Debt Management in Covid19 Economy

The RBIGuv’s announcement today has more or less been on expected lines.

1. EXTENSION OF MORATORIUM ON EMI PAYMENTS TILL AUGUST, 2020

The borrowers have not been too happy with the earlier package, as the so-called moratorium is only a deferral of loan instalments, not waiver. Borrowers will need to pay the entire amount later WITH INTEREST. Certain banks may apply compound interest as well. The overall impact may be extension of tenor of the loan, and an increased outgo from the borrower’s wallet.

Borrowers who do not suffer from a liquidity crunch have been advised to repay the amount in regular instalments, and stay away from the moratorium.

2. PROVISION FOR A FUNDED INTEREST TERM LOAN (FTIL)

Funded Interest Term Loan is not a new concept. It is normally extended to MSME borrowers whose loan accounts are under stress.

It is a loan given to settle unpaid amounts of pre-existing loans. This is not a debt consolidation loan. It is given only for settlement of unpaid interest amount of existing loans. The rate of interest may be same as that on the existing loan. FITL can be granted to MSMEs for a period of seven years.

In the Covid19 economy, FITL is proposed for borrowers availing of the moratorium, for a period of seven months from Sep’20 to Mar’21. Banks are yet to make announcements about rates of interest to be applied.

ADVANTAGES FOR THE BORROWER

  • The tenor of the loan is not extended
  • It prevents compounding of interest for a longer term
  • The borrower is aware of the exact amount of unpaid interest, and resultant outflow from his wallet towards settlement
  • The loan is not classified as a non-performing asset.
  • In case loans linked to MCLR (Marginal Cost Lending Rates) or External Benchmarks,  the loss may be compensated by a drop in interest rates.

3. DROP IN INTEREST RATES

Repo rate (rate at which banks borrow from RBI) has been dropped from 4.4% to 4%.

This is intended to persuade banks to pass on the benefit to customer by a further drop in interest rates.

Unfortunately, a drop in lending rates also leads to a drop in deposit rates. Savings account rates are set to drop further, and the average person suffers with practically nil returns on money parked with banks.

Tips on how to maximise returns on a savings account can be found here https://www.moneygoalz.com/how-to-earn-higher-returns-on-savings-accounts/

Reverse repo rate (rate at which banks place money with RBI) has been reduced from 3.75% to 3.35%.

The intent of a reduction in reverse repo is to make the RBI window less attractive, and persuade banks to deploy funds in the market, by disbursing more loans.

The strategy has not succeeded so far, die to risk-aversion of banks.

LESSONS ON DEBT MANAGEMENT IN COVID-19 ECONOMY

Debt is dicey.

You apply for a loan, and it is approved based on certain assumptions. Circumstances can change, to the detriment of both lender and borrower. The lender’s returns on deployed funds will be delayed. The borrower has to shell out a larger amount than whatever was initially assumed.

The actual cost of the item purchased increases manifold. Resale value may not be proportionate to the total outgo from your wallet.

Those days of availing housing loans to acquire a second home/prestigious property or avail of tax benefits are now over. Fall in real estate prices is only going to compound problems.

It is the time for individuals to be as debt-free as possible.

It is the time for individuals to reduce debt by prepayment of loans, if one can afford it.

Businesses might be compelled to borrow, and the rates of interest are attractive, but uncertainty looms ahead, at least for the next 18 months.

Other announcements by the RBI governor on inflation outlook and GDP forecast are well summarized by LiveMint at https://www.livemint.com/industry/banking/repo-rate-cut-extension-on-moratorium-rbi-s-5-key-announcements-today-11590130455293.html

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