Reserve Bank of India (RBI) Governor Shaktikanta Das has done well to signal a change in the interest-rate environment. If the bond markets are feeling somewhat let down, frankly, that is their problem. These are tough times with potential inflationary pressures—demand-pull and cost-push—growth is coming back and is estimated to touch 10.5-11% as the economy normalises, faster than anticipated. Under the circumstances, yields cannot be expected to rule at the same levels as they did in a much more sluggish economy when commodity prices were benign. RBI, it would appear, isn’t unhappy that long-term yields could inch up about 10-15 bps, maybe even up to 6.25%. And that the government must be prepared to borrow at these rates.
Governor Das’snarrative is a strong and clear one. The supply of government paper may be very large but, fear not, there will be ample liquidity. The liquidity stance stays accommodative, and the borrowing programme will be managed without any disruptions. It doesn’t get better than that. Right now, given the rather uncertain nature of the growth trajectory—with the many imponderables across the globe and US treasury yields rising—RBI can only cross the river by feeling the pebbles, and that is as good a way as any to negotiate the normalisation.
In fact, the clearly dovish tone might come across as somewhat contradictory at a time when the central bank has raised the projected inflation range to 5-5.2% for April-September; earlier, this was 4.6-5.2%. There is caution on the cost build-up through rising petroleum and raw material prices, all of which could mean higher price levels for services and manufactured goods. In fact, the Governor calls on states and the Centre to ensure there is no further escalation.
Moreover, there is the GDP growth target of 10.5% for FY22. But RBI clearly wants to support the Centre in re-igniting the economy; it wants to support the nascent recovery. The markets should take heart from the dovish messaging despite the potential inflationary pressures building up; they should be reassured by Governor Das’s terrific track record, he will take care of the borrowing programme.
True, there are reasons to be concerned. A `12 lakh crore government borrowing isn’t something to be sneezed at, especially on the back of large borrowings in the current year; also, the fisc has turned out to be a lot more expansionary than anticipated. But surely they would have worked out that the liquidity surplus would shrink as growth picks up pace, loan and consumer spends increase. One can hardly expect an economy that is rebooting—at a reasonably brisk pace—to see average surplus liquidity levels of `5 lakh crore. Given how foreign portfolio flows as also FDI, are expected to remain buoyant, and RBI is likely to continue to build forex reserves, liquidity should be adequate.
As economists have pointed out, leaving yields at artificially depressed levels—at a time when the economy is expanding—could turn out to be harmful in the medium term. Real interest rates, especially at the shorter end, have been negative for far too long, favouring borrowers and hurting savers. A 12-15 bps rise in yields should not be cause for worry; in fact, a rise of 20-25 bps should not be worrying either.
For much of 2020, post the pandemic, RBI left liquidity surpluses at record levels, and the banks made most of this by parking the surpluses in the reverse repo window—lazy banking at its worst. RBI went out of its way to coax them to lend—offering them cheap funds through the TLTRO windows—in the hope they would. But banks barely lent, staying rigidly risk-averse and merely chose to enjoy the bonanza from their bond portfolios. Well, the party is coming to an end. Someone needs to remind them to get back to their core business of lending.
They have been allowed more time to fix their bond portfolios; concessions on the HTM have been extended for one year to be precise, a big break. Moreover, the pace of restoring the CRR to 4% has been staggered, another break. One can always count on the central bank to use the extra room to roll out more measures. The Governor has said as much. Some experts observed the bond markets are sulking because the Open Market Operation (OMO) calendar was not announced. Trust Das, it should be out soon. In an interesting comment, Das said financial stability and orderly evolution of the yield curve were seen as public goods as they benefitted all stakeholders in the economy. We beg to differ. Over the past couple of years, banks have been the biggest gainers of low yields with a negligible number of borrowers benefitting. The biggest gainer has been the government. And the biggest losers the savers. It is time interest rates get real.