policy-measures-go-beyond-textbook-economics-in-uncertain-environment

Recent monetary policy announcements by RBI are thoughtful policy measures and masterstroke in every aspect. These measures come just hours after Moody's Investors Service cut India's growth forecasts for 2020 calendar year to 2.5% from 5.3%.

Need of such measures: 

  • To counter the negative impact of lockdown:Asia's third largest economy has been locked down for three weeks ,putting millions of daily wage earners and lakhs of businesses in unprecedented hardship.
  • It was also needed to fulfill the commitment made by G20 nations to fight this pandemic.
  • Uncertain impact of COVID-19
    • In an environment of uncertainty, going beyond textbook economics  was required over typical rule-based policies. 
    • Covid-19 pandemic has brought the world economic activity to a near-standstill.
    • Impact on supply chains, trade and commodity prices all remain uncertain. 
  • Cash flow mismatch : social distancing adversely impacts receivables, resulting in an extreme form of cash flow mismatch for everyone in the real sector, with consequent implications for banks.
    • To minimize friction arising out of this cash flow mismatch due to social distancing.

Highlights of the announcements by RBI

  • Relief for self employed and for those whose income had become uncertain in the wake of the lockdown.
    • A moratorium : All commercial, regional, rural, NBFCs and small finance banks are being permitted to allow a 3-month moratorium on payment of instalments in respect of all term loan EMIs outstanding on March 31.
    • Applicability: Moratorium will apply to corporate loans, home loans and car loans. Personal loans will also qualify for this.
  • To maintain the credit flow:
    • Reduction in repo rate: reduced repo rate by 75 basis points to 4.4 per cent.
    • The reverse repo rate was cut by 90 bps to 4 per cent, creating an asymmetrical corridor.
  • Three-way liquidity injection: These will make available a total Rs 3,74,000 crore to the country's financial system.
    • Auction of targeted long term repo operations of 3-year tenor for total amount Rs 1,00,000 crore at floating rate.
    • Reduction of CRR (Cash Reserve Ratios)for all banks by 100 basis points. Will release Rs 1,37,000 crore across the banking system.
    • Accommodation under Marginal Standing Facility to be increased from 2% from SLR(Statutory Liquidity Ratio) to 3% with immediate effect till June 30. It will release Rs 1.37 lakh crore into the system.
    • Statutory Liquidity Ratio, shortly called as SLR, also an obligatory reserve to be kept by the banks, as prescribed securities, based on a certain percentage of net demand and time liabilities.
    • Cash Reserve Ratio, or popularly known as CRR is a compulsory reserve that must be maintained with the Central Bank. Every banking company is required to maintain a specific percentage of their net demand and time liabilities as cash balance with the Reserve Bank of India.
  • Conduct TLTRO in three-year maturities for ₹1 trillion with an end-use condition that liquidity availed under the scheme by banks has to be deployed in investment grade corporate bonds, commercial papers and non-convertible debentures.
  • Permitting Indian banks, which operate International Financial Services Centres, to participate in the NDF(Non Deliverable Forward) market .
    • RBI has tried to balance the delicate trade-off—minimizing volatility in FX markets versus the volatility in domestic interest rate.
  • On the regulatory front: Implementation of BASEL III norms are deferred for six months.

 

Non Deliverable Forward Market

  • A non-deliverable forward (NDF) is a cash-settled, and usually short-term, forward contract. 
  • The notional amount is never exchanged, hence the name "non-deliverable." Two parties agree to take opposite sides of a transaction for a set amount of money - at a contracted rate, in the case of a currency NDF.
  • This means that counterparties settle the difference between contracted NDF price and the prevailing spot price. 
  • The profit or loss is calculated on the notional amount of the agreement by taking the difference between the agreed-upon rate and the spot rate at the time of settlement.

Targeted Longer Term Refinancing Operations

  • It provides financing to credit institutions: By offering banks long-term funding at attractive conditions they preserve favourable borrowing conditions for banks and stimulate bank lending to the real economy.
  • The TLTROs, therefore, reinforce the Bank’s current accommodative monetary policy stance and strengthen the transmission of monetary policy by further incentivising bank lending to the real economy.

MSF(Marginal standing facility)

  • Marginal standing facility (MSF) rate refers to the rate at which the scheduled banks can borrow funds overnight from RBI against government securities. MSF is a very short term borrowing scheme for scheduled commercial banks.

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