The RBI has chosen to provide liquidity under these long-term repos to banks, with an aim to 'target' this credit freeze in commercial paper and corporate bond markets, despite ample liquidity available with banks in the system. The first such three-year targeted long-term repo for 250 bln rupees will be held today, and will be at the prevailing policy rate. The RBI today cut the benchmark repo rate by a sharp 75 basis points to 4.40%, in response to the economic impact of COVID-19. "Liquidity availed under the scheme by banks has to be deployed in investment grade corporate bonds, commercial paper, and non-convertible debentures over and above the outstanding level of their investments in these bonds as on March 27, 2020," RBI said in its statement.
As per the release, banks will have to acquire up to 50% of their incremental holdings of such papers from the primary market and the remaining 50% from the secondary market, including from mutual funds and non-banking finance companies. Crucially, any investments made by banks under this facility will be classified as held-to-maturity even in excess of 25% of total investment permitted under this portfolio. Additionally, exposures taken by banks under this facility will not be reckoned under the large exposure framework.
The central bank's statement noted that the spread of COVID-19 in India has led to large sell-off in domestic equity, bonds and foreign exchange market. Compounded by redemption pressures, the liquidity premia on corporate bonds, commercial papers, and debentures had surged. Rates on short-term debt papers today fell 150-175 bps after RBI announcement the repo rate cut, long-term repo operations, and liquidity measures.
Yields on corporate bonds also fell 80-155 basis points across tenures. RBI said that its action was prompted by fall in trade activity due to the COVID-19 outbreak, and as financial conditions for these instruments had tightened at a time when these instruments were being used for working capital as bank credit remained sluggish. On Mar 19, Cogencis had reported that market participants had proposed to the RBI that it provide a special liquidity window to banks and primary dealers to buy corporate papers, to address the prevailing credit squeeze in the market.
