The money policy of the Reserve Bank of India (RBI) has proved to be tight only for commercial borrowers—for the government, it has been an easy money policy.
What RBI has done in the bond market is nothing but our own version of an extended quantitative easing. The central bank has distorted the interest rate market to keep rates ultra low for the government to borrow cheaply. Otherwise, how can it justify an open market operation (OMO) as huge as Rs.1.74 trillion in calendar 2012?
RBI bought Rs.58,719.33 crore of bonds in calendar 2011, Rs.49,737.77 crore in 2010 and Rs.1.04 trillion in 2009—the year the global economy went under. RBI had no option but to buy such a huge amount of bonds in 2009. But why was there a need to continue this huge buyback of bonds in 2012? Also, note that 2012’s massive OMO programme, done to manage liquidity, was against the backdrop of 17% growth in credit. What happens when economic growth picks up and credit growth moves up to 25%?
The fact is that this liquidity scarcity is artificial. One good indicator is the call money rate, which never spiked up except on two days at the end of fiscal 2012 when it touched 15%. The rates have remained at around the repo level. Banks really don’t need that kind of liquidity if they just keep their bond-buying to the minimum mandatory level of 23% of their deposit base. Another 2% is considered a good buffer, but banks’ statutory liquidity ratio holding is now at 30% or more. In the absence of a healthy credit pick-up, banks have parked their entire money in government bonds, helping the government’s borrowing programme to sail through. And through OMO, RBI has ensured that the money is cheap for the government. The 10-year bond is in the 8.15% region, 35 basis points lower than a year ago, while the liquidity deficit is about Rs.1.45 trillion. A slowing economy, ironically, enhances bank investment in government bonds.
The irony is that despite all the emphasis on inflation being the top priority, the Reserve Bank of India, through OMO, continues with its backdoor monetization and pumps more money into the system.
But then, everyone knows the bond market is distorted in India. The bulk of the government bonds are bought by government-owned banks. The market is a captive one.