The Reserve Bank of India has kept its focus on the massive debt monetisation programme of the government while taking a side look at growth and inflation.

In its first bi-monthly monetary policy for the financial year unveiled on Wednesday, the RBI has also sought to anchor interest rates at low levels while some banks have inched up their deposit and lending rates on certain products.

Taming the yields on the government bonds seems to be the Reserve Bank’s main obsession. For the first time, the central bank has introduced a quasi-quantitative easing programme that involves a bond purchase of Rs 1 trillion in the first quarter of the financial year, akin to what the Bank of Indonesia and Central Bank of Philippines (BSP) did last year. But they undertook bond purchases in the primary market.

Called the G-sec acquisition program (GSAP 1.0), RBI will buy back the first tranche of Rs 25,000 crore on 25 April. Dealers expect a liquidity infusion of Rs 4 trillion during the current financial year under the GSAP.

Controlling the debt market is part of the RBI’s main game for now. RBI governor Shaktikanta Das showed today who is the boss when it comes to the debt market. The yields came down by close to 10 basis points even as Das was making the announcement. This is expected to act as a counterbalance to the Rs 7.2 trillion that the government intends to borrow in the first half of this fiscal. The yields for the 10-year benchmark bond finally closed 4.5 basis lower at 6.05%. Dealers, however, don't expect it to go below 5.90%.

With this, Das has ensured that both deposit and lending rates would stay where they are today with no moves to hike them. Though some banks have moved up their deposit and lending rates on certain products, it is expected that there will be a status quo on interest rates across the banking system.

During the post-policy conference, Das told reporters that G-SAP is different from the regular open market operations (OMOs) that RBI conducts.

"It has a distinct character, in the sense that for the first time we are giving out a particular quantum of bond purchase in the secondary market. Within this particular quarter, we will be suitably depending on the evolving situation and will be announcing auctions from time to time," he said.

A bond dealer with a leading bank spoke to Indianbankingnews.com on the balancing act the RBI is playing as it carries the government’s heavy borrowing programme on its shoulder. “The current policy is nothing but the debt monetisation programme of the government. The RBI is infusing liquidity to keep the yields under check and then through the variable repo rate of longer maturity proposed in the policy, it will suck out the excess liquidity,” the dealer said on condition of anonymity.

Besides being the monetary authority, the RBI is the government’s debt manager. It has to oversee a massive Rs 12 trillion borrowing during the financial year starting this April. So when the RBI brings the yields down, the prices of the bonds rise, thus helping the government earn better rates from its bonds.

RBI deputy governor Michael Patra said the RBI, for the first time, is committing its balance sheet to the conduct of the monetary policy. "When we are unchanged on the policy rate, we need an instrument to run monetary policy. In the past, all our actions were to move the interest rates up and down and ensure that proper transmission happens across the market spectrum. This time we are being more explicit.”

"We are not waiting for the indirect channel of interest rates and prices to operate. We are directly committing an expansion in our balance sheet of a certain specified amount which is known to the public with the hope of ensuring orderly conditions in the market," Patra further clarified.

State Bank of India managing director Ashwini Kumar Tewari admitted that the RBI has a delicate and fine balancing act to do to manage interest rates and inflation. “But now that inflation is not so high, they can keep the interest rates low. Banks on their part will not increase interest rates on deposits and loans. But if credit suddenly picks up, the situation can reverse. However, with variable repo rate of longer maturity proposed in this policy, RBI will ensure that the reverse repo is the signaling rate for shorter tenure bonds. Some companies have borrowed at very fine rates close to the repo rate,” he said.

As was widely expected, RBI kept the repo rate unchanged at 4% for the fifth consecutive time. The principal aim is to keep the interest rates low, which would in turn spur demand and propel growth.

Das said the central bank’s singular endeavour was to eschew volatility in the government bond market, considering that it is the signaling rate for general interest rates in the system. “While laying out the liquidity management strategy for 2021-22, let me unequivocally state that the Reserve Bank’s endeavour is to ensure orderly evolution of the yield curve,” Das said in a televised address.

Managing yield is the main task cut out for the Reserve Bank at this stage. Said HDFC Bank chief economist Abheek Barua, “The focus of the policy is clearly on yield management and the announcement of the G-sec acquisition program (GSAP 1.0) is likely to stabilise and support long term yields. The extension of tenures for the VRRR (variable rate reverse repo auctions), though, might lead to some hardening at the short-end of the curve.”

The central bank also announced that it will conduct 14-day VRRR auctions of longer maturity as indicated in the Revised Liquidity Management Framework announced on 6 February 2020. “They will suck out the excess liquidity through the reverse repo so that there will not be too much of excess liquidity floating around,” said another bond dealer of a leading public sector bank.

Inflation, deposits and credit growth

The resurgence of the pandemic and the heavy borrowing programme of the government is forcing the central bank to tolerate higher levels of inflation while promising to inject additional liquidity into the banking system.

For the first half of the current fiscal, the RBI’s projection for retail inflation is 5.2%. Only in the third quarter it is at 4.3% while for the fourth quarter it is pegged at 5.1%. The inflation mandate approved by the government is 4%, plus or minus 2%.

“Most of the inflation is due to the spike in the commodity prices so there is little the RBI can do to douse the inflationary flames. But once the demand sets in after the pandemic abates, the interest rates on both deposits and lending rates will rise,” said another bond dealer of a bank.

With rates on the one year deposits hovering around 4.90% for most of the major banks and the inflation expectations at 10%, avenues for investments in gold or the equity markets are opening up. According to a Reuters report, India imported a record 321 tonnes of gold in the March quarter, up from 124 tonnes a year ago. With bank deposit growth slowing at 12% versus 20% a few years ago, small savers are certainly looking at alternate saving instruments.

“We are certainly concerned if the banks’ share in financial savings goes down. It is challenged by the mutual fund industry, the insurance sector and the small savings schemes. But the gold import figures of just one quarter is not a big worry. India has touched 1000 tonnes of gold import earlier. But if this trend of high gold imports continues for a few quarters, it will become a cause of serious concern for the banks,” said Federal Bank executive director Ashutosh Khajuri.

With interest rates on small savings instruments ranging between 6.8% and 7.6%, banks will be forced to hike deposit rates to prevent an exodus. Banks will also have to hike lending rates when the demand for credit sets in. Already, SBI has withdrawn its special interest rates on home loans at 6.70% to 6.95% effective 1 April. This will force other banks to follow suit, analysts said.

Until the middle of March, the credit growth was at 6.5% while the deposit growth was at 12%. With rates in the bond market lower than the lending rates of the banks, most companies are raising money from the bond market.

For a long time, banks have been waiting for credit growth to accelerate. That is surely not going to happen in a hurry.