Just as the April monetary policy was announced in late March 2020, the June policy was also pulled back to May 22, 2020. This monetary policy announcement was unique as it followed nearly 2 months of pan-India lockdown. Back in March, the RBI had announced the monetary policy just after the lockdown commenced. At that time RBI had cut repo rates aggressively by 75 basis points. Here are highlights of the May 22, 2020 RBI policy.
The repo rates were cut by another 40 bps from 4.40% to 4.00%. This is the lowest repo rate that the RBI has ever maintained in India.
As a result, the reverse repo rate stands reduced from 3.75% to 3.35%, the idea being to leave banks with little incentive to park funds with RBI.
This resulted in the bank rate and the marginal standing facility (MSF) also standing reduced from 4.65% to 4.25%.
The six members of the Monetary Policy Committee (MPC) voted unanimously for an accommodative stance and they voted 5:1 in favour of cutting rates by 40 bps.
How repo rates and reverse repo rates have panned out?
If you look at the trend of repo rates and the reverse repo rates since the IL&FS crisis of 2018, they have been consistently trending lower. Between September 2018 and May 2020, the repo rates have been cut by 250 basis points while the reverse repo rates have been cut by 290 basis points. In March 2020, the spread between repo and reverse repo was broadened from 25 basis points to 40 basis points. In addition, the RBI also announced a special 25 bps cut in reverse repo rates in April, increasing the spread between repo rates and reverse repo rates to 65 basis points.
It is essential to understand why the RBI has been more aggressive in cutting the reverse repo rates as compared to the repo rates. The reverse repo rate is the rate that banks earn on their deposits with the RBI. In the last few months, the banks had turned extra cautious and preferred low yielding central bank deposits over lending to customers. The idea of a sharper cut in reverse repo rate was to make such deposits unattractive to banks. It is a different issue that banks continue to park excess funds with the RBI.
What was the macro backdrop for the RBI policy?
It must be acknowledged that RBI announced this policy in the midst of a data vacuum. The inflation figure for April has not been announced since prices would not be representative in the midst of the lockdown. The IIP de-growth for March 2020 was (-16.5%). For April, the PMI Manufacturing came in at 27 and the PMI Services at 5.4. These are historically low values and clearly hint at an economy that is stagnating. That is hardly surprising considering that most economic activity came to a standstill in April. That means, IIP for April and May could be much lower. In addition, the GDP for the March quarter is also expected to be announced on May 31st
. One thing is clear that the economy needs a stimulus and rate cuts are the easiest way to deliver.
Policy shifts announced in the monetary policy
Apart from the outlook on rates and liquidity, RBI made some important announcements in the policy.
RBI had announced a 90-day special Rs.15,000 crore refinancing facility to SIDBI for on-lending to small industries. That tenure stands extended to 180 days.
Tenure of pre and post shipment credit to exporters enhanced from 12 months to 15 months. EXIM Bank also gets liquidity support.
The time period for the EMI moratorium for corporate and retail borrowers has been extended by 3 months till August 31st 2020.
RBI has also allowed further deferment of interest on working capital by 3 months but has been silent on the one-time restructuring demand of industry.
State governments can use the balance in the consolidated sinking fund (CSF) to handle redemption of market borrowings in order to reduce stress.
Will this rate cut really boost credit growth?
That remains the million dollar question. Credit pick up has to be driven by retail or corporate demand. In the case of corporates, the macro environment is still unclear and most businesses are putting their capital investment plans on hold. In terms of retail demand, the risk aversion is still quite high and most households are facing the pressure of job losses / income cuts. Under these circumstances there is limited visibility of growth. The 40 bps cut in repo rates may have limited the policy options for the RBI. After the 75 bps cut in March, a bigger fiscal thrust may have worked better.