Our take on the RBI policy measures

Morningstar Investment Management team shares its perspective on the measures announced by the RBI today.

The RBI’s Monetary Policy Committee (MPC), decided to keep the policy repo rate unchanged at 4%.

Consequently, the reverse repo rate stands unchanged at 3.35%, and the marginal standing facility (MSF) rate and the Bank Rate at 4.25%. All the members of the MPC voted unanimously to keep rates unchanged and continue with the accommodative stance as long as necessary – at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.

To provide further support to the market and increase transparency on the normalization of the liquidity management, the RBI announced the following measures:

  • Inclusion of NBFCs in the TLTRO on tap scheme – Funds from banks under the TLTRO scheme is extended to NBFCs for incremental lending to stressed sectors. This move will help banks/NBFCs avail liquidity to lend to the stressed sectors and disseminate credit flow.
  • Restoration of CRR – Gradually restore the Cash Reserve Ratio (CRR) in two phases in a non-disruptive manner. Banks would now be required to maintain the CRR at 3.5% of NDTL effective March 27, 2021, and 4.0% effective May 22, 2021. The normalization of CRR was expected by the market participants. Increasing it in a phased manner should give comfort.
  • SLR holding in HTM category – RBI had earlier increased limits under the Held To Maturity (HTM) category from 19.5% to 22% of NDTL up to 31st March 2022, which is now extended to 31st March 2023. This will help banks to absorb the heavy G-sec supply and plan their investments in SLR securities. The HTM limits would be restored from 22% to 19.5% in a phased manner starting from the quarter ending June 30, 2023.
  • Credit to MSME entrepreneurs – Banks will be allowed to deduct credit disbursed to ‘New MSME borrowers’ from their NDTL for calculation of the CRR. This should help improve the credit flow but comes with a condition of a new borrower who has not availed any credit facilities from the banking system as on January 1, 2021. The overall impact of this measure might be minimal as a large share of MSMEs would have availed the benefit of credit facility part of the Atma Nirbhar Bharat package.
  • Basel III Capital Regulations and Deferment of the implementation of Net Stable Funding Ratio (NSFR) – RBI decided to defer the implementation of the last tranche of the Capital Conservation Buffer (CCB) of 0.625% from April 1, 2021, to October 1, 2021. RBI also decided to defer the implementation of NSFR till October 1, 2021. Both of these measures should free up capital available for lending.
  • Allowing Retail Investors to Open Gilt Accounts with RBI – Opening the G-sec market to retail investors is a major structural reform as it widens the base. This comes in at a time when the government’s market borrowing is at an all-time high. Although further clarity is awaited in terms of retail investor definition and participation.
  • Marginal Standing Facility (MSF) – Relaxation extended by six months till Sept 30, 2021.

Our Take

Post the Union Budget, the 10-year benchmark G-sec yield is up ~15 bps on announcement of additional Rs 80,000 crore market borrowing in this fiscal and a gross market borrowing of Rs 12 lakh crore in FY22 to finance a much bigger fiscal deficit (9.5% of GDP for FY21 and 6.8% for FY22). For FY22, with a ceiling of net borrowing at 4% of Gross State Domestic Product (GSDP) and an additional 0.5% of GSDP (subject to conditions) borrowing by states, combined, centre and states gross borrowing is estimated at Rs 23 trillion. Though, there are a few pockets that could help the government – higher tax collection, the buffer on short-term borrowing, and drawdown of cash balance with RBI.

As expected RBI maintained status quo on the policy rate and its accommodative stance. Yields, further inched up by 10 bps post policy announcement as market participants were expecting some guidance on the OMO purchase plan from RBI to help absorb heavy G-sec supply amid higher market borrowing of the government. The RBI is expected to step in and fill in the gap through OMO purchases and other options.

The possibility of another rate cut seems low and the probability of a prolonged pause has increased further as the revival in the economic activity is expected to be stronger. Whereas, upward inflationary pressure continues to linger with an expanding fiscal, rising fuel and input costs.

The three tranches of the Atma Nirbhar Bharat package announced earlier were focused on providing credit facilities to various sectors and to an extent, increase the disposable income in the hands of the weaker section of society. The recently concluded budget is an extension to the earlier fiscal measures, with a focus on infrastructure spending and improving farm income. Capital expenditure is estimated to grow at 26.2% in FY22 and as a portion of total expenditure, share increases to 15.9% from 12.7% in FY21. This should give a considerable boost to revive the lagging capex cycle.

The high-frequency indicators signal a decent recovery in the urban and rural consumption demand, business activity, and energy consumption. Demand conditions are improving with an increase in imports and improvement in inter-and intra-state movement as indicated by E-way bill issuances. Auto sales witnessed growth for the first time in FY2020-21 with registrations in December growing 11% y-o-y, on the back of a robust tractor and 2-wheeler sales – indicating sound rural demand. Indian manufacturers signalled growth in new orders, production volumes, and exports with January PMI coming in at 57.7 (expansion zone) higher than 56.4 reported in December. The services PMI for January at 52.8 also shows a positive momentum in growth recovery. The composite PMI output index at 55.8 in January is up from 54.9 reported for December. The recent monthly GST collection numbers are encouraging.

The proposals part of the union budget should help remove infrastructure bottlenecks to compete effectively with other Asian manufacturers/exporters. Along with government spending on infrastructure, improvement in ease of doing business and private investment in factories and other fixed assets should also pick up meaningfully. The recent pick-up in consumption demand looks resilient and if it sustains should instil confidence of banks to lend and of manufacturers to improve private capex. This along with a strong rebound in credit growth should bode well for the economy in the near term.

Short-term yields may see some uptick with the normalization of the banking system liquidity. With the last few days of yield movement at the longer end, yields may remain range-bound supported by the RBI’s efforts to keep borrowing costs lower. The current term spread in the medium-long term segment i.e. 5-10 years maturity (~2.5%) is above the long-term historical average of 1.5% – improving its relative attractiveness over short-term debt and cash where the real rates are at sub 1% and negative respectively.

In an ultra-low interest rate environment, the focus shifts on chasing high yields at the cost of adding a substantial amount of credit risk which to an extent is similar to adding equity risk in the portfolio. Our approach focuses on the risk-reward trade-off. We try to look at what could be the impact on return estimates after considering potential defaults & downgrades. We assess this by evaluating the credit loss impact due to defaults and credit migration impact due to downgrades. After adjusting the credit spreads with credit cost, we derive our return estimates for the corporate bond (credit risk category). Based on our valuation-implied return forecasts, the corporate bond segment (3-5 years) looks relatively attractive over the short-term debt (G-sec & banking PSU debt) segment as the real rate gap looks attractive from a risk-reward basis. Having said this, the AA and A issuers segment could see downgrades and defaults, which needs to be monitored carefully.

In this unique economic situation, we are actively reviewing our views across asset classes and portfolio positioning.

Source: Morningstar India Website