Things RBI should be mindful of before issuing own bonds
In view of the huge liquidity inflows in the Indian markets, the authors of the Report on Currency and Finance (RCF) that was published by the Reserve Bank of India (RBI) last week has an interesting proposal to manage the influx: The RBI, it says, should be able to issue its own bonds to mop up the excess liquidity.
Many global central banks in Switzerland, Japan and Sweden have issued their own bonds to absorb liquidity in the aftermath of the global financial crisis. Among emerging market economies, Bank of Indonesia pioneered the use of central bank securities even before the Asian financial crisis of 1997.
“In the absence of budgetary allocations of marketable securities for the conduct of monetary policy in an open economy context, lessons can be drawn from the practice of several central banks that issue their own securities to effectively pursue goals set for monetary policy in the face of large autonomous increase in surplus liquidity due to capital flows,” the report said. The views are of course that of the authors of the report working in different departments of the central bank and not the views of the central bank.
However, there are a few issues that the central bank should consider before issuing these bonds.
As the thinking is that such bonds would replace the bonds issued under the Market Stabilization Scheme, it is likely that those will be of shorter tenure. In that case, there could be an issue of oversupply of shorter tenure bonds which could push up the yields.
“I don’t see the need for such bonds. The idea is, the RBI may have to do this if they run out of securities for reverse repo. The
RBI’S own security is essentially an alternative to MSS, but with the central bank having full control over issuance quantum. But whether it’s MSS or the RBI’S own bonds they will act as competition to short-end borrowing by the government and push up yields,” said A Prasanna, head-fixed income research at ICICI Securities PD.
Instead of issuing its own bonds, the RBI should actually use Standing Deposit Facility (SDF) to mop up liquidity.
“SDF, which is available to the RBI, is also a sterilisation tool. Under SDF, the RBI can take money from banks without giving any collateral. It is less complicated and so my view is SDF should be the first option,” Prasanna added.
There is a cost angle also. Since these bonds are issued by the RBI, the central bank has to bear the cost. If the RBI’S cost increases, that will have an impact on its dividend payout to the government.
On the other hand, there is also the thinking that another discretionary tool in the central bank’s armoury is welcome at a time when liquidity management is the need of the hour.
“The RBI highlighting the need for greater discretionary access to liquidity management tools is very timely, said Suyash Choudhury, head, fixed income, IDFC Asset Management Company.
“As it notes, the precautionary building up of forex reserves is a public good even as it may render challenges for the conduct of domestic monetary policy. This can be somewhat mitigated, and the central bank can exercise better control over liquidity and the setting of short-term rates, if either it has access to unconstrained issuances on MSS bonds or it could issue its own securities,” Choudhury told Business Standard. MSS or market stabilization scheme is a monetary policy tool that is used by the RBI to manage liquidity. MSS bonds, which are mostly of shorter tenure, are floated by the RBI on behalf of the government to mop up excess liquidity.
“It is not a bad idea. They have also mentioned other countries doing it,” said Madhavi Arora, lead economist, Emkay Global.
The RBI issuing its own bond will be relevant for three reasons, Choudhury says.
“One, India’s long-awaited cyclical recovery that seems to be finally underway will likely attract stronger capital flows. Two, measures like bond index inclusion as well as an ambitious asset sale programme are likely signalling a greater willingness to invite global capital into the country,” he said.
The third reason is, since the yields on the government bonds are hardening, the central bank would like to see orderly evolution of the yield curve, which the RBI governor has emphasised in recent times.
The central bank observed that sterilised intervention is an effective solution to manage the trilemma in India. “Enhancement of sterilisation capacity may be necessary to deal with possible surges in capital flows in future,” the report said, while adding activation of SDF to address the security availability constraint of the RBI for undertaking sterilisation operations.