India’s very own Quantitative Easing

RBI’s willingness to look through inflationary pressures for the moment and instead support a struggling economy is absolutely the right approach. Core inflation may remain elevated, and the pressures from a revival in the demand for services have not even been felt. The central bank must be cognizant of this as it has raised inflation projections slightly. But, right now, growth deserves top priority, given fresh uncertainty following the sharp resurgence in infections and local lockdowns in some key states. The economic recovery, as many have pointed out, has been rather uneven, with the formal sector running away with gains but the larger informal sector losing out. Moreover, there has been some loss of momentum in the last couple of months.

By reiterating that RBI will continue with its accommodative stance until “the prospects of recovery are well secured”, Governor Shaktikanta Das has given himself room and time to deal with whatever challenges come his way, including spillover risks from expansionary US policies. Das has asserted liquidity would remain ample, going so far as to add the system would be in surplus even after the financial markets and productive sectors of the economy have had their fill.

Das has walked the talk. There could not have been a stronger and clearer signal of RBI’s intent to support the bond markets than the G-Sec Acquisition Programme (G-SAP), unveiled on Wednesday. The scheduled open-market purchases for an amount of Rs 1 lakh crore of bonds in the secondary market in Q1, with the promise of more thereafter, is an excellent move that should calm the bond markets. Since the buyback will run alongside the various other liquidity-infusing measures that RBI has been using this past year—the long-term repos, OMOs and Operation Twists—liquidity should be abundant to support the government’s massive borrowing, of a gross `12.1 lakh crore and to facilitate the recovery. In 2020-21,the central bank had bought a net Rs 3.1 lakh crore of bonds via OMOs; the total purchases this year could be bigger.

Indeed, the G-SAP is the first ever instance of the Indian central bank committing its balance sheet to further monetary policy, but the risk is well-taken as it is an explicit assurance to the markets. Right now, it is important yields stay reined in so that both the government and companies are able to borrow at affordable rates. As bond market experts point out, RBI’s objective is to flatten what is a somewhat steep yield curve and bring down the term premium—spread between the repo and the ten-year yield—which is about 100 basis points bigger than the five-year average of 115 points.

To be sure, savers are getting a raw deal as real interest rates at the short end are negative, but the priority now is to keep borrowing costs in check. Also, the rupee has lost some value following the announcement, slipping to 74.565 against the dollar on Wednesday, but that should not be of much concern immediately since the country’s forex reserves are nudging $600 billion; on the contrary, it would help exporters. Given RBI has left its growth projection for FY22 unchanged at 10.5% and projected 6.8% in FY23, it probably should have talked about an exit from the accommodative stance. But, in these times of heightened uncertainty, it is justified in waiting to see how growth plays out before committing itself.