How RBI's Rs 3.74 lakh crore stimulus will impact financial markets

Like they say, for every action, there is an equal and opposite reaction. A slew of measures including Rs 3.74 lakh crore liquidity boost announced by the RBI Governor Shaktikanta Das for the financial markets today are directed at easing the pain in the domestic economy. These are 'extraordinary' measures because of an unprecedented situation that the outbreak of Covid-19 has created in the global economy. Let's make a sense of key measures announced:

A massive cut in the repo rate

A massive 75 basis points cut in the repo rate at 4.4 per cent will help improve the sagging sentiments in the economy. The new borrowers of consumer loans will greatly benefit while the reduction will slowly percolate to existing borrowers. The repo rate action of the RBI will lead to reduction in deposit rates, which will impact savers. In the long-term, the narrow interest rate differential between India and the rest of the world may impact foreign inflows in India as they will end up with lesser returns after factoring in the rupee hedging cost.

Reverse repo rate at 4 per cent to lower banks' earnings

The phrase that you can take the horse to drink water, but you cannot force him to drink is quite apt for banks today. The RBI has narrowed the reverse repo window by a big margin to 4 per cent, which means the central bank is discouraging banks to park money with it. The reverse repo rate is the rate at which RBI absorbs surplus funds of banks. The RBI has also reduced the cash reserve ratio (CRR) by 100 basis points to 3 per cent, which means more cash in the hands of banks to deploy it in the market.

The RBI says that it will encourage banks to use the funds for lending to productive sectors of the economy. But the credit offtake was in single digit even before the outbreak of Covid-19. In the current situation, the lending avenues will get even more limited because of the impact on the retail loans.

Surplus liquidity to fuel inflationary pressure

The RBI has created a surfeit of liquidity over the last six months by way of open market operations, rupee-dollar swaps and long-term repo auction. The RBI Governor has assured more such auctions to create liquidity. Globally, central banks are pumping in trillions of dollar into their economy. History shows part of such liquidity finds its way into different asset classes such as equity, debt, real estate and commodities. That said, at some point of time, this excess liquidity will fuel inflation and push up interest rates, thereby impacting the growth. While the economy needs liquidity, the RBI has to find a right balance and use all the tools to absorb any excess liquidity.

Moratorium on loans to halt NPA recognition, but impact income

The three-month moratorium scheme offered by the RBI to banks will certainly help in halting the NPA classification. However, it holds all the potential of misuse by the borrowers, especially by the large borrowers. Banks will have to be extra careful in assessing the each case on merit because many companies with enough cash flows to service their loans would try to take advantage of the scheme. In addition, this measure will have a direct impact on banks' earning over the next two quarters.

Also read: Coronavirus impact: RBI on war footing! Repo rate cut by 75 bps, CRR by 100 bps

Also read: 'Don't link banks' share prices with safety of deposits,' says RBI chief Shaktikanta Das