RBI is in uncharted territory with quantitative easing
The use of a tool invented by the US Fed will have ill effects that a loan-for-shares scheme could have avoided
Without saying so, the Reserve Bank of India (RBI) has embarked on quantitative easing (QE). It has given it a fancy new name: Government Securities Acquisition Programme (GSAP), which has a promise of becoming meme-worthy if pronounced as G-zap. What exactly is RBI hoping to zap or obliterate? Well, it wants you to perish the thought of the yield on government securities going above, say, 6.25%. It wants to put a ceiling on market participants’ expectations. This might be harder than imagined. You can’t put a bound on thinkable thought, nor can you tame market sentiment, even if you are RBI. It’s like the case of a class teacher telling students, “Don’t think of a pink elephant." Bond market players will be determined to test this ceiling, and RBI will need to keep coming back to zap their greedy intentions. For now, RBI says that the GSAP promise is to buy ₹1 trillion worth of government securities in the secondary market in the first quarter of this fiscal year. But the market has already read that as a guaranteed purchase of ₹4 trillion in four quarters. So that would mean funding one third of the annual budget deficit of ₹12 trillion via GSAP. Even though this is not outright monetization of the deficit, it amounts to that. The GSAP is also intended to reduce the gap in yields that have arisen between short- and long-tenor securities, also known as the term premium. In guaranteeing to be the purchaser of last resort of government bonds, RBI has crossed a mental ‘Lakshman Rekha’, a line that was thought uncrossable in normal times. But these are anything but normal times. The deficit is huge and the second wave of covid threatens to stall an economic recovery. RBI is now merely following a precedent set by the US Federal Reserve, followed by the European Central Bank (ECB) and Bank of Japan. Over the past 12 years, we have seen several versions of QE in the Western world, the result of which has been interest rates close to zero. The Fed and ECB went even further, buying up blue-chip corporate bonds and later junk bonds, exemplified by Mario Draghi’s slogan of “doing whatever it takes" to keep rates low and revive growth.