27 highlights
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Sahgal managed to get the moratorium on some of his loans and also raised some fresh loans under the government’s emergency credit guarantee scheme. But this required considerable effort, and some bit of naming and shaming via emails and social media.
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A major private bank also reported a default on his loan account to the credit bureaus, despite there being a moratorium on the loan. (Reminder: A loan moratorium allows a borrower to defer repayments without it being marked as a default, while interest continues to accrue.) He chased the bank, and the mistake was corrected.
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Banks are sitting on Rs 4.63 lakh crore of liquidity as of Monday. But when these businessmen actually want it, the tap seems to turn dry.
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It’s a thorny issue that lies at the heart of monetary policy in India today. In the middle of a prolonged economic slump, the Reserve Bank of India has been struggling to get money where it needs to be. Understanding why lenders and economists are obsessed with the idea of “liquidity” will take us down a deep rabbit hole.
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Several economists have noted that India is heading towards a period of stagflation, i.e. a situation where inflation and unemployment rise despite falling economic growth.
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This would be the third financial crisis India faces in a little over a decade. While the previous two—the bad loan pile-up at banks from 2012 onward and the collapse of the Infrastructure Leasing and Financial Services Group in 2018—were caused by fraud, internal misgovernance and excesses by bankers and non-bank lenders, this one is the proverbial act of god.
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The sudden shock of the defaults in the bond markets led to the cost of borrowing beginning to rise for everyone including the government. So the Reserve Bank of India stepped in and began pumping money into the financial system—what economists, bankers and traders mean when they say “liquidity”
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Since COVID-19 hit, RBI stepped up its liquidity operations. But despite the large amount of liquidity being pumped into the system over the last two years, credit growth has been weak.
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But in the weeks and months following demonetization (the government’s November 2016 move to invalidate all Rs 500 and Rs 1,000 notes), it began to pump funds into the banks so that they could continue lending. By the start of 2018, it had reversed the surplus liquidity and maintained liquidity at a neutral or deficit level.
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Surplus liquidity, simply put, is when the central bank offers more money to the system than banks need on a day-to-day basis, while a deficit is the opposite
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Now, usually, this would mean that the government has to increase the interest rates or yields it offers on its bonds; to sell a lot more bonds, you need to offer better rates. The government, naturally, wanted to do no such thing in a time of crisis. So, to keep the cost of borrowing stable for the government, around 6%, RBI also started buying up government debt, artificially keeping bond prices high (a higher price for a bond means that the yield or effective interest rate on that bond goes down).
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At the same time, as the second wave hit, expectations rose that the government would have to borrow even more in the current fiscal year. Traders, of course, want yields on the G-Secs, particularly 10-year bonds, to increase in order to account for the fiscal hit this year.
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Effectively, a large part of the surplus liquidity in the system went to finance the government’s borrowing programme. Even banks used this liquidity to buy up short-term and long-term government bonds, apart from financing large corporations with low-cost capital.
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While the government has benefited from a lower cost of borrowing for its bonds, the banks have been flooded with liquidity and low-cost capital for a few years now. Yet, this liquidity doesn’t get transmitted on to small businesses and individual borrowers, because banks have better and safer options of investment than regular lending. Particularly since economic growth has gradually been sliding downwards over the past few years. The pandemic added another whammy.
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Bankers say three reasons can be attributed to the slowdown in credit: corporations are deleveraging or reducing their debt, banks are worried about future defaults and there is low demand for credit in general as businesses tighten their belts.
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As the central government had to respond to the crisis, it stepped up its borrowing programme.
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Since banks are wary of lending, they have either parked this liquidity in deposits back with RBI or invested in G-Secs, T-Bills and corporate bonds in lieu of a return
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Small-to-medium NBFCs are large lenders to SMEs across the country. While banks and the big NBFCs cater to high credit quality businesses and corporations, smaller NBFCs do not have this luxury.
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“The rating agencies have the same model for rating a big NBFC and a small NBFC. So, many small NBFCs do not get the required ratings, which is why most of the deals failed,” this person adds, asking not to be named.
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“The big players got bigger, while the smaller NBFCs had to run elsewhere for funds or they had to slow their lending operations down as they had no avenues for funding.”
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Funding to small/medium NBFCs resumed in the course of the year, after these small lenders stopped lending entirely and focused on loan collections so that their cash inflows improved.
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By the time NBFC funding resumed to normal levels, it was not necessarily funded with the help of RBI’s TLTRO funds, which had to be invested within 30 working days of the funds being received.
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RBI is in a tight spot today. With rising inflation, theory suggests that it has to hike interest rates. But if it does so, it may deter fresh borrowing by individuals and MSMEs. If it does not hike rates, inflation could continue rising, eating into household and business finances.
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It faces a similar dilemma when it comes to liquidity. Flood the system and hope that the funds get passed on to revive growth, or reduce the amount of liquidity and risk shattering the debt markets’ comfort with this level of support.
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RBI recently tweaked its liquidity programmes to ensure that the banks provide these funds to specific sectors like emergency health services and stressed industries such as hospitality, tourism and aviation.
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The fundamental difference here in policy is that under liquidity programmes, RBI takes on the burden to spur credit growth by providing the system with low-cost, long-term capital. Under the various credit guarantee schemes of the government, its institutions take on the risk of future loan defaults, which gives bankers an incentive to lend again.
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“Only fiscal policy can rekindle animal spirits at this juncture—monetary policy has almost nil headroom,” it said in a recent note.