Why proactive regulatory actions are the need of the hour

The various measures introduced by the Government of India and RBI last year have helped limit the adverse impact of the Covid-19 pandemic on the economy.

Measures such as the sharp cuts in policy rates, the transmission of the same to lending rates by virtue of maintaining abundant liquidity conditions, targeted operations to meet the funding requirements of NBFCs, and facilitating a large sovereign borrowing programme at competitive rates were some of the major initiatives undertaken by the Monetary Policy Committee (MPC) and the central bank.

While the industry and markets have become far more optimistic after the announcement of a growth-oriented Budget by the Finance Minister, continuing regulatory support to make economic growth more durable, while not compromising on the financial sector stability, is certainly the need of the hour.

The RBI remains cognizant of the surplus systemic liquidity and, expectedly, resumed normal liquidity operations from January 2021 to absorb a part of the excess liquidity, which has led to a rise of around 30 bps in the short-term rates and contributed to flattening of the yield curve.

Subsequently, with the announcements of increase in the GoI’s dated market borrowings as a consequence of slippage in fiscal deficit relative to the earlier targets surfaced, the long-term yields recorded a sharp rise. The effects spilled over on the corporate bond markets as well, with the yields on the 3-year and 5-year AAA corporate bond yields rising by 37 and 30 bps, respectively, in the days immediately after the announcement of the Budget FY22.

Bond markets

However, in its review on February 6, the MPC allayed the market concerns by continuing the assurance of maintaining the accommodative stance of monetary policy into the next financial year to revive the growth on a durable basis. This was supplemented by the RBI with policy measures such as extension of enhanced levels of held-to-maturity levels of bond portfolio of banks by one-year and phased hike of cash reserve ratio.

Additionally, the RBI Governor’s statements of ensuring the orderly completion of sovereign borrowing for FY22, assurance that the stance of liquidity remains accommodative in consonance with that of monetary policy, and reiteration that the yield curve is a public good, were intended to reassure the bond market.

The subsequent announcement of open market operations to purchase government securities of ₹20,000 crore helped in reversing a part of the rise in yields on benchmark government bonds. However, despite the reassurances, the devolvement of government bonds on to the primary dealers in recent auctions is likely to keep an upward pressure on government securities as markets continue to remain concerned on huge supply.

Despite recent RBI measures, the yields on corporate bonds still remain elevated compared to pre-budget levels.

Apart from the short-term measures to address the investor demand for large supply of sovereign debt, the regulatory proposal to provide direct access to retail investors could widen the investor base for government securities in the long term. If successful, this could lead to a structural change in yields on risk-free instruments, which act as pricing benchmarks for corporate bonds. Improved investor education and awareness on linkages of bond yields and price will be needed to attract retail investors, who also have access to other risk-free investment products such as Small Savings Deposit products of GoI which, though illiquid, offer higher returns.

Extension of time period

A continued assurance to markets with necessary actions to prevent a sharp rise in bond yields will be vital to maintain continued buoyancy in the Indian debt capital markets. Over the years, NBFCs have accounted for more than 50 per cent of the domestic bond issuances.

With bank exposure to NBFCs rising steadily over the last few years, better access to bond markets will be important for the latter to scale up, given the recent events that have reduced the investor appetite for NBFC papers. The announcement of funding availability under on-tap TLTROs is a welcome move; however, an extension of time-period beyond March 31, 2021, could have been considered by the RBI as the availability of adequate funding is still a challenge for the sector.

The GoI’s proposal to have an institutional framework for the proposed body, which will act as market maker in corporate bonds in normal and stressed times, is a welcome measure. If operationalised well, it will aid in improving not only the secondary market liquidity, but also deepen the bond markets. The measure will also help improve the credit flow at competitive rates to the NBFC sector, which helps in last-mile credit delivery in India. While the RBI continues to reiterate the importance of NBFCs in the Indian financial system, the proposal to tighten the regulations for NBFCs, along with higher supervision, is a welcome move as the investor confidence levels are not uniform across issuers. In that context, the discussion paper released by the RBI does not seem onerous on the NBFCs. While the paper did not articulate on a backstop facility from the RBI as available to banks, it did not stipulate any CRR or SLR requirements as well.

The anxiety on outcomes of asset quality among lenders and investors remains high, and though the government has budgeted capital of ₹200 billion for public banks for FY22, the proposal to defer the peak regulatory capital by six months could be a confidence booster for public banks.

Given the uncertainty on asset quality and timing of capital infusion by the GoI, the proposed measure will reduce the risk aversion of lenders towards making fresh credit proposals, as their worries on capital position ease. Apart from capital, improved confidence among lenders on faster resolution of stressed assets could address the issue of low credit growth.

A focussed approach for faster resolution, which the proposed asset management company could bring in, could be a positive. Regulatory incentives, which can prompt lenders to transfer stressed asset to the proposed AMC, could aid in the consolidation of such assets for faster resolution. Going ahead, the regulator could consider providing sufficient incentives for the same. To conclude, proactive monetary policy measures will be required to sustain the recovery being witnessed in financial sector, to retain the improved confidence of lenders as well as investors.

The writer is MD and Group CEO, ICRA Limited