Key Highlights of RBI Monetary Policy on 9 October 2020

The Reserve Bank of India (RBI), also known as the Apex Bank of India was established as India’s central bank to regulate the issue of banknotes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage and to formulate a modern monetary policy framework to meet the challenge of an increasingly complex economy. The primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth.

Reserve Bank of India (RBI) governor Shaktikanta Das on 9^th October announced RBI’s monetary policy decision after three days of deliberations of its monetary policy committee (MPC). The MPC decided to continue with the accommodative stance of monetary policy until necessary (at least during the current financial year and into the next year), to revive growth on a durable basis and to mitigate the impact of COVID-19, while ensuring that inflation remains within the target.

No change in Repo Rate

The Repo rate remained unchanged at 4%. Repo Rate is the fixed interest rate at which the RBI provides overnight liquidity to banks against the collateral of government and other approved securities under the LAF. It is the policy rate decided by the MPC.

No change in Reverse Repo Rate

The reverse repo rate also stands unchanged at 3.35%. Reverse Repo Rate is the fixed interest rate at which the RBI absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the Liquidity Adjustment Facility (LAF).

No change in the Marginal Standing Facility (MSF) rate and the Bank rate

The Marginal Standing Facility (MSF) rate and the Bank rate also remained unchanged at 4.25%.

The MSF is a facility under which scheduled commercial banks can borrow additional amount of overnight money from the RBI against their excess SLR securities and also by dipping into their SLR portfolio up to a specified limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.

Bank Rate is the standard rate at which the RBI is ready to buy or rediscount bills of exchange or other commercial papers. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.

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Economy Highlights

After the steep decline into which the global economy plunged in the second quarter of 2020, global economic activity appears to have rebounded sequentially in the third quarter, but unevenly among and within economies.
By persevering in the pandemic, the rural economy looks resilient. Early estimates suggest that food grains production is set to cross another record in 2020-21.
Job creation under the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) has provided incomes and employment in rural areas.
MPC projections indicated that inflation would ease closer to the target by Q4:2020-21.
The manufacturing purchasing managers’ index (PMI) for September 2020 rose to 56.8, its highest mark since January 2012, supported by acceleration in new orders and production.
The services PMI for September at 49.8 remained in contraction but has risen from 41.8 in August. These expectations are also reflected in RBI’s growth projections which suggest that GDP growth may break out of contraction and turn positive by Q4.
For the year 2020-21 as a whole, real GDP is expected to decline by 9.5%, with risks tilted to the downside. If, however, the current momentum of upturn gains ground, a faster and stronger rebound is mostly probable.
The weighted average cost of borrowings by the central government during the first half of 2020-21 at 5.82% was the lowest in the last 16 years. The weighted average maturity of the outstanding stock of the centre had also been the highest so far.
The RBI assured that the borrowing programme of the centre and states for rest of 2020-21 would be completed in a non-disruptive manner without compromising on price and financial stability.
In pursuit of this objective, the limit for Ways and Means Advances (WMA) for the centre is kept higher at Rs 1.25 lakh crore compared to Rs 35,000 crore of the previous year.
Also, the 60% increase in WMA limit for states in the first half of 2020-21 has been extended for a further period of 6 months till March 31, 2021.
The RBI will maintain comfortable liquidity conditions and will conduct market operations in the form of outright and special open market operations. The size of these auctions will be increased to Rs 20,000 crore and it is expected that the market participants will respond positively to this initiative.

Observations on Inflation

Headline inflation has moved up from March 2020 levels and has persisted above the tolerance band of the target.
MPC’s assessment is that it will remain elevated in the September print, but ease gradually towards the target over Q3 and Q4.
MPC’s analysis suggested that supply disruptions and associated margins/mark-ups were the major factors driving up inflation. As supply chains were restored, these wedges should vanish.
Aggregate demand remained subdued and there is evidence of considerable resource slack. Large excess supply conditions characterise food grains and horticulture production, and the outlook for agriculture is bright.
Crude prices remain range-bound.

Liquidity Measures – On Tap TLTRO

TLTROs were introduced in March 2020 to provide longer duration money to specific sectors/instruments. Liquidity availed by banks under TLTROs had to be deployed in investment grade corporate bonds, commercial paper, and non-convertible debentures in both primary and secondary markets.
In April 2020, RBI announced a Targeted Long-Term Repo Operations 2.0 (TLTRO 2.0) to channel liquidity to small and mid-sized corporates, including non-banking financial companies (NBFCs) and micro finance institutions (MFIs) that had been impacted by COVID-19 disruptions. The funds availed under TLTRO 2.0 had to be deployed in investment grade bonds, commercial paper (CPs) and non-convertible debentures (NCDs) of Non-Banking Financial Companies (NBFCs).
MPC now decided to conduct on tap TLTRO with tenors of up to 3 years for a total amount of up to Rs 1,00,000 crore at a floating rate linked to the policy repo rate.
The scheme will be available up to 31^st March, 2021 with flexibility of enhancement of the amount and period after a review of the response to the scheme.
Liquidity availed by banks under the scheme has to be deployed in corporate bonds, commercial papers, and nonconvertible debentures issued by entities in specific sectors over and above the outstanding level of their investments in such instruments as on September 30, 2020.
The liquidity availed under the scheme can also be used to extend bank loans to these sectors.

Banks that had availed of funds earlier under targeted long-term repo operations (TLTRO and TLTRO 2.0) will be given the option of reversing these transactions before maturity.
In view of the borrowing requirements of the centre and states in the second half of 2020-21 and the likely pick-up in demand for credit as the recovery gathers strength, on tap TLTROs are intended to enable banks to conduct their operations smoothly and seamlessly without being hindered by illiquidity frictions.
The objective is to ensure that liquidity in the system remains comfortable.

Liquidity Measures – SLR Holdings in Held to Maturity Category

In India, the Statutory liquidity ratio (SLR) is the Government term for the reserve requirement that commercial banks are required to maintain in the form of cash, gold reserves, PSU Bonds and RBI approved securities before providing credit to the customers. The SLR to be maintained by banks is determined by the RBI in order to control the expansion.
On 1^st September, 2020 the RBI increased the investments permitted to be classified as Held to Maturity (HTM) from 19.5% to 22% of NDTL (net demand and time liabilities) in respect of SLR securities acquired on or after September 1, 2020 up to March 31, 2021.
In order to provide certainty to banks as regards their investments and to foster orderly market conditions while ensuring congenial financing costs, it is decided to extend the dispensation of the enhanced HTM limit of 22% to March 31, 2022 for securities acquired between September 1, 2020 and March 31, 2021.
In order to impart liquidity to SDLs and thereby facilitate efficient pricing, it has been decided to conduct open market operations (OMOs) in SDLs as a special case during the current financial year.

Other Measures to be undertaken by RBI

RBI will henceforth undertake caution-listing on the basis of case-specific recommendations of the Authorised Dealer (AD) banks
In order to facilitate higher credit flow to this segment, which mainly consists of individuals and small businesses (with turnover up to Rs 50 crore) and in harmonization with the Basel guidelines, it was decided to increase the maximum aggregated retail exposure to one counterparty threshold limit to Rs 7.5 crore (it was Rs 5 crore before) in respect of all fresh as well as incremental qualifying exposures.
In recognition of the role of the real estate sector in generating employment and economic activity, it is decided to rationalise the risk weights and link them to loan-to-value ratio (LTV) ratios only for all new housing loans sanctioned up to March 31, 2022. Under the current regulations, differential risk weights are applicable to individual housing loans, based on the size of the loan as well as the LTV
In 2018, the RBI put in place a framework for co-origination of loans by banks and a category of NBFCs for lending to the priority sector, subject to certain conditions. Based on the feedback received from stakeholders, it is decided to extend the scheme to all NBFCs, including HFCs, in respect of all eligible priority sector loans, and allow greater operational flexibility to the lending institutions
In order to facilitate swift and seamless payments in real time for domestic businesses and institutions, it has been decided to make available the RTGS system round the clock on all days from December 2020.

In order to prevent licensing and business uncertainty for PSOs, RBI will grant authorisation for all PSOs (new applicants as well as existing PSOs) on a perpetual basis, subject to certain conditions. Under the Payment and Settlement Systems Act, 2007 the RBI currently gives on tap authorisation to payment system operators (PSOs) for limited periods of up to 5 years.

The global economy is still reeling under the impact of the unprecedented COVID-19 shock. As major central banks have pledged to keep rates at the current historic low levels and governments are implementing large fiscal support programmes, there is hope for the improvement in financing conditions.

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