Monetary policy: RBI measures preserved financial stability, says Das

The RBI's monetary policy committee has kept the repo rate unchanged at 4 per cent, amid rising inflationary pressure and a grim economic outlook

The Reserve Bank of India (RBI) has pumped in Rs 9.57 trillion, which is 4.7 per cent of gross domestic product, of liquidity into the system to stave off the financial stability crisis and ease domestic financial conditions substantially, Governor Shaktikanta Das said in his monetary policy speech on Thursday.

The actions taken by the central bank have ensured that the spreads of three-year ‘AAA’-rated corporate bonds over government securities (G-secs) have reduced from 276 basis points (bps) on March 26 to 50 bps by end-July.

Spreads on ‘AA+’-rated bonds softened from 307 bps to 104 bps; spreads on ‘AA’ bonds narrowed from 344 bps to 142 bps over the same period. Even for the lowest investment-grade bonds (‘BBB-’), spreads have come down by 125 bps as of July 31, said Das.

The RBI went for a sharp 75-bps repo rate cut on March 27 in response to the Covid crises. Again, on May 22 the monetary policy committee (MPC) went for another round of 40-bps repo rate cut.

“It may be noted that the transmission of rate cuts by the MPC would not have been possible to the extent achieved so far without creating comfortable liquidity conditions,” the RBI governor said.

“The overriding objective was to prevent financial markets from freezing up, ensure normal functioning of financial intermediaries, ease the stress faced by households and businesses, and keep the lifeblood of finance flowing,” said Das.

The easing of financial conditions has enhanced monetary transmission and, thereby, the effectiveness of the MPC’s accommodative stance and actions, he said.

The RBI used a number of instruments for this purpose, particularly the daily liquidity adjustment facility, and also used open-market operations (OMOs) for bond purchases and sales, special operations, and foreign exchange interventions. The liquidity generated was fully sterilised by absorptions through reverse repo, “while preventing seizure of money markets under extreme risk aversion and uncertainty”.

The OMOs were aimed at reducing funding costs for private sector entities that issue instruments in the market, which are usually priced off the G-sec yields as benchmark.

“In fact, it is worthwhile to see who is benefiting from the RBI’s actions,” the governor said, adding, “borrowing costs in financial markets have dropped to their lowest in a decade on the back of abundant liquidity. Interest rates on instruments like the three-month treasury bill, commercial paper, and certificates of deposit have fully priced in the reduction in the policy rate and are trading below the policy rate in the secondary market.”

The rates on commercial papers of non-banking financial companies (NBFCs) have softened to 3.8 per cent on July 31, for non-NBFC borrowers, rates have softened to 3.4 per cent. Illiquidity premiums have dissipated after Operation Twist and Targeted Long Term Repo Operations 1.0, in which the RBI sold short-term paper and bought longer tenure, and offered liquidity to purchase NBFC bonds.  

Lower borrowing costs have enabled record primary issuance of corporate bonds of Rs 2.09 trillion in the first quarter of 2020-21. Financing conditions for NBFCs have largely stabilised in the wake of targeted policy measures.

“Abundant liquidity has supported other segments of financial markets, too. In particular, mutual funds (MFs) have stabilised since the Franklin Templeton episode,” the governor said, adding, “assets under management of debt MFs, which fell to Rs 12.2 trillion as of April 29, recovered and improved to Rs 13.89 trillion as of July 31.”