RBI cuts repo rates by 25 bps and does a lot more

The February monetary policy did spring a surprise. The general consensus in the market was that the RBI would shift its stance to neutral. However, the MPC went one step ahead. It not only shifted the stance to Neutral but also cut the repo rates by 25 bps on the back of lower inflation estimates. But, this policy was significant in more ways than one.

First, the rate cut story

The RBI voted 4-2 in favor of a rate cut. Dr. Viral Acharya and Dr. Chetan Ghate were in favor of a status quo on rates. The logic for the rate cut was three fold. Firstly, CPI inflation had fallen to 2.19% in December and the RBI estimates that the weak inflation trend would continue. Despite the fall being limited to food, the policy decided to focus more on headline inflation rather than on core inflation. Core inflation (excluding food and fuel) was still high at 5.5%. It also means that the policy focus in future will be on headline inflation and not on core inflation. Secondly, the RBI clearly decided to put growth over price control. The IIP had been under stress and the global slowdown is also likely to rub off on the Indian economy. Thirdly, the US Fed had given a very dovish view on rates. The CME Fed Watch Tool is now almost factoring in zero rate hikes in this year. So the worry of rate differentials being compressed is also not a real problem. The situation was ripe and this actually reverses part of the rate hike implemented last year.

Boost for FPIs and NBFCs

The policy statement, interestingly, had a lot more of interesting tidbits for the markets this time around. Firstly, foreign portfolio investors (FPIs) will now be freed from group exposure restrictions. Currently, FPIs cannot invest more than 20% of their debt corpus in India in a single business group. That has been relaxed and rightly so because there are enough reputed fund managers to take such decisions. Secondly, the RBI has also ensured that the liquidity taps to the NBFCs are kept open. Normally, when banks led to NBFCs, it is assigned 100% risk weight for capital adequacy purposes. This has now been relaxed and the bank shall be free to assign risk weights based on the credit rating of the NBFC. For banks, it now becomes cheaper to lend to NBFCs.

A boost for the IBC too

 With a view to giving a boost the bankruptcy resolution process, the RBI statement has also allowed ECBs for bidders. Currently, ECBs are not permitted to be raised to repay domestic debt. However, the RBI has now made an exception for IBC bidders. Potential buyers can raise funds via ECBs to repay the domestic debt of the stressed companies. This enables these bidders to raise money at a low cost. This ECB relaxation is only for the purpose of IBC and it should certainly be a leg up for the NCLT resolution process! ©