillion by July 31. 
3. Primary issuance of corporate bonds has increased to Rs 2.09 trillion in Q1, FY21. Market financing conditions have stabilised for NBFC in the wake of targeted policy measures. Even for AA+ rated 3-year NBFC bonds, spreads over similar tenor G-secs have narrowed from 360 bps on March 26 to 139 bps on July 31, 2020.
4. While non-food bank credit has slowed to 5.6% by mid-July, credit to NBFCs grew by 25.7% in June; loans to services by 10.7% & to housing sector by 12.5%.
5. The weighted average lending rate on fresh rupee loans sanctioned by banks declined by 162 bps during Feb-19 to Jun-20, of which 91 bps transmission was witnessed during Mar-Jun, 2020.

• As expected, the RBI announced a select regulatory & developmental measures (given below) to improve the sense of Financial Stability. 

1. It announced an additional special liquidity facility of Rs 100 billion at the policy repo rate to NABARD (Rs 50 billion) and NHB (Rs 50 billion) to support the stressed housing sector and smaller NBFCs & MFIs, respectively.  
2. It has now offered lenders a Resolution plan for eligible corporate exposures without change in ownership, as well as personal loans, while classifying such exposures as Standard subject to specified conditions. The resolution plan may have components like rescheduling of payments, conversion of any interest accrued, or to be accrued, into another credit facility, or, granting of moratorium, based on an assessment of income streams of the borrower, subject to a maximum of two years. Correspondingly, the overall tenor of the loan may also get modified commensurately. The resolution plan may be invoked anytime till Dec 31, 2020 and shall have to be implemented within 180 days from the date of invocation. Lenders shall have to keep additional provisions of 10% on the post-resolution debt. In the light of past experience with regard to use of regulatory forbearance, necessary safeguards have been incorporated, including prudent entry norms, clearly defined boundary conditions, specific binding covenants, independent validation and strict post-implementation performance monitoring. The RBI will also constitute a committee under the chairmanship of Mr K. V. Kamath which shall recommend a list of financial parameters (leverage, liquidity, debt serviceability) which, in their opinion would be required to be factored into the assumptions that go into each resolution plan, and the sector specific benchmark ranges for such parameters. Loans to micro & small enterprises will also be restructured. For advances against Gold Ornaments and Jewellery, the RBI increased the permissible loan to value ratio (LTV) for loans against pledge of gold ornaments and jewellery for non-agricultural purposes from 75% to 90%. This relaxation shall be available till Mar 31, 2021. 
3. The RBI also streamlined the "Use of Multiple Operating Accounts by Large Borrowers" and harmonised risk weights for bank investments in Debt Mutual Funds & Debt ETFs. 
4. To address the regional disparities in the priority sector lending (PSL), the RBI has put in place an incentive framework for banks. Higher weight will be assigned for incremental PSL in the identified districts where credit flow is comparatively lower and a lower weight to identified districts where credit flow is comparatively higher. Other changes include broadening the scope of PSL to include start-ups; increasing the limits for renewable energy, including solar power and compressed biogas plants; and, increasing the targets for lending to ‘Small and Marginal Farmers’ and ‘Weaker Sections’. 
5. With the significant rise in the number of digital transactions, there is an increase in disputes and grievances. Hence, there is a need for tech-driven redressal mechanisms that are rule-based, transparent and involve minimum or no manual intervention. Hence, the RBI wants payments' system operators to implement online dispute resolution systems for failed transactions in their respective systems, in a phased manner. It has also proposed to allow a pilot scheme for small value payments in offline mode with built-in features for safeguarding interests of users and liability protection, among others.   

In our opinion, today's policy is dovish and supportive of "growth with equity" even though there was no policy rate reduction. Provision of a Resolution Framework for Covid-19 related stressed assets is a strongly positive move to facilitate credit flows to productive sectors.