Deciphering Monetary Policy

RBI announced Monetary policy on expected lines with respect to policy rates. The repo rate was left unchanged under the liquidity adjustment facility (LAF) at 5.15 %. RBI acknowledged that there is monetary policy space for future action and that the MPC would continue with the accommodative stance for “as long as it is necessary to revive growth”, hinting at the possibility that RBI could resume rate cuts in the future.

Key announcements

While the policy rates were left unchanged, the central bank did announce a few crucial measures to reinforce liquidity and augment credit flow to critical sectors. These include measures aimed at improving the flow of credit to specific sectors, help bank and HFC profitability in the near term and give some leeway by allowing them to provide further moratorium to CRE (Commercial Real Estate) exposures and incentivise banks to lower lending rates.

Long Term Repo Operations (LTROs) for improving Monetary Transmission

RBI announced that it will conduct Long-Term Repo Operations (LTRO) of one and three years’ tenor of up to Rs. 1 lakh crore at 5.15% (current policy rate) from February 15. This is a master stroke in our view and should aid better monetary transmission for longer tenure loans.

  • This move is bigger than a rate cut in pushing the short-term yields down for certain and expected to remain low for a while.
  • With this, banks will be borrowing at 5.15% which is 100-150 bps cheaper than the current borrowing rate of 1-3 year tenor. This is expected to lower the lending rate too.
  •  The key reason for not lending cheap was that repo rate cut was not transmitting to borrowing rates. Thus with LTRO introduction, at least 100 bps reduction in incremental borrowing cost of upto Rs. 1 lakh crore.
  • Longer the tenor in 1 & 3 year of borrowing by the banks, deeper and lasting transmission in the bond and loan markets is expected
  • LTRO will likely lower corporate bond yields, deposit rates and lending rates too in terms of credit-spread compression.

Incentivizing bank credit to specific sectors

Incremental disbursements to Housing, Automotive and MSME loans (disbursed after Jan 31,2020) are to be exempt from CRR calculations. This exemption is available for disbursements done upto July 31, 2020. It seems like RBI aims to drive greater credit to these specific sectors. Housing, MSME and auto credit for the banking sector is INR 18-19tn. Annual disbursements should be around INR 3tn. Potentially, this should amount to a liquidity release of INR 100-150bn for the banking system.

Commercial Real estate (CRE) projects under implementation

Permission to extend of date of commencement of commercial operations (DCCO) of project loans for commercial real estate, delayed for reasons beyond the control of promoters, by another one year without downgrading the asset classification, in line with treatment accorded to other project loans for non-infrastructure sector. (Detailed guidelines awaited)

We view this as a positive step for HFCs and banks which have exposure to real estate projects and would help defer the recognition of NPLs and hence credit costs as well.

Impact & Way forward

  • We do not rule out the possibility that RBI may resume its rate cuts again by H2 FY21 provided inflation comes down below 4 – 4.5% and that the interest rates could even breach the historic low of 4.75%.
  •  Strong case for spread compression can be made between AAA and non AAA credit assets over medium term
  •  Long-Term Repo Operations announced by RBI will push the short-term rates down and eventually lower the longer-end of the curve too. There will be an immediate transmission in the sovereign assets which will lead to a chase in the corporate bonds lowering the corporate bond yields too.
  •  Global risk-off led to bond yields falling sharply in US Treasuries;. The yields of other developed economies also continue to remain low. This may, sooner than later, lead to chase for Indian sovereign assets which are still offering high real rates.
  •  We expect at least 25 50 bps cut in the policy rates in CY 20.

Actionables :

  • In a nut shell, key driver for returns will be Corporate spread compression or flattening of the yield curve. It will start with AAA/PSU followed by NBFC/HFC like Bajaj/HDFC and then, it may percolate to lower grade NBFC /Corporate bonds.
  • We believe that the investment opportunity in Short Duration Bond Funds, Credit Funds and Dynamically managed Duration Funds is still present and becoming more attractive. Investors may look to invest in the funds depending on the scale of risk appetite and the investment horizon.

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Author: Midas Finserve

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