Context: The Reserve Bank of India (RBI) purchased bonds worth ₹25,000 crore recently as part of its security called the Government Securities acquisition programme (G-SAP 1.0), under which it will buy bonds worth 1 lakh crore from the secondary market in the three months to June 30 (Q1 of the current financial year).
- The central bank asserted that this measure will ensure favourable financial conditions for the economic recovery to speed up.
Analysis
Why is RBI buying bonds ₹1 lakh crore?
- The central bank’s ₹1 lakh crore bond-buying plan, aims to control long-term interest rates amid a massive government borrowing programme.
- G-SAP 1.0 for the financial year 2021-22 will enable an orderly discovery of interest rates in the market.
G-SAP vs OMOs
- G-SAP is different from the regular Open Market Operations (OMOs) that RBI conducts.
- G-SAP has a distinct character, in the sense that for the first-time particular quantum of bond purchase in the secondary market has been fixed and declared by the RBI.
- In an OMO type of situation, the market is guessing. How much will RBI put up there? When will it do the auction?
- But in GSAP, it’s an explicit commitment that will ensure that liquidity in the market for banks to lend to private sector and individuals.
- The RBI has been under pressure from bond traders, worried about a glut of government papers, to announce a purchase plan to mop up the surge in supply of government securities as a result of Govt Atamnirbhar Package.
- Last year, the RBI bought ₹3.3 lakh crore worth of government securities through open market operations (OMO), which helped it manage a record ₹13.7 lakh crore government borrowing programme. The government plans to borrow ₹12.05 lakh crore this year.
- Note: This G-SAP programme will run in addition to normal liquidity adjustment facility (LAF), special open market operations (OMO) and other instruments.
Why do governments borrow?
- Governments like companies always spend more than they earn via taxes.
- The assumption is that, if government invests in education, health and infrastructure, it will improve productivity and boost economic growth. This should more than pay for the debt the government has incurred.
- It depends on the support that RBI extends to the government’s borrowing programme. If RBI buys some of the bonds issued by the government, the economy will be benefitted as interest rates will not rise.
- But if the economy does not grow, the excess money sloshing around in the system can cause inflation.
Effect of Government Securities Acquisition Programme on Economy
Corporates
- If the RBI supports the government borrowing, corporates will be less hurt by a rise in cost of borrowing.
- Also, companies will hopefully get their dues from the government.
- Right now, the government is postponing legitimate payments due to private sector.
Consumer
- There will be nor or little increase in interest rates for private individuals.
Bond market
- With RBI support, yields (interest rate) on government bonds will stay at 6 percent for 10-year bonds. Without RBI support, yields can rise to 6.5 percent or even 7 percent
What are the problems of high government borrowing?
- The potential problems of government borrowing include; higher debt interest payments, a need to raise taxes in the future, crowding out of the private sector and – in some cases – inflationary pressures.