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In the article, you will learn about...
- The Reserve Bank of India's new G-SAP policy and the bond market
- What is imported Inflation
- How the policy is connected to rising inflation
- How the second Covid-wave is just making things worse
- How to play safe and invest money during this time
The Reserve Bank of India, in its latest bi-monthly monetary policy, announced the new programme for acquiring government securities (G-sec), which is referred to as Government Securities Acquisition Programme or G-SAP. The overall objective for the latest policy is quantitative easing by printing and supplying more money to the economy.
The central bank usually acquires and trades government securities in order to control the money supply in the market, which is referred to as Open Market Operation or OMO, without any notification. But, in G-SAP the central bank notifies before the move. And that is the basic difference between OMO and G-SAP.
The G-SAP, as provides notification before acquiring, it comforts the market participants. Some experts also referred to it as OMO with a distinct character.
The Purpose:
Before getting into this, first, we have to recall basic things about bonds. Whenever bond prices increase, bond yield decreases, and whenever bond prices decrease, bond yield increases. This is connected to the demand and supply of bonds in the market.
As revenues of the government saw a dip last year due to the Covid19 pandemic, the government is not expending enough money to contribute to the economy. Thus, it has to borrow money from the market with the help of the central bank and set a target to borrow INR 12 lakh crore in the union budget. Since the budget day, bond yields were rising with the expectations that inflation will rise in the country and the rupee will depreciate against the US dollar. So, market participants want higher interest to be paid, and it was a bad thing for the government as it has to pay more interest on bonds, which, the overall interest payment of the central government accounted for 22.8% of total government expenditure out of INR 26.9 lakh crore, the highest among other expenditures in the FY20.
So, the RBI came up with the idea of G-SAP to acquire INR 1 lakh crore worth of government securities (G-sec) in the first quarter of FY22 in order to supply more money to the economy and reduce the rising bond yields. And guess what? Since the announcement in the monetary policy, the bond yields are dropping in the expectation of a high supply of bonds in the market. It was good news for the government as it will get a chance to borrow money at a lower interest rate than expected. However, it is seen a couple of times that the market participants do not want to purchase the government bond at a low interest rate or low bond yields as the inflation is surging in the country significantly and currency value is dropping, it is not the appropriate rate for them.
The Consequences:
Hopefully, the government will fulfill its targets of borrowing money from the market at lower interest so that they can contribute to the economy. But this move, according to economists is dangerous for a healthy economy. In a healthy economy, according to them, interest rates should be driven by demand and supply. And the central bank is now artificially controlling it, introducing G-SAP and notifying the market participants.
The move, introducing G-SAP, already showing its consequences. Firstly, the commercial banks will be giving lower interests to savings scheme holders and that is very dangerous for countries like India where the majority of the population is the middle-class who are heavy money savers. However, the Ministry of Finance took the lower-interest-rate scheme back after the social media protests, maintaining the bank interest rates higher only for money-savers, it is just a little hold and will announce later, according to economists, as Indian banks are already suffering a heavy financial loss and growing Non-Performing Assets (NPA), which is projected by the central bank at nearly 10% by the end of this year.
The second consequence relates to the money supply. As RBI will purchase more government bonds, it will supply more money in the market, and the value of the national currency will decrease against the benchmark US dollar. The value of the Rupee already touched a record low against the USD after the announcement. As currency value is decreased, one has to pay more rupee per dollar, and subsequently raises import costs, fuel prices, transportation cost, cost of production, cost of foreign education and traveling, or in technical term, raises inflation in the country, which we have already seen in the new statistics in the month of March. All of this can be referred to as imported inflation. As inflation rises, people will consume less and as a result, it affects the GDP. And already the season of GDP-downgrade started with this report.
Inflation in India is increasing faster than ever before. The Indian rupee is now the worst-performing currency in Asia from the best in just two weeks in April. And the second Covid19 wave, over 2,00,000 cases a day is just making this whole thing worse as local authorities are imposing partial lockdowns. In addition to this, the foreign investors divest their investments from the country, making the currency depreciate even more lowering the foreign reserves in the country. The federal bank has already warned the currency valuation will decrease further, raising the inflation in the country. This is a clear indicator from the regulator that currency fall is out of control and we can just sit and watch the further consequences.
The Investment opinion with the purpose of education:
If we talk about equity investments firstly, investing in an international fund, diversifying the portfolio would be best while the country's economy is going through its tough times and the currency is depreciating. This step is for those who do not understand the local market properly and do not know companies that give higher profits during this period. The global market has a low correlation with the Indian market and would help in tough times, learn more at Economic Times. Secondly, if one wants to play safe, one can invest in foreign currency, in this case, in the US dollar by opening an account in a foreign bank. However, this move should be taken before the peak of currency depreciation.
