Tough game

The RBI is clearly using all its ingenuity to tackle multiple challenges in supporting the government’s huge borrowing plan, even while ensuring that the yield curve evolves in an orderly manner and growth is not hurt. The secondary market G-Sec acquisition programme unveiled by the RBI is meant to create demand for government securities and keep yields under check. The G-SAP programme needs to be seen in conjunction with the variable rate reverse repo auctions, that will also be done at the longer end now. The surplus liquidity created by the G-SAP will be drained through these auctions. This innovative move seems to have assuaged the bond market, with 10-year bond yields moving down by 10 basis points since the monetary policy. But the new programme signals the entry of the RBI into the league of central banks who are helplessly caught in unending quantitative easing (QE) programmes. It is also moot whether our currency market will be able to withstand a prolonged bond buying programme.

It is not difficult to see why the RBI needed to provide assurance to bond markets. According to Bank of America Merrill Lynch, the annual demand from banks and other market participants for G-secs amounts to ₹8.98 lakh crore. With both Centre and States set to flood the market with papers worth over ₹17.6 lakh crore, excess G-sec supply this fiscal is expected to be ₹8.62 lakh crore. The central bank will therefore have to use all the tools in its arsenal to absorb the extra paper, including open market operations, G-SAPs and ‘operation twists’. Besides buying government bonds in the G-SAP, it is expected that the RBI may also have to conduct OMOs in FY22, which may be higher in value than the ₹3.13 lakh crore purchased last fiscal. The RBI may need to take other measures including increasing the held-to-maturity dispensation given to banks by an additional 1 per cent and altering its forex intervention strategy. Since purchases of dollars in spot market increases liquidity, it will have to shift intervention to the rupee forward market.

The central bank’s challenges are going to increase with the second wave of Covid-19 threatening to impact growth and fiscal deficit. Also, yields are rising globally due to growing uncertainty. As the Governor indicated, there has been robust growth in money supply over the past year due to the borrowing of almost ₹22 lakh crore (Centre plus States) in FY21. G-SAP will add to the money supply and apply pressure on inflation. The bond purchases in FY21 have already resulted in expanding the RBI balance sheet. Unlike central banks of advanced economies, the RBI does not have the space to print money endlessly given the lower demand for Indian sovereign paper. The RBI should not get wedded to QE. It should have a well-thought out exit strategy in place even as it rolls out the G-SAP move.

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