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RBI should look at credit growth for taking policy decision and not CPI inflation: Murthy Nagarajan, Head-Fixed Income, Tata Asset Management

Government security and AAA Bond yields have fallen by 150 to 200 basis points up to 5-year segment and the spread between G sec and corporate bonds have narrow to 40 to 60 basis points from 100 to 150 basis points prevailing in the month of April 2020.

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RBI has done an excellent job on the monetary policy side by applying conventional and unconventional policy to handle the Covid-19 crisis. Conventional policy like cutting repo rate by 115 basis points and 155 basis in reverse repo rates, path breaking unconventional policy of Long-term Repo Auction and Targeted Loan Term Repo Auction for 3 years to buy corporate bond has proved very effective. This has eased financial conditions in the economy. Government security and AAA Bond yields have fallen by 150 to 200 basis points up to 5-year segment and the spread between G sec and corporate bonds have narrow to 40 to 60 basis points from 100 to 150 basis points prevailing in the month of April 2020.

NBFC and HFC are able to borrow at 20 to 70 basis points over t bills rates up to one-year segment and corporates are able to borrow at 10 to 40 basis points over comparable T bills in the one-year segment. Issuance of corporate bonds and commercial papers are the highest in recent years in the last four months. RBI has prevented a liquidity crisis from morphing into a solvency crisis for the corporates. The transmission of policy rates has percolated into the money market/ corporate bonds and to an extent into the lending rates of banks also. SBI has reduced its lending rates by 115 basis points for its repo linked loans matching the repo rate cuts by RBI from March 2020. 

However, the banking system and the NBFC are facing challenging situation. 50 % of their books went under moratorium in the month of April 2020, when the moratorium was announced. The results of banks which has declared their first quarter results is showing significant reduction in loans under moratorium. However, there is no standardization for the basis of classification of loans reflected under moratorium. Various banks have their own definition of loans under moratorium, some banks has classified borrowers who have not paid any of the last four instalment under moratorium, some banks have classified one loan instalment out of the 4-installment also as moratorium loans. Based on this classification, the loans moratorium in the books of the banks range from 9 % to 17 % amongst top quality banks. As per Acuité rating agency, 25 % of the books of the banks are under moratorium and as per SBI Research team, 15 % of the books are under moratorium. RBI in its Financial Stability Report has estimated Gross NPA to rise from 8.5 % to 12.7 % in a baseline scenario of negative economic growth. Banks have shown lower NPA due to moratorium which is in force till August 2020. The NPA will start reflecting from December 2020 results. 

Given that 30 % of the bank loan book are for entities rated A and below, we should see significant amount of stress in the books of the banks in this year, after the moratorium is lifted. There is demand for one-time restructuring of loans of banks. Past experience have shown around 40 % to 50 %, of the restructured loans have gone bad after 2 years. Still this is a better solution, given the dire state of these banks, in which they may have to write off 100 % of the stressed assets in one go. The coming years will see the banking system coming under stress due to low economic growth, challenging the capital adequacy of banks as they provide for higher NPA. This will make the banks and NBFC more risk averse. 

Government fiscal stimulus is not feasible given high debt to GDP ratios of 70 %. Structural reforms will take time to show results, necessitating RBI may have to carry a heavy load to stimulate the economy. Recent CPI inflation reading have shown CPI inflation being above the target for the last 3 months. Due to supply disruption induced by lockdowns, food inflation has remained high. Monsoon has been good and sowing area is higher by 18 % over last year, reservoir levels are 118 % over last year levels, which bodes well for rabi crop production. Given that capacity utilization of the industry was below 75 % pre Covid, there should not be any pricing pressure in the economy when thing normalize. 

Already, in the month of July, activity levels after showing increase has stabilized at lower levels than what was prevailing in the month of July 2019. Bank credit growth on a year on year basis has come down to 5.7 %, given risk aversion of banks. In such a scenario, RBI should go for more unconventional measures in its monetary policy, like onetime restructuring package for the banks loans, increase in Held to Maturity portfolio of banks, having a Marginal Standing Facility rates lower than reverse repo rates. Increase HTM of banks, will allow banks to buy long term papers in the held to maturity portfolio for better carry and avoid mark to market risk in their portfolio, instead of deploying in reverse repo rates and earning 3.35 %. RBI should ignore the clamour for focusing on CPI inflation in this pandemic situation and focus on getting GDP growth back in the economy. Measures to control CPI inflation if it does not normalize in the coming months, can be done after the economy stabilize on a positive growth path."

Disclaimer: The views expressed in this article are personal in nature and in is no way trying to predict the markets or to time them. The views expressed are for information purpose only and do not construe to be any investment, legal or taxation advice. Any action taken by you on the basis of the information contained herein is your responsibility alone and Tata Asset Management will not be liable in any manner for the consequences of such action taken by you. Please consult your Financial/Investment Adviser before investing. The views expressed in this article may not reflect in the scheme portfolios of Tata Mutual Fund. 


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