May 22, 2020 I Economics

Credit Policy Review – May In less than 2 months and in an unscheduled monetary policy meeting, the
2020 RBI announced another fairly steep rate cut along with regulatory measures
to further ease the financing conditions in the domestic economy which has
been severely impacted by the shutdown in the last 2 months. Today’s policy
Contact: announcement was the RBIs second monetary policy review for the fiscal
Madan Sabnavis
Chief Economist year 2020-21.
madan.sabnavis@careratings.com
91-22-6837 4433 The MPC reduced the repo rate by 40 basis points to 4% while maintaining
its accommodative stance. The MSF, bank rate and reverse repo rates which
Authors:
are linked to the repo rate has also been lowered accordingly. The repo rate
Kavita Chacko and reverse repo rate now stands at a near two decadal low.
Senior Economist
kavita.chacko@careratings.com
The RBI also extended the earlier announced relaxation (announced in the
Dr. Rucha Ranadive last 2 months) for debt servicing and compliances. It also announced
Economist measures to support exports and imports including providing a line of credit
rucha.ranadive@careratings.com
for EXIM banks, increased the group exposure limit and measures to ease
Sushant Hede the stress of state governments.
Associate Economist
sushant.hede@careratings.com % May 2020 Change
Repo rate 4.00 ↓
Reverse repo 3.35 ↓
Marginal standing facility 4.25 ↓
Bank rate 4.25 ↓
Mradul Mishra (Media Contact)
Cash reserve ratio 3.00 −
mradul.mishra@careratings.com
91-22-6837 4424
The MPC took note that the two months of COVID-19 induced lockdown has
had severe ramifications on economic activities and financing conditions
across all segments and this called for an easing in financing conditions and
a reduction in policy rate. While all members of MPC voted for a reduction
in repo rate, 5 were in favour of a cut of 40 bps while one member voted for
a reduction in repo rate by 25 bps.

The MPC stated that there still remains policy space for future actions. The
RBI only gave directional guidance on inflation and economic growth and
refrained from giving any numerical projections amidst high uncertainty
surrounding the pandemic. Though the outlook of inflation is highly
Disclaimer: This report is prepared by CARE Ratings Ltd. uncertain the headline inflation is expected to remain below target in H2.
CARE Ratings has taken utmost care to ensure accuracy
and objectivity while developing this report based on Economic growth is expected to contract in FY21 with prominent downside
information available in public domain. However, neither risks.
the accuracy nor completeness of information contained
in this report is guaranteed. CARE Ratings is not
responsible for any errors or omissions in
analysis/inferences/views or for results obtained from the
We had lowered its GDP growth projections for FY21 to -1.5-1.6% earlier this
use of information contained in this report and especially week in our Report – Road to Recovery.
states that CARE Ratings has no financial liability
whatsoever to the user of this report.
 Economics: Credit Policy Review – May 2020

RBI’s Assessment on global and domestic economy

Global scenario

• Global economic activity stagnated due to lockdown and social distancing

• Volatility in financial markets ebbed after fiscal and monetary policy response
• Revival in foreign fund flows to EMEs
• Weakness in US dollar with gradual improvement in risk appetite
• Crude oil prices firmed up. Gold prices remained elevated
• Subdued CPI inflation across advanced and emerging market economies. Pick up in food inflation due to supply
disruptions
• Global trade to contract this year as per WTO projections.

Domestic scenario
• Server impact on domestic economic activities on account of 2 months of nation-wide lockdown
• Depressed rural as well as urban demand.
• Decline in private consumption as well as investment activity
• Sizable contraction in service activities
• Improvement in agriculture and allied - Kharif sowing is higher and Rabi procurement is under progress
• Uptick in retail inflation led by supply shocks in food component
• Abundant systematic liquidity
• Narrowing liquidity premia in various markets segments
• Increase in FDI and FPI inflows in equity segment. Outflows from debt segment
• Sizable foreign exchange reserves

RBI’s outlook on inflation and economic growth

The RBI has given only directional guidance on the inflation trajectory and economic growth due to high uncertainty
surrounding COVID-19 pandemic.

Inflation
• Headline inflation could be below 4% target in Q3 and Q4 FY21.
• Favourable base effect, expectations of gradual relaxation in lockdown, moderation in food inflation, forecast of
normal monsoon, low input costs with subdued metal and raw material prices globally, deficient demand will
dampen inflationary pressures going ahead.
• However, upside to the inflation could emanate from likely firming up of global crude oil prices, persistent supply
dislocations and volatility in financial markets.
• Risk to inflation is anticipated to be short lived. With inflation expected to remain benign there remains a policy
space to address growth concerns.

Economic growth
• MPC noted that the macroeconomic impact is more severe than earlier anticipated. Various sectors are under stress
due to supply disruptions and low demand.
• GDP growth in FY21 is expected to remain in a negative territory

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 Economics: Credit Policy Review – May 2020

• Depressed economic activities barring agriculture, expectations of subdued economic activities due to continuation
of social distancing norms post lockdown easing and temporary shortages of labour will weigh on economic growth.
• Gradual revival in activity in H2 with recovery in Q3 and increase in growth momentum in Q4 is expected.
• There is high uncertainty regarding duration of pandemic and thus, downside risks to the economic growth are
significant.

Developmental and regulatory policies

The statement of regulatory and development policies includes measures which broadly focuses on improving the
functioning of the financial markets, support to export and imports, ease financial stress caused by COVID-19 and steps to
ease financial constraints faced by the state governments.

I. Measures to improve functioning of the markets:

• Refinancing facility for SIDBI: The special refinancing facility of Rs 15,000 crs which was provided to SIDBI for on-
lending/refinancing to small industries for a period of 90 days will be rolled over by another 90 days from the
end of the 90th day.
• Additional duration to meet investment limits by FPIs under VRR: From the current level of 3 months, additional
3 months is to be allowed to FPIs to fulfill the requirement of meeting atleast 75% of the allotted FPI limits.

II. Measures to support export and imports

• Export credit: The RBI has permitted an increase in the maximum permissible period of pre-shipment and post-
shipment export credit sanctioned by banks from existing 1 year to 15 months for all the disbursements made
up to July 31, 2020
• Liquidity facility for EXIM banks: The RBI has decided to extend a line of credit of Rs 15,000 crs to EXIM bank for
90 days (with a rollover of maximum 1 year) with a view to enable the bank to avail US dollar swap facilities to
meet its foreign exchange requirements.
• Extension of time for payment for imports: The RBI has extended the period for completion of remittances
against normal imports into India (except in cases where amounts are withheld towards guarantee) from 6
months to 12 months from the date of shipments made on or before July 31, 2020.

III. Measures to ease finance stress

• Moratorium on term loan installments: The RBI has permitted commercial banks, cooperative banks, small
finance banks, AIFIs and NBFCs (termed as “lending institutions”) to allow a further 3 month moratorium i.e from
June 1 to August 31, 2020 on the payment of installments in respect of term loans outstanding as on March 31,
2020. Consequently, the repayment schedule may be shifted by additional 3 months
• Deferment of interest in working capital facilities: The lending institutions are permitted to allow a deferment
of another 3 months from June 1 to August 31 for the working capital facilities sanctioned in the form of cash
credit / overdraft.
• Conversion of accumulated interest rate into funded interest term loan: The lending institutions are permitted
to convert the accumulated interest on working capital facilities over the deferment period into a funded interest
term loan facility. This loan facility has to be repaid by March 31, 2021.
• Asset classifications: The moratorium / deferment availed by the borrowers will not result in an asset
classification downgrade. The 90 day NPA norm for all standard accounts (as on March 1, 2020) which have been
granted moratorium/deferment shall exclude the period of moratorium. Thereafter, the normal ageing norms
shall be applicable.
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Economics: Credit Policy Review – May 2020

• Easing working capital financing: The lending institutions are permitted to recalculate the “drawing powers” for
working capital financing by reducing the margins till August 31, 2020. The margin requirements are to be
restored to the original level by March 31, 2021.
• Extension of Resolution Timeline: The lending institutions, which have an additional provision of 20% in the case
of large default accounts (for which resolution plan has not been implemented within 210 days), shall exclude
the entire period of moratorium (i.e March 1, 2020 to August 31, 2020) from the calculation of resolution period.
• Limit on Group Exposures under the Large Exposure Framework: The RBI has permitted to increase bank’s
exposure to a group of connected counterparties from 25% to 30% and this limit will be applicable till June
30,2021.

IV. Ease financial stress of state governments

Relaxation in the rules governing the withdrawals of funds from the CSF of states, which is maintained by states
as a reserve fund for the amortization of their debt obligations. The relaxation offered (till 31 March 2021) will
release an additional amount of Rs 13,300 crs is expected to help States meet about 45% of their redemption
for FY21. As of end March’20, a total of Rs.1.34 lakh crores was being maintained by different states/UTs with
the RBI. Among states, Maharashtra has the highest reserves at around Rs.40,000 crs, followed.

Consolidated Sinking Fund (CSF): Rs

State/Union Territory
crs
Maharashtra 39,948
Gujarat 13,277
Odisha 13,004
West Bengal 10,730
Andhra Pradesh 8,059
Bihar 7,683
Tamil Nadu 6,437
Telangana 5,500
Assam 4,301
Chhattisgarh 4,300
Karnataka 4,110
Uttarakhand 3,069
Kerala 2,090
Haryana 2,022
Nagaland 1,595
Arunachal Pradesh 1,344
Meghalaya 644
Goa 578
Mizoram 536
Manipur 367
Tripura 319
Puducherry 285
Punjab 234
Total 1,30,431
Source: RBI

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 Economics: Credit Policy Review – May 2020

CARE Ratings View

• While these measures are aimed at easing the funding pressures and make available bank funds for
distressed segments it needs to be seen if bank credit offtake sees a noteworthy increase, given the
underlying heightened risk aversion among banks to lend on fears of the lending turning bad in the
future. The credit guarantee provided by the central government for lending to MSMEs, NBFCs, HFCs
and MFIs in the special economic package in conjunction with the relaxation offered by RBI would help
moderate the risk aversion to an extent. Banks could continue to prefer to park funds in the reverse repo
facility of the RBI. The reverse repo rate has now made it very unattractive for banks to deploy their
surplus funds. But they could be waiting to invest them in GSecs and SDLs which would be higher this
year and offer better and safe returns.
• The present rate cut and other facilitation should be more as measures aimed to help firms to survive
and will not really bring about revival in economic activity in the next few months. Further support
through TLTROs may still be required once the lockdown ends and companies require funding to enhance
investment and hence growth. This is probably the reason the RBI Governor also spoke of possibility of
more rate action in future if required.
• A rate cut may not prompt significantly higher borrowing as given the lack of economic activity and
expectations of weak prospects, businesses could be reluctant to borrow and add to their liabilities.
Therefore, a lot depends on when the shutdown ends and a move to normalcy begins.
• The extension of moratorium was expected and provide more time for the borrowers to adjust to their
debt servicing commitments. However, such interest and loans have to be repaid as there is no waiver
involved and hence it is imperative for economic activity to re-commence so that production increases
and they are able to earn their revenue to meet these commitments.
• The allowance made to states to dip into their CSF is encouraging as those which have created this fund
will now be at an advantage. In future, more states would opt to maintaining this fund as ‘the rainy day’
argument works.

On the whole the measures of the RBI are extremely supportive of the ‘revival’ process that was sparked by the government
last week with a series of reforms announced. The policy lowers the cost of funds and also points out that the transmission
has been quite satisfactory of late. As activity has come to a virtual standstill companies would still not be able to service
their debt and hence the moratorium has been extended. The same has been done for the earlier announced measures on
working capital limits. All this will provide support to firms in these challenging times. The response of banks and borrowers
would be interesting and determine how quickly the revival takes place. Further we could expect another rate cut during the
year as conditions evolve.

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