We have complained that the RBI isn’t doing that much to help in #Covid19, while the west is going bonkers. But now we stand corrected – in what seems to be a big bazooka underappreciated mechanism, the RBI has just done a quantitative easing of serious size.
In the last two months, since 19 March when the Coronavirus impact really hit us, the Reserve Bank has bought over Rs. 160,000 cr. of Indian government bonds on it’s balance sheet.
Through the Covid19 Crisis, the RBI has been buying government bonds, keeping them from sliding.
This may not sound big to you, but it effectively does two things:
- reduces the interest rates that the government has to pay, and then, in the whole system
- keeps the system flush with liquidity, which is important in a crisis.
How does the RBI buy government bonds?
The RBI will not directly buy bonds from the government. The government issues bonds to the market (banks, mutual funds, insurers etc. are buyers). The RBI then goes to the market and buys bonds – usually different bonds from the ones sold. But the RBI does this for a different purpose – for liquidity management, usually.
Meaning, the RBI can print money to buy these bonds. When money is printed it will go to the seller of the bond, who now has the money. That money can then be made available for lending or for chasing other opportunities. In a parallel effect, since the RBI buys government bonds, the yield on government bonds reduces. That makes them unattractive to keep. So the people who sell bonds to them can go buy private or PSU bonds (which the RBI doesn’t buy). Which helps reduces rates across the system.
Is This Bad? Good? Better Than The Fed?
The RBI Balance Sheet is up 33% in the last one year, but not only because of this. The balance sheet itself is up because of three factors:
- Total buying of roughly 209,000 cr. of government bonds – taking RBI ownership to 11 lakh cr.
- Total buying of over $45 bn (312,000 cr.) of foreign currency assets
- Dollar depreciation of about 10% which resulted in RBI ownership ballooning to 34 lakh cr.
It’s important to understand that RBI buying government bonds is not to finance the government, though that becomes a by-product. The government wants the market to buy 30,000 cr. of bonds per week, and if the RBI is also buying 30,000 cr. from the market, a market player like a bank or a mutual fund has to just buy bonds from the government and sell them to the RBI.
This is good; it reduces rates because if they don’t do this, the safest instrument in India (the government bond) will fall in price due to massive supply, and a fall in price is a rise in yield or interest rate.
A rise in yield in the safest instrument means every other instrument will see a rise in yields, which will effectively raise interest rates for all corporates. Not a good thing in a crisis like #Covid19.
Will this cause inflation? Possibly, but we haven’t seen demand destruction like this ever, and inflation is a function of demand as much as of supply. In a crisis like Covid19, when the western central banks are printing like it’s going out of fashion, it’s nice to see the RBI also keep its printing presses running to buy Indian bonds rather than only buying dollars.
How Does This Impact Me? My Mutual Funds?
We have a two hour workshop (Register now) on 23rd May 2020, on the concept of Debt Funds. We’ll go into some detail helping you understand how this impacts:
- Your shorter term debt mutual funds
- Longer term oriented gilt funds
- Why it’s important to see what the RBI is doing, Inflation impact, and the Crowding effect
In fact, you’ll realize why this is one reason that Gilt funds have given stellar returns in the last few months even when other debt funds have been shaky.
Click the banner below to register! (Note: it’s a paid workshop)