Not to mention, the Reserve Bank of India (RBI) has launched Quantitative Relaxation (QE). It gave it a new name: the Government Securities Acquisition Program (GSAP), which would become competitive if it was pronounced G-Zap. What exactly does the RBI hope to do or eradicate? Well, it wants to ruin the idea of a return on government securities mentioned above, say, 6.25%. It wants to limit the expectations of market participants. It may be harder than it sounds. You cannot adhere to a conceivable idea, or you can tame market sentiment even if it is the RBI. It’s like a class teacher telling students “Don’t think about the pink elephant”. Bond market players are determined to test this roof, and the RBI must come back to thwart their greedy intentions. For now, the RBI has said it will buy GSAP Promise ₹1 trillion worth of government securities in the secondary market in the first quarter of this financial year. But the market has already read it as a guaranteed purchase ₹4 trillion in four quarters. So that means funding one-third of the annual budget deficit ₹12 trillion by GSAP. Even if it does not make full money of the deficit, it is equal to it. GSAP is also intended to reduce the yield gap between short- and long-term securities, also known as the term premium. In guaranteeing the last resort buyer of government bonds, the RBI crossed a psychological ‘target line’ that was considered insurmountable in normal times. But these are nothing more than normal times. The deficit is huge and the second Kovid threatens to halt economic recovery. The RBI is now following an example set by the US Federal Reserve, followed by the European Central Bank (ECB) and the Bank of Japan. Over the past 12 years, we have seen many reforms of QE in the Western world, with the result that interest rates are close to zero. The Fed and the ECB went further, buying blue-chip corporate bonds and later junk bonds, an example of Mario Draghi’s “do it anyway” motto to keep rates low and revive growth.
Last year, the RBI did some extraordinary work to address the impact of the epidemic. This allowed a temporary ban on loan repayment. It also announced a massive long-term repo operation, particularly low-cost overnight lending for a period of three years. This is on top of a rate reduction spree that has been going on for almost three years. However, this does not restore credit growth, which is the main goal of this exercise. Currently, credit growth is only 6% of the total, of which the industrial credit component is very small. To sustain high gross domestic product (GDP) growth, we need credit growth to be close to 20% per annum. India’s own experience since the 1990s has been that high interest rates have not deterred animal spirits and strong investment growth. In contrast, low rates are not enough to encourage industries to plan large capital expenditures or expand their factory capabilities. Therefore, if GSAP aims to keep capital expenditure low for corporates, including small and medium-sized businesses, it is not enough, let alone high-credit off-tech. Worse, some high-rated large companies may refinance their loans and pocket beautiful profits. Policy stability, revival of consumer and business confidence, success with India’s universal vaccination drive and reduction of regulatory and tax burden are required to encourage new investments. What low rates can do is boost the property markets, especially stocks and housing. It becomes another headache when it starts threatening financial stability. Currently, the only real beneficiary of GSAP is the central government, which is the largest borrower in the economy. The slightly higher cost of borrowing can be huge on the treasury, especially when the government debt mountain is at once ₹100 trillion. Therefore, a 1% increase in the average cost of borrowing this year will also increase its interest burden ₹1 trillion, which is 0.5% of GDP. The additional burden of state government debt should not be forgotten.
Is there any other way to reduce the sovereign cost of borrowing? Yes. As this column suggests more than once, why not choose a bilateral loan against a share exchange between the RBI and the central government, bypassing the bond market altogether? This is accompanied by droplet sales of shares pledged by public sector entities.
Is there a problem with QE entry in India? Yes. For one, the central bank does not control both bond yields and the external value of its currency. The rupee’s slump after the RBI’s announcement is a testament to this maxim. Be prepared for a currency slide. Second, it is like entering a ‘labyrinth’ where the exit path is unknown. This has implications for financial stability, as it could lead to a stock market and housing bubble. Third, it also leads to inflation (above all, there is more money in circulation). This will further reduce the real income for bank depositors and other savers. This puts pressure on the RBI’s monetary policy committee to raise short-term rates. Fourth, how does the GSAP limit on rates compromise the additional demand for loans? Although deposit growth is promising ₹15 trillion this year, the central and state deficit requirements will lose all borrowable funds. If interest rates do not rise, how can this circle be classified?
Ajit Ranade is the Chief Economist at the Aditya Birla Group.