Monetary Policy: RBI may talk the walk on liquidity but hold off any special packages

A 25 basis point cut in repo rate is in the bag. The big question in the market’s mind is what more will the Reserve Bank of India (RBI) and the Monetary Policy Committee (MPC) do; even more important what will they say.

One basis point is a hundredth of a percentage point.

First, let us dispose of the rates issue. There is a small group that expects a 35 bps rate cut and an even smaller one that expects 50 bps cut. The other members of the MPC may not agree with the governor on 35 bps, simply because it is untested anywhere in the world and this may not be the time for experiments. What if it confuses the market.

An even stronger argument against both the 35 bps and the 50 bps rate cut move is that the cuts so far have barely been passed on. Rates on some tenors in some banks have even gone up. So why waste firepower. There is always a chance eight weeks down the line.

Next, the market will look at the action and speak on liquidity. Although four out of the five members of the CNBC-TV18 MPC voted for a “neutral” stance, chairman Pronab Sen may have called the RBI right with his vote for an accommodative stance.

The argument against accommodative stance is that after three rate cuts such a change in stance is pointless because a bulk of the cuts are over. But given the global collapse in yields and the all-around growth scare, any guess that we may be at the end of the rate cutting cycle may be premature. Also, an accommodative stance is a good way to signal to the market that RBI intends to keep liquidity comfortable.

Remember, the years from 2004-2007 when YV Reddy moved stance from “ample” liquidity to “adequate” to “appropriate liquidity” to signal that he is tightening. The RBI can now take a leaf out of Reddy-speak to signal loosening.

Actually, liquidity in the banking system has gone into surplus mode since early June. On June 3, RBI absorbed net Rs 86,632 crore from the banking system via the reverse repo window. This is likely to remain the shape of things as many factors are coming together. The cash lying in the government account in April and May has been spent and is back with banks. June, July August are months when cash withdrawal is limited and indeed cash comes back into the banks.

And finally, RBI has announced an Open Market (OMO) bond purchase even in a situation of surplus, unlike last year when it came with OMOs only in the second half. The central bank has thus walked, and it is most likely to talk the walk by changing into an accommodative stance. This may be reinforced by more assurances at the press conferences. But the question in the market’s mind is will the RBI also announce an institutional mechanism to help mutual funds and housing finance companies. There are a few good ideas:

One, that RBI may allow a lower LCR (Liquidity Coverage Ratio) if that space is used to lend to housing finance companies and non-banking financial companies (NBFCs) against their loans. A similar arrangement called FALLCR (Facility To Avail Of Liquidity Under LCR) is already available, but it may be useful to reiterate with an emphasis on funding housing finance companies.

Secondly, the RBI or the government may provide refinancing to banks through the National Housing Bank (NHB) if they lend against loans of housing finance companies. The reasons in favour of such a policy are that currently,

housing finance companies (HFCs) are selling their good loans at distressed valuations, which permanently maims their growth. If they can mortage their loans and raise cash, then the pain is short lived.

Mutual funds too have been asking for a line of credit. RBI can announce that banks may lend against CD (certificates of deposits) holdings of MFs and avail of refinancing from RBI. But many will rightly argue that such policies may be too hasty. MFs and indeed even HFCs and NBFCs have to sleep in the bed they have made. Markets must be not interfered with unless markets themselves are in danger of breaking down.

One hears that DHFL has already arranged to pay its dues within a week. Also, it is negotiating to sell the company itself. Such steps should be encouraged, even forced. The ministry of corporate affairs via the company law board can intervene as it did in the Satyam case and force a sale if there is a major default. Only, such a sale gets complicated in this case especially if buyers feel they need a haircut on the loans because of doubts over the quality of the assets. If the process of sale thus gets long drawn and markets continue to suffer, then government and regulator will have to step in as a lender of the last resort. But that step need not be announced at the policy meeting. The RBI governor can take a leaf out of Mario Draghi and say he will do “whatever it takes” to keep markets robust but stop short of concrete steps.

For the longer run, however, two urgent steps are needed. The National Housing Board as the regulator of HFCs needs to be vastly strengthened or HFCs must be turned over to RBI for supervision. Thorough annual inspections are called for. The NHB is an extremely weak regulator and the current absence of any thorough regulation and supervision over HFCs is an unpardonable blind spot in our regulatory architecture.

Secondly, a resolution corporation is absolutely the crying need of the hour. Such an institution was envisaged by the FRDI (Financial Regulation and Development Institution) Bill. The perceived danger to bank deposits led to the government withdrawing the bill. It needs to be re-introduced and quickly passed with appropriate assurances to depositors.