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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.

Last year, RBI did quite a few unorthodox things to tackle the impact of the pandemic. It allowed a moratorium on loan repayment. It also announced a massive long-term repo operation, essentially giving away low cost overnight loans for a period of three long years. This was on top of a rate-cutting spree that has been underway for almost three years. Yet, this has not revived credit growth, which, after all, is the main objective of this exercise. Currently, credit growth is barely 6% overall, of which the industrial credit component is much lower. To sustain high gross domestic product (GDP) growth, we need credit growth to be closer to 20% per annum. India’s own experience since the 1990s is that high interest rates have not deterred animal spirits and robust investment growth. Conversely, it is not low rates that spur industries to plan large capital expenditure or expand their factory capacities. Thus, if GSAP aims to keep the cost of capital low for corporates, including the small and medium businesses, anticipating higher credit offtake, that won’t be enough. Worse, some high-rated large companies may simply refinance their loans and pocket handsome gains with no fresh investment in the offing. Spurring new investment needs policy stability, a revival of consumer and business confidence, success with India’s universal vaccination drive, and a reduction in regulatory and tax burdens. What low rates can do is inflate asset markets, especially stocks and housing. That would be another headache as and when it starts threatening financial stability. For now, it seems that the only real beneficiary of GSAP is the central government, which is the biggest borrower in the economy. The impact of a slightly higher cost of borrowing is huge on the exchequer, especially when the government’s debt mountain alone is a whopping 100 trillion. Hence, even a 1% increase in the average cost of borrowing this year can increase its interest burden by 1 trillion, which is 0.5% of GDP. Not to forget the additional burden of servicing state government debt.

Was there a different way of lowering the sovereign cost of borrowing? Yes. As this column has suggested more than once, why not opt for a bilateral loan against a share swap between RBI and the Union government, bypassing the bond market altogether? This could be coupled with dribbled sales of the pledged shares of public sector undertakings.

Is there a downside to QE’s debut in India? Yes. For one, a central bank cannot control both bond yields and the external value of its currency. The slippage of the rupee after RBI’s announcement is evidence of this maxim. Be prepared for a currency slide. Secondly, this is like entering a ‘chakravyuh’ from which an exit path is unknown. It has implications for financial stability, as it might lead to a stock market and housing bubble. Thirdly, it could also lead to inflation (after all, that’s what too much money in circulation does). It will further erode real returns for bank depositors and other savers. That, in turn, will put pressure on RBI’s Monetary Policy Committee to raise short-term rates. Fourthly, how will a GSAP-imposed ceiling on rates be reconciled with excess demand for loans? Even if deposit growth is an optimistic 15 trillion this year, central and state deficit requirements will gobble up all loanable funds. Unless interest rates rise, how can this circle be squared?

Ajit Ranade is chief economist at Aditya Birla Group.

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