Monday, May 17, 2021
NewsFile Institute
Home / Business  / RBI’s monetary policy announced: Cautious optimism is the bottomline

RBI’s monetary policy announced: Cautious optimism is the bottomline

RBI takes proactive steps to address lack of enough liquidity in the system

By Samudrajit Gohain

Amid the Covid 19 pandemic-induced economic contraction of unprecedented proportions, the RBI announced its policy outlook on Friday (Oct 9).

Mumbai: Reserve Bank of India Governor Shaktikanta Das addresses a pess conference at the RBI Headquarters in Mumbai on Apr 17, 2020. (Photo: IANS)

The policy statements announced by RBI governor Sashikant Das is a delicate mixture of cautious optimism, with an aim to assuage several frayed nerves at the same time. 

Key takeaways from today’s policy announcements are as follows:

Repo and reverse repo rates unchanged

Both repo and reverse repo rates have been kept unchanged for the time being. RBI proactively uses both these rates to target inflation and money supply or liquidity in the system. 

Repo rate is the rate at which RBI lends money to commercial banks and hence increasing or decreasing repo rate directly impacts commercial banks ability to lend to their customers. 

The repo rate has been kept unchanged at 4 per cent.This means that banks are unlikely to increase lending rates to customers for the time being. 

On the other hand, reverse repo rate is the rate at which RBI borrows money from commercial banks. Increasing reverse repo rate sucks out liquidity from the banking system and decreasing reverse repo rate enhances liquidity in the system. 

Reverse repo rate, too, has been kept unchanged at 3.35 per cent. 

This indicates the RBI’s comfort level with inflation as inflation is directly proportional to liquidity or money supply in the system.

The retail inflation or CPI (consumer price inflation) range comfortable to RBI is 2 percent to 6 percent. 

The CPI was 6.73 per cent in July, 6.69 per cent  in August and 6 per cent in September. 

The RBI is hopeful that by Q4, (January,February and March) of FY21, CPI will be firmly within the upper range of RBI’s comfort level. 

The full year GDP contraction is going to be 9.5 per cent.

But the GDP growth is likely to enter the positive zone by Q4 of FY21.

RBI move to address liquidity concerns

The RBI is still concerned about lack of enough liquidity in the system. To address this problem, it is taking two proactive steps. The first one is Rs 20,000 crore OMO (open market operations) next week.

The RBI will purchase Rs 20,000 crore worth of investment grade bonds and commercial paper from commercial banks and authorised dealers. 

This will ensure Rs 20,000 crore of additional funds with commercial banks which can be lent by banks to their corporate customers to meet short term working capital requirements. 

On the other hand, the RBI has announced on tap TLTRO (targeted long term repo operations)of Rs1 trillion at 4 per cent till March, 2021.

This massive TLTRO programme would ensure that commercial banks would have to invest as much funds (after getting from RBI) in investment grade corporate bonds and commercial paper of short duration. 

This will address massive liquidity concerns of the corporate debt market and would bring down the short term yield (interest rate) of corporate bonds/commercial paper in line with prevailing benchmark rates or yield. 

This reduction in yield spread (difference between corporate bond yield and benchmark yield like G sec) would enable stressed investment grade companies especially from NBFC (non-banking finance companies) and housing finance companies to resume their lending operations as well as taking care of working capital requirements.

Bond market would definitely cheer these two steps by RBI and we can expect bond yields to come down a bit and bond prices to move up (bond yields and bond prices are inversely proportional).

Housing loans 

In another boost to the badly struggling housing sector, the RBI has announced that all new housing loans risk will be linked only to loan to value. This will prompt banks to resume lending to the housing sector more aggressively in the coming days. 

This step, plus the previously mentioned liquidity enhancing measures by RBI should address many concerns of housing loan companies and stresses the real estate sector.

Overall, today’s policy announcements by RBI should keep both the stock market and bond market happy in the coming days.

Banking stocks should react positively in the coming days due to the RBI’s policy announcements. 

Corporate bond yields should come down a bit and this in turn should enhance bond prices.

Corporate bond market in India is currently starved of funds. Hopefully this desperate situation should improve now.

Also read: 

Samudrajit Gohain holds a B.Tech in Mining from NIT, Surathkal ,Karnataka and is an associate member of CISI, London. He specialises in international financial markets, trade, economic relations. He worked in the mining industry for a few years before shifting to financial management and investment.