Why G-SAP 1.0 is a bold move by RBI

In RBI’s language, the positive externalities of G-SAP operations need to be seen in the context of those segments of the financial markets that rely on the G-Sec yield curve as a pricing benchmark.

By Rohit Chawla

As we approach April 15, 2021, the day when the Reserve Bank of India (RBI) will make the first purchase of government securities (G-Secs) for an aggregate amount of Rs 25,000 crore under G-SAP 1.0, it is crucial to understand the nuances behind this initiative. For beginners, the G-Sec Acquisition Programme (G-SAP) is basically an unconditional and a structured open market operation (OMO), of a much larger scale and size.

The central bank Governor himself called the G-SAP as an OMO with a ‘distinct character’. On April 8, RBI announced that it will purchase G-Secs totalling Rs 1 lakh crore over FY2021-22. The word ‘unconditional’ here connotes that RBI has committed upfront that it will buy G-Secs irrespective of the market sentiment. This aspect is crucial as an altogether different literature on the subject emerges once the assumption of certainty/commitment is built in.

While RBI has been conducting liquidity management operations like the regular OMOs under the Liquidity Adjustment Facility (LAF), the TLTRO (Targeted Long-Term Repo Operations), the Operation Twist, etc, all of which involve buying/selling of G-Secs/bonds from the open market through an auction, essentially to infuse/suck liquidity into the system, the intent of the G-SAP announced recently is no different. Only the modus operandi is slightly altered.

In fact, RBI has already clarified that G-SAP 1.0 is not a substitute to other operations, but will complement them as a simultaneous measure. They are all a means to a common end, which is nothing but a stable and orderly evolution of the yield curve along with management of liquidity in the economy. The announcement has already led to the softening of the yield on the benchmark 20 year G-Sec. The government of India, with its massive borrowing programme, can now breathe a sigh of relief as long-term borrowing costs come down.

In RBI’s language, the positive externalities of G-SAP operations need to be seen in the context of those segments of the financial markets that rely on the G-Sec yield curve as a pricing benchmark. So, not only governments (both central and states) benefit, but a whole lot of institutions relying on financial markets for long-term supply of funds will also gain.

However, not all is hunky-dory. The flip-side of such a big programme is seen in the foreign exchange market. Critics of the G-SAP say that the rupee might get adversely affected. They are of the view that the G-SAP announcement has already led to depreciation of the rupee and may continue further as investors might pull out money in search of higher interest rates elsewhere. So, critics are pointing to the fact that there is a trade-off between a tumbling rupee and lower borrowing costs/low yields.

Not to deny that a stable rupee is important as too much depreciation of the rupee vis-à-vis the dollar can drive up the import costs, particularly crude oil costs. However, if one tries to dig dipper, the trade-off surely doesn’t disappear, but appears less convincing. The question is whether investors really have other lucrative markets to park their funds? Neigh. The world over, interest rates are low or near zero. While, in India, these are hovering around 4% (repo or bank rate); the effective federal fund rate in the US is 0.07%, the marginal lending facility rate in the Euro area is around 0.25%, and so is the case with Japan. All of the above corroborates the fact that India still has room for manoeuvring when it comes to the exchange rate.

The underlying belief is that the money won’t fly away immediately, which should ideally be the case. But critics will argue that the rupee showed signs of depreciation last week. Is G-SAP to be blamed? It’s not clear yet. The dollar-rupee exchange rate was oscillating between 73-74 since the onset of the pandemic, and during the last week it crossed the mark of 74. Part of the reason around the deprecating exchange rate may be the second wave of Covid-19. India has been reporting all-time highest number of cases.

So, the exchange rate depreciation and G-SAP may not be entirely correlated as claimed by some in recent news articles. Furthermore, a G-SAP-like operation has not been implemented ever in India, so there is no data or precedence to see the correlation between exchange rates and the intervention. Also, depreciation of the currency per se is not all bad. It might lead to increase in exports, which will accelerate the rate of recovery of the economy.

Another important aspect is the linkage between G-SAP and zero interest rates. Ceteris paribus, economic theory says that too much liquidity will drive up inflation and lead to near-zero interest rates. However, how much is too much is yet to be seen. During 2020-21, RBI made net outright purchases amounting to Rs 3.13 lakh crore through OMOs, which is three times the size of the proposed G-SAP intervention. So, let’s hold the horses before we term this as quantitative easing of sorts or India’s Zero Interest Rate Policy moment.

India, with its 130-crore-plus population, is uniquely placed in terms of employment needs that are catered largely by an unusual mix of formal and informal sectors. The government is seized of the situation and its programmes like the expanded Production-Linked Scheme or the National Infrastructure Pipeline are steps in the right direction. The capital expenditure earmarked for these schemes is huge, and a structured programme like G-SAP could not have been announced at a more opportune time. The pandemic is an extraordinary situation, and by all means the government needs enormous amount of funding to put the economy back to track. The need of the hour is undoubtedly the revival of the economy and RBI should be appreciated for making this bold move. Rest, time will tell.

The author is a deputy director at the Ministry of Finance. Views are personal