New Delhi, The financial conditions index prepared by the CII and the Indian Banks' Association (IBA) for the April-June quarter of the financial year 2020-21 recorded a steep drop below the 50 mark owing to the expectation of deterioration in the overall financial conditions in the economy on account of worsening funding liquidity, external financial linkages and economic activity index.

The financial conditions index, which is formed of four sub-indices, 'cost of funds' Index, 'funding liquidity' index, 'external finance linkages' Index and 'economic activity' Index, was recorded at 44.2, down from a reading of 60.5 in the fourth quarter of FY 2019-20.

"This is primarily due to the outbreak of the COVID-19 pandemic which has sent economies and financial sector across the world into a meltdown. With a series of lockdowns happening across the world bringing economic activities to a virtual halt, organizations in the global arena are uncertain about the whereabouts of their cash flows and business prospects. India is not an exception," said the joint report.

Chandrajit Banerjee, Director General, CII said: "The impact of COVID-19 has been much worse than the financial crisis faced by the world including India in 2008. While the lockdown was necessary to mitigate the impact of coronavirus on the population, it has had dire implications on the financial conditions of the economy."

He noted that in this hour of need, banks along with NBFCs and MFIs have the ability to ensure smooth and continuous flow of credit, particularly to MSMEs, farm sector and retail sector and ensure some economic activity. The measures announced by the government and RBI, have come as a big relief to them and with an expected upliftment of the lockdown soon, the financial conditions can only improve, Banerjee added.

"On the first quarter results of the CII-IBA Financial Condition Index, Sunil Mehta, Chief Executive, IBA said: "Low reading of the overall index for the Q1, FY 2020-21 is on the expected lines. Corona virus has created havoc across the world and India is not an exception. Preventive measures like lockdown would have adverse effect on the economy."

According to the CII-IBA Financial Conditions Index, there was a sharp decline in the overall expectation of banks and financial institutions signalling deterioration in all the parameters barring the Cost of Funds Index.

On a quarter-on-quarter basis, there was a significant decline from the previous quarter across most of the sub-indices leading to deterioration in the Financial Conditions Index. Among the sub-indices, cost of funds index recorded the highest value and showed a significant improvement in the reading compared to the previous quarter indicating benign cost of borrowing from banks.

The economic activity index and external financial linkages index reading were at the lower level as against the previous quarter.

Evidently, lock down over a month is expected to have adverse effect on the growth of the domestic economy, it said, adding that there was a decline in the funding liquidity index compared to the previous quarter and it recorded a value of 47.2 indicating pessimism in the overall expectations.

The cost of funds index was recorded at 83.5 in Q1 of FY 2020-21 compared to 52.4 in the previous quarter showing optimism among the participants on reduction in the cost of funds.

"Majority of the respondent banks and financial institutions expected the short-term interest rates (the interbank call rate and three month bank certificate of deposit rate) the Corporate Bond Spread - between Top Rated 10 Year Corporate Bond and GoI Bond and Marginal Cost of Funds based Lending Rate to come down," said that statement.

It noted that the expectation of lower interest rates, both short term and long term and MCLR-based lending rate is primarily due to the havoc created by the pandemic wherein majority of the businesses in India were locked down. The regulator had appropriately stepped in with monetary measures to bring in lower interest rate regime to provide relief for the economy, the report added.

The funding liquidity index in the current quarter recorded a value of 47.2, which has reduced significantly in comparison to the previous quarter.

"The fall is primarily due to the lockdown in the Indian economy due to the spread of COVID-19. The value depicts pessimism in the expectation of the respondents. The index depicts the likely liquidity position in the market."

Further, the external financial linkages index was recorded at 20.6, the lowest amongst all indices. It has dropped significantly in comparison to the previous quarter.

As per the report, the low expectation is not a surprise given the state of the global economy due to the spread of COVID-19 leading to economic shutdowns in majority of the countries.

The economic activity index registered a value of 25.6 as opposed to 55.8 in previous quarter showing a significant decline in the reading, which indicates pessimism in the expectation of the respondents. The value of economic activity index is supported by the decline in the GDP, Non-food Bank Credit and Asset Price movement due to the spread of COVID-19.