FY19 was quite unique in so far as it
witnessed the highest level of open market operations (OMOs) in India’s
monetary history. At Rs 2.99 lakh crore of purchase of securities, it exceeded
the previous high of Rs 1.54 lakh crore in FY13. OMOs are a tool of monetary
policy whereby the RBI provides durable liquidity to the banking system by
buying government securities held by banks or absorbs liquidity by selling such
papers. Can this be interpreted as a case of monetisation of deficit? In FY19,
incremental deposits were Rs 10.5 lakh crore while incremental credit was Rs
11.4 lakh crore. Incremental investments were Rs 0.62 lakh crore. Considering
that banks hold on to around 50 per cent of total G-Secs with issuances of Rs
5.71 lakh crore, the incremental investments should have been much higher even
after adjusting for repayments. The answer is that the RBI had bought back Rs
2.99 lakh crore of G-Secs, thus providing liquidity to the system. Is this the
right thing? Two issues come up here. First is that we may be moving back to
the system of monetisation of fiscal deficit. When the FRBM was introduced in
2003, it was decided that automatic monetisation of deficit by the RBI (through
4.6 per cent adhoc T-bills) would be done away with from April 2006. But, it
was silent on RBI buying securities in the secondary market as part of monetary
policy which implied monetisation through the backdoor.
The table gives the OMOs conducted in the
last 8 years, gross borrowings of the central government and ratio of
OMO/borrowings. In 6 of the 8 years, the RBI was buying G-Secs from banks and
hence plugging the liquidity gap
In FY19, a little over half of the gross
borrowings has in effect been financed by the RBI through OMOs. This has also
led to an increase in reserve money of Rs 3.67 lakh crore while the rise in net
RBI credit to the government was Rs 3.70 lakh crore. Government lending was the
main driver of money supply this year. The RBI support has been around 10-50
per cent of total borrowings. There is a direct linkage between deficits and
monetisation. While primary issuances are being subscribed, the RBI does step
in to provide funding to banks by buying back other G-Secs under OMO.
The second issue relevant from the point of
view of the market is that the RBI has actually helped to keep bond yields
artificially down. Counterintuitively if liquidity was not supplied through
OMOs, G-Sec yields would have increased sharply. On a point to point basis,
GSec yields were almost unchanged – 7.42 per cent end-March 2018 and 7.34 per
cent end-March 2019. By continuously intervening through OMOs, the RBI
facilitates government borrowing at a lower cost. As a corollary, higher
borrowing does not quite lead to private sector getting squeezed or crowded
with automatic RBI support coming in as there is an implicit view that yields
should not move up sharply. Ideologically, OMOs should be used for supplying
durable liquidity when the system has deep shortfalls. The 2018-19 ‘episode’
appeared to be one where the system could not generate funds because bank
deposits did not grow as financial savings were down. As demand for credit
picked up, the private sector had to compete with the government’s borrowing
programme and the market equilibrium would have justified a higher rate of
interest if not for RBI OMOs. In this context, can we really say that there has
to be some limit on the OMOs by the RBI so the true G-Sec yields are determined
in the market? High government borrowing should lead to prices moving down and
interest rates going up. However, with assured support from the RBI, the
interest rate structure has been retained at a lower level. Whether this is
right or wrong is hard to say, but for sure the case made out of high
government borrowing crowding out the private sector can be contested.
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