There may be room for further rate cuts, only that they may happen at a later date.
In today’s RBI policy review, as always, the debate and anticipation centred on whether the RBI would reduce rates further or wait for inflation to ease. Let us get over this notion that all action pertains only to changes made to the repo or reverse repo rate; it is a review and not a compulsory action point. It is not practical for the RBI monetary policy committee to tweak rates at every meeting. Having said that, let us look at what the policy statement said.
“The stance of monetary policy remains accommodative as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy. While space for further monetary policy action in support of this stance is available, it is important to use it judiciously and opportunistically.” What the RBI is saying is that there is room for further rate cuts, only that it would do it at a later date. The RBI has cut rates by 2.5 percentage points since February 2019 and by 1.15 percentage points since March 2020.
Lower lending rates
“Transmission to bank lending rates has improved further, with the weighted average lending rate (WALR) on fresh rupee loans declining by 91 bps during March-June 2020,” the RBI statement noted. To put things in perspective, the RBI has cut rate by 115 basis points in this period and the transmission of 91 bps is satisfactory. Usually, the transmission of RBI’s rate cuts takes a longer time to reflect on the lending rate of banks, or the extent of transmission is lower. That is, in these challenging times, the impact of RBI’s rate cuts thus far have been meaningful.
“The spreads of three-year AAA-rated corporate bonds over G-Secs of similar maturity declined from 276 bps on March 26, 2020 to 50 bps by end-July 2020,” according to the release. A spread is the additional or higher yield on an instrument over another security of better credit quality, but of similar maturity. In March, the bond market was in a stalemate due to various reasons and the RBI stepped in with a host of measures. Bond market conditions eased thereafter, and the easing of spreads referred to by the governor represents that improvement.
“Lower borrowing costs have led to record primary issuance of corporate bonds of ₹2.1 lakh crore in the first quarter of 2020-21,” the RBI said. In a challenging phase, when corporates are struggling for cashflows, the availability of liquidity, that too at easier rates, is welcome.
There was a lot of debate, in the run-up to the policy review, on the moratorium. The moratorium is available till August 31 and the argument was that it should not be extended as it may lead to lack of discipline and would push the problem further down the road.
Not extending the moratorium by itself can be considered as a move. Any slippage in bank NPAs due to the non-extension of the moratorium is a bitter pill, but it needed to be swallowed and a decision had to be taken. The other action is that the RBI has outlined a restructuring process for borrowers, which may or may not include a moratorium. On June 7, 2019, the RBI issued a framework for stressed borrowers; the RBI will provide a window within that framework.
There would be safeguards implemented such as entry norms, boundary conditions, binding covenants, independent validation and post-implementation performance monitoring. The idea was that restructuring should lead to a culture of easy-going or ever-greening of loans by banks that used to happen earlier, prior to 2015. There would be an expert committee headed by banking veteran KV Kamath for recommending the financial parameters and sector specific benchmarks, for the restructuring. MSMEs facing stress may restructure their debt under the existing framework.
Takeaways for debt fund investors
The outlook for the market or interest rate movement remains the same as earlier. The RBI committee maintains the accommodative stance. It has only paused today. While the scope for rate cuts in the future remains, the extent may be limited, given that 250 basis points have already been reduced. As we are at the fag-end of the rate-cut cycle, instead of venturing into long-maturity debt funds, it is better to be in shorter maturity schemes. The attractive returns we saw over the past year or so are due to the rally in bond yields that has already happened. These returns may not be repeated over the next one year.
On credit quality of debt funds, there is an indirect and medium-term benefit in this policy review. If a corporate is under stress and a mutual fund has exposure to bonds/other instruments, the one-time restructuring of bank loans would be lenient on the cashflows of the company, so that it can service the other instruments such as bonds or CPs.