India’s G-SAP versus Japan’s yield curve control policy

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 5 min read . Updated: 21 Apr 2021, 12:38 AM IST Vidya Mahambare

RBI’s approach is different in key ways and it’s difficult to directly assess the success or failure of G-SAP

The Reserve Bank of India (RBI), India’s central bank, recently announced its Government Securities Acquisition Programme (G-SAP). Under this programme, RBI has explicitly committed itself to purchasing ₹1 trillion worth of outstanding government securities (G-secs) from the market during the April-June 2021 quarter. The first round of purchases worth ₹250 billion were done on 15 April.

The G-SAP, in RBI’s words, is designed for “enabling a stable and orderly evolution of the yield curve" (bit.ly/3dxxUt9). This is how it is supposed to work: The central bank would purchase a pre-announced amount of outstanding G-secs from the market at a pre-announced date, with the seller of the bonds receiving cash in return. Increased market liquidity would help ensure sufficient demand for the central government’s expanded market borrowing programme of ₹12.06 trillion for 2021-22, and at a lower cost. The policy, if successful, would lower the gap between the short-term and long-term risk-free rates in the economy, or in other words, flatten the yield curve.

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Apart from helping make government debt sustainable, how would this affect the Indian economy? Lower interest rates on G-secs would be expected to keep the banking sector’s lending rates lower. It may also help maintain stock prices higher and lower the pressure on the rupee appreciation by discouraging excess capital inflows. If such a scenario is to play out, then it may encourage borrowing, spending and investment by households as well as firms in due course.

Is G-SAP equivalent to the Bank of Japan’s policy of Yield Curve Control (YCC)? Simply put, no. First, YCC directly caps the prices of G-secs by explicitly announcing the G-sec yield that the central bank is committed to. Second, YCC tends to target the price of a specified duration G-sec. For example, the Bank of Japan (BoJ) targets a 10-year G-sec price that’s consistent with “around 0 per cent" yield, and had allowed for a narrow fluctuation of 0.1% on either side when it began in 2016. The BoJ’s current band, with its latest revision last month, allows a fluctuation of 0.25% on either side. Third, under its YCC policy, the central bank commits to buying any amount of G-secs that the market wants to sell, consistent with its target.

In contrast, neither does RBI’s G-SAP provide an explicit target for G-sec yields, nor is it a commitment to buy an unlimited amount of these bonds from the market. Instead, G-SAP focuses on purchasing a specified volume of G-secs by inviting bids and then announcing a cut-off yield, but still not necessarily accepting all the bids that are consistent with that yield. For example, as per an RBI press release, in the first round of purchases under G-SAP, while the cut-off yield on the specified G-sec maturing in 2035 was 6.6122%, RBI accepted only 76.36% of the competitive offers at the cut-off price. Further, under G-SAP, RBI would not restrict itself to purchase a G-sec of only one tenure. On 15 April, only ₹75 billion of the total ₹250 billion was for the 10-year benchmark bond.

Why are these differences critical? If the market perceives the central bank’s commitment to yield-control as credible, then G-sec prices in the secondary market will adjust to the central bank’s target prices. With an on-tap option to sell G-secs to the central bank at a specific price, a holder of these bonds would not sell it to another investor for a lower price. This enables the central bank to achieve a target level of G-sec prices without actually having to make large bond purchases as before, limiting the expansion of its balance sheet.

YCC has allowed the BoJ to scale down its actual volume of G-sec purchases since 2016 (bit.ly/32y6vAE). RBI’s G-SAP, in contrast, as is the case with other open market operations, would require the country’s central bank to buy G-secs at the same pace, thereby resulting in the continued expansion of its balance sheet and an increase in market liquidity.

There is one more crucial difference between YCC and G-SAP. YCC is followed when the central bank’s main tool, its short-term policy rate, hits the lower nominal bound of zero or is close to zero. Despite that, if there is no economic revival in sight and inflationary expectations are well below its target, then the central bank has to find an alternative way to cap long-term interest rates.

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Could RBI have gone for YCC? No. First, for Japan-style YCC to work, the secondary G-sec market needs to be deep enough, with sufficient liquidity. Only if there is a liquid secondary market with a larger number of players will market participants trade among themselves at the central bank’s target price, instead of selling G-secs to the central bank. Second, the market should perceive the central bank’s commitment to buy a government security at a specific price as credible, which is not feasible if inflation is on an upward trajectory, since bond-holders would demand to be compensated for it. India’s consumer price index-based inflation rose to a four-month high of 5.52% in March, reaching close to the 6% upper end of RBI’s target range.

Will RBI’s G-SAP lower and stabilize the G-sec yield curve in India? It is hard to judge what G-sec yields would have been in the absence of a particular policy. However, unless the bond market believes in RBI’s ability to keep inflation within its target range, keeping government borrowing costs low for too long is unlikely to be feasible. The success of G-SAP can never be measured directly, since there is no explicit commitment on RBI’s part to achieve specific G-sec yields.

Vidya Mahambare is professor of economics, Great Lakes Institute of Management, Chennai

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