RBI G-SAP. Why RBI’s G-SAP is a masterstroke

In the recent bi-monthly monetary policy announcement, the RBI promoted a new programme — the Government Securities Acquisition Program (G-SAP). The initiative is believed to be a counterpart of Open Market Operations (OMOs) — the purchase and sale of government securities (G-Secs) by the RBI on behalf of the government — to reduce the volatility in the bond market.

Keeping the policy rates unaffected, the RBI continued its commitment to ‘accommodative policy’ stance while announcing the purchase of G-Secs worth ₹1-lakh crore in the first quarter of financial year 2021-22 through the secondary market.

Under OMOs, the central bank prints money and purchases securities in the secondary market from those interested in selling them. The idea here is to inject more liquidity into the economy. The biggest drawback of OMOs is that investors do not know the timing of these purchases. The RBI, till now, was disclosing OMO purchases weekly, which created uncertainty in the bond market.

With G-SAP, the RBI fulfils the long-pending demand of the market participants of OMO purchase calendar. G-SAP holds a close relation to OMO, with an upfront commitment and clear communication about the OMO purchase calendar. Under this, the RBI will purchase bonds worth a specific amount, which will reduce the uncertainty and allow investors to bid better in the scheduled auction with a pre-decided calendar set by the RBI.

The central bank acts as a debt manager to the government, which manages the borrowing programmes and ensures the debt is available at the lowest cost (interest rate).

During the financial year 2020-21, the government borrowed around ₹12.8 lakh crore and plans to borrow another ₹12.05 lakh crore in FY 2021-22. Due to this excessive borrowing, the bond market demands a higher return from government securities.

The average return (popularly known as yield-to-maturity; YTM) on the benchmark 10-year bond yield traded at around 5.93 per cent from April 2020 to June 2020, which rose to a high of 6.25 per cent on March 10, 2021, before falling. The YTM is the annual return the investor can expect when a security is bought at a particular price at a specific time and held on until maturity.

The problem with this hefty borrowing is that the financial system can lend money up to a certain limit. When the demand for money in the market goes up, it is quite natural that the investors start demanding a higher rate of return on their lending. At the same time, it leads to the bond market asking for higher returns, thus pushing up the yield on the G-Sec.

The government is facing issues with increased bond yields. When the returns on the existing securities go up, the RBI has to offer a higher rate of returns for the fresh securities it will be issuing in 2021-22, which will eventually push up the interest cost of the government. G-Sec is the benchmark for any other form of borrowings in the country since it is deemed the safest form of investments. Once the G-Sec interest rates go up, all the different lending rates the RBI is not looking at will surge.

Hence, through G-SAP, the RBI is indirectly financing the government’s borrowing as it will print money and buy bonds. In this way, it will be able to put enough money in the financial system, which will ensure that the returns on G-Sec do not go up, and the RBI will borrow money for the government at a lower rate of interest.

Road ahead

Soon after the announcement to purchase G-Sec worth ₹1 lakh crore through G-SAP, , the 10-Year G-Sec bond yield dropped from 6.08 per cent to 6.03 per cent.

There is no doubt that the cheaper rates will be good news to the government and corporates as they can raise funds by selling securities at a lower cost. But lower interest rates accompanied by inflation will be a fundamental problem for the savers who are already getting negative returns on their deposits if the real rate of return is taken into account.

With lower interest rates, economists fear that investors may pull their capital out of India. Amid all these fundamental problems, G-SAP is believed to be a master-stroke to support the mammoth borrowing by the government.

The programme would reduce the spread between the repo rate and government bond yields, which will reduce the aggregate cost of borrowing for both the Centre and States in FY22.

Through this programme, the RBI has taken the market participants into confidence and put forth a strong message that it will ensure lower rates no matter what happens to support the borrowings by the government.

The writer is Assistant Professor – Finance & Accounting, Vinod Gupta School of Management, IIT Kharagpur

COMMENT NOW