RBI is fighting the coronavirus seriously.
“Amidst the coronavirus panic, the RBI today (27.03.20) decided to reduce the repo rate by 75 bps, i.e, from 5.15% to 4.4%. The reverse repo rate has been cut down by 90 bps and it now stands at 4%.“Source: Govt of India
To understand the basic implications of these two policies we need to first understand what repo rate and reverse repo rates basically are:
Very simply put, repo rate is the rate at which the central bank grants loans to the commercial banks. So basically, if a country faces an inflationary environment and the central bank wants to curb it to some extent, it might increase the repo rate.
Now that borrowing has become expensive for the commercial banks, they would lend out less or charge a higher rate of interest, this would ultimately help in reducing the money supply in the economy. Thus, there is an inverse relationship between repo rate and money supply.
Talking about the reverse repo rate, it is also a part of the liquidity adjustment mechanism. It is the rate at which the central bank borrows from the commercial banks. Thus, an increase in the reverse repo rate will decrease the money supply and vice versa. An increase in reverse repo rate implies that the commercial banks would be more than willing to extend their funds to the central
bank (as they would be getting a higher rate) and thus reducing the supply of money in the economy.
Thus, reducing both the repo rate and the reverse repo rate is a step to increase the supply of money in the economy.
The RBI today also announced some other sources of how liquidity is being injected in the economy due to coronavirus (Source : Governor’s statement).
An easy explanation for few of the steps taken are as follows:
• Two USD buy/sell swap auction of USD 5 billion each conducted on March 26 and April 23, 2019, injecting liquidity into the banking system amounting to ₹34,561 crores and ₹34,874 crores, respectively.
The auction was undertaken to help boost India’s forex reserves by $5 billion. The reserves as on March 15, 2019 was $405.6 billion. The forex reserve is one tool which the RBI uses to intervene in the currency market at times of abnormal volatility.
Let’s see how this works. Buying a swap auction as such means that the RBI will purchase 5 billion worth of USD from banks and in return it will pay them an equivalent amount of INR at the current spot rate. If we assume a spot rate of 70 per dollar, the RBI can infuse around Rs 35000 crores through this process. RBI for coronavirus.
Simultaneously the banks will buy-back the same amount of dollars from the RBI after the tenor of the contract (3 years in this case). The banks will have to quote a forward premium (in terms of paisa) that they would pay to buy back the dollars. For example, if bank A quotes a premium of 200 paisa and bids for $20 million, it will get Rs140 crore (70Rs/$ x $20m). After 3 years the bank will have to pay back approximately Rs144 crore (72Rs/$ x $20m) to the RBI in order to buy back $20m.
Two such swap options were conducted last year and the proceeds will help improve liquidity conditions in the market.
• Two 6-month US Dollar sell/buy swap auction providing dollar liquidity amounting to USD 2.71 billion.
Seven open market purchases, injecting ₹92,500 crore into the system.
This one is quite simple. Whenever the central bank wishes to increase the money supply, it purchases government securities in the open market. This pumps in more money in the economy. This will also absorb the supply of government securities in the market. The central bank, RBI because of coronavirus had earlier notified its intent of purchasing securities maturing between 2022 and 2025.
• Four simultaneous purchase and sale of government securities under Open Market Operations
(special OMOs or what is known as operation twist) during December and January (December 23 and 30, 2019 and January 6 and 23, 2020) to ensure better monetary policy transmission.
The changes in monetary policy and decisions about it impact the asset prices and other economic conditions. This process is called monetary policy transmission.
Operation twists are generally performed to reduce the long term interest rates in a country’s money market. On 23rd December 2019, RBI sold short term securities
worth Rs10,000 crore through OMO and purchased long term securities of the same value. The short term security will be maturing this year and the long term security
will mature in 2029. The purpose of this operation was to moderate
the long term interest rate and bring them closer to the repo rates.
The probable impact of this twist?
The interest rate for long term investment will come down and an investor would take more loans for long term investments. Also, the flow of money will increase and boost aggregate demand in all sectors (this seems to be unlikely in the current catastrophic scenario, but once this situation ameliorates, AD will rise).
• Five long term repo operations (LTROs) between February 17 and March 18, 2020 for one-year and three-year tenors amounting to ₹1,25,000 crore of durable liquidity at reasonable cost (fixed repo rate).
An LTRO reduces the rate at which commercial banks lend to borrowers. This is a process which was introduced by RBI recently. Instead of cutting down policy rates, the RBI introduced LTRO. Under this, the RBI provides longer term loans to banks at the prevailing repo rate. Because banks get longer term funds at a lower rate, their cost of funds fall and hence they can lend at a cheaper rate. RBI has taken good steps for its part against coronavirus
This means that borrowing would be cheaper. People could borrow more at this time of quandary and this would definitely be beneficial for the lower segment of the society.
Quite an effective way to inject liquidity!
• Exemption on incremental credit disbursed by banks between January 31 – July 31, 2020 on retail loans for automobiles, residential housing and loans to micro, small and medium enterprises (MSMEs) from the maintenance of cash reserve ratio (CRR).
The amount under the Standing Liquidity Facility (SLF) available for standalone primary dealers was enhanced from ₹2,800 crore to ₹10,000 crore on March 24, 2020 and this will be available till April 17, 2020.
I must say that the steps taken by RBI due to coronavirus today are acutely focussed towards enhancing liquidity in the economy. Also, a great news shared by Mr. Shaktikantha Das today was that the banks in India which operate International Financial Services Centre (IFSC) Banking Units (IBUs) will be allowed to participate in the non deliverable forward (NDF) market with effect from June 1, 2020. He said, “The offshore Indian Rupee (INR) derivative market – the NonDeliverable Forward (NDF) market – has been growing rapidly in recent times. At present, Indian banks are not permitted to participate in this market, although the benefits of their participation in the NDF market have been widely recognised. The time is apposite to improve efficiency of price discovery.”
These policies are also coherent towards reviving growth, mitigating
the negative effects of the virus and preserving financial stability.
Also Read: why yes bank is falling?
The RBI due to coronavirus has extended a 3 month moratorium on repayment of term loans by borrowers. This means that borrowers would not have to pay their EMIs during this period and this will also not affect their credit rating. Risk classification of the loan would also not be impacted. In all probability this is the best news I’ve heard today! The credit card companies have not announced any such good news, but if they do so, it would be really appreciated by all and I think that would also enhance their goodwill.
Concluding with what Mr. Das said today in his speech – “Tough times never last. Only tough people and tough institutions do.” The steps taken by RBI are really praiseworthy and their promise to do “whatever it takes” has come good. I think the steps taken will keep the credit flowing to the needy sector. The efforts taken to ease financial stress caused by covid 19 by the Reserve Bank of India are commendable.
Let’s not panic and fight this pandemic together. Stay safe!