India’s G-SAP vs Japan Yield Curve Control Policy

The Reserve Bank of India (RBI), the central bank of India, has recently announced its Government Securities Acquisition Program (G-SAP). Under this program, the RBI is clearly committed to the acquisition 1 trillion worth of government securities (G-seconds) from the market in the April-June 2021 quarter. First round purchases are worth it 250 billion on April 15th.

G-SAP, in RBI words, is designed to “initiate a sustainable and orderly evolution of the yield curve” (bit.ly/3dxxUt9). How it works: The central bank buys a pre-announced amount of G-seconds from the market on a pre-announced date, while the bond seller receives cash. Increasing market liquidity will ensure that the central government has sufficient demand for the expanded market borrowing program 12.06 trillion by 2021-22, and at a lower cost. If this approach is successful, it will reduce the gap between short-term and long-term risk-free rates in the economy, or in other words, flatten the yield curve.

Apart from helping to keep government debt stable, how will it affect the Indian economy? Low interest rates in G-seconds are expected to keep banking sector lending rates low. This may help to keep stock prices high and reduce the pressure on the rupee appreciation by discouraging additional capital inflows. To play such a scenario, it encourages borrowing, spending and investing through homes and companies.

Is the yield of G-SAP Bank of Japan equivalent to Curve Control (YCC) policy? Simply put, no. First, the YCC directly limits G-sec prices by clearly declaring the G-sec yield that the central bank is committed to. Second, the YCC targets a specific duration G-second price. For example, the Bank of Japan (BoJ) has set a 10-year G-second price target of “about 0 percent” yields, allowing 0.1% narrow fluctuations on both sides when it opens in 2016. Bose’s current band, with its latest revision last month, allows 0.25% fluctuations on both sides. Third, according to its YCC policy, the central bank is committed to buying the amount of G-seconds that the market wants to sell. The goal.

In contrast, RBI’s G-SAP does not provide a clear target for G-Sec yields, nor does it commit to buying an unlimited amount of these bonds from the market. Instead, G-SAP focuses on inviting bids, purchasing a certain volume of G-seconds and then announcing cut-off yields, but still not accepting all bids that correspond to that yield. For example, according to an RBI press release, in the first round of purchases under G-SAP, the cut-off yield in the G-second maturing in 2035 was 6.6122%, while the RBI accepted only competitive offers of 76.36% of the cut-off price. Furthermore, under the G-SAP, the RBI does not restrict itself to purchasing G-Sec for one term only. Only on April 15th Total 75 billion 250 years for a 10 year benchmark bond.

Why are these differences so complex? If the market believes the central bank’s commitment to yield-control, G-seconds prices in the secondary market will adjust to central bank target prices. With the on-tap option to sell G-Secs to the Central Bank at a fixed price, holders of these bonds will not sell it to another investor at a lower price. This allows the central bank to achieve the G-Secs price target level without making large bond purchases as before and limiting its balance sheet expansion.

Since YCC 2016 GJ has allowed BoJ to reduce its actual size (bit.ly/32y6vAE). RBI’s G-SAP, like other open market activities, requires the country’s central bank to buy G-Secs at the same pace, thereby expanding its balance sheet and increasing market liquidity.

There is another key difference between YCC and G-SAP. The YCC is followed when the central bank’s main instrument, its short-term policy rate, touches the low nominal zero or is close to zero. However, if there is no economic recovery in view and inflation expectations are lower than its target, the central bank should find an alternative way to overcome long-term interest rates.

Can RBI go for YCC? First, for a Japan-style YCC to work, the secondary G-second market must be deep enough with sufficient liquidity. If there is a liquid secondary market with a large number of players, market participants will trade among themselves at the central bank’s target price instead of selling G-seconds to the central bank. Second, the market must realize the central bank’s commitment to buy government securities reliably at a certain price, which is not possible if inflation goes up, as bondholders demand compensation for it. Inflation based on the Indian consumer price index rose to a four-month high of 5.52 per cent in March, reaching the top end of the RBI target range of 6 per cent.

Will RBI’s G-SAP reduce and stabilize G-sec yield curve in India? In the absence of a specific approach it is difficult to determine what the yield of G-seconds will be. However, unless the bond market trusts the RBI’s ability to keep inflation within its target range, it will not be possible to keep government borrowing costs low for long. The success of G-SAP cannot be measured directly because the RBI has no clear commitment to achieve a specific G-second yield.

Vidya Mahambare is Professor of Economics and Economics at the Great Lakes Institute of Management, Chennai

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