In the recent bimonthly monetary policy announcement, the RBI promoted a new program – the Government Securities Acquisition Program (G-SAP). The initiative is believed to be a counterpart to open market operations (OMOs) – the buying and selling of government securities (G-Secs) by the RBI on behalf of the government – to reduce volatility in the bond market.
By keeping key rates unchanged, the RBI continued its commitment to an accommodative policy while announcing the purchase of G-Sec worth 1 lakh crore in the first quarter of fiscal year 2021-22 via the secondary market. .
Under OMOs, the central bank prints money and buys securities in the secondary market from those who wish to sell them. The idea here is to inject more liquidity into the economy. The biggest downside to OMOs is that investors don’t know when to buy them. Until now, the RBI has disclosed OMO purchases on a weekly basis, which has created uncertainty in the bond market.
With G-SAP, RBI responds to long-standing demand from market players for the OMO buying schedule. G-SAP has a close relationship with OMO, with initial engagement and clear communication on the OMO procurement schedule. By virtue of this, the RBI will buy bonds of a specific value, which will reduce uncertainty and allow investors to bid better in the auction scheduled with a schedule predetermined by the RBI.
The central bank acts as the debt manager with the government, which manages the borrowing programs and ensures that the debt is available at the lowest cost (interest rate).
In fiscal year 2020-2021, the government borrowed approximately ₹ 12.8 lakh crore and plans to borrow another ₹ 12.05 lakh crore during fiscal year 2021-22. Because of this excessive borrowing, the bond market demands a higher yield from government securities.
The average yield (popularly known as yield to maturity; YTM) on the 10-year benchmark bond yield traded at around 5.93% from April 2020 to June 2020, which reached a peak of 6.25% on March 10, 2021, before falling. The YTM is the annual return an investor can expect when a security is bought at a particular price at a particular time and held to maturity.
The problem with these large loans is that the financial system can lend money up to a certain limit. When the demand for currency in the market increases, it is only natural for investors to start demanding a higher rate of return on their loans. At the same time, this leads the bond market to demand higher yields, thus pushing the yield of G-Sec.
The government faces problems related to rising bond yields. When the yields on existing securities rise, the RBI must offer a higher rate of return for the fresh securities it issues in 2021-2022, which will ultimately drive up the cost of government interest. G-Sec is the benchmark for any other form of borrowing in the country as it is considered the safest form of investment. Once the G-Sec interest rates go up, all of the different loan rates that the RBI doesn’t look at will go up.
Therefore, through G-SAP, the RBI indirectly finances government borrowing as it will print money and buy bonds. In this way, he can invest enough money in the financial system, which will ensure that G-Sec’s yields do not increase, and the RBI will borrow money for the government at a lower interest rate.
Shortly after announcing the purchase of G-Sec worth 1 lakh crore through G-SAP, the yield on 10-year G-Sec bonds fell from 6.08% to 6 , 03%.
There is no doubt that the lower rates will be good news for government and businesses alike as they can raise funds by selling securities at a lower cost. But falling interest rates accompanied by inflation will be a fundamental problem for savers who are already getting negative returns on their deposits if the real rate of return is factored in.
With lower interest rates, economists fear that investors will withdraw their capital from India. Amidst all of these fundamental issues, G-SAP is seen as a masterstroke to support the government’s gigantic borrowing.
The program would reduce the spread between the repo rate and government bond yields, which would reduce the overall cost of borrowing for both the Center and the states in FY22.
Through this program, the RBI has gained confidence in market participants and sent a strong message that it will guarantee lower rates no matter what to support government borrowing.
The author is Assistant Professor – Finance & Accounting, Vinod Gupta School of Management, IIT Kharagpur