By Ashish Kapur
The G-Sec benchmark prices, to which other lending prices are intricately linked, should really ideally be a reflection of true industry rates—so as to encourage constructive channelisation of monetary savings towards investment demands of the economy. While setting low G-Sec yields is the prerogative of the Reserve Bank of India (RBI), with the apparent cooling government borrowing expenses coming as a massive spend-off, it has damaging consequences, also, which is becoming increasingly disconcerting.
First of all, benchmark prices suppressed with a view to finance deficits cheaply drive down the associated interest prices in the economy. The resultant decrease bank deposit prices and muted modest savings coupons hence grow to be a damaging spend-off. The current announcement and prompt withdrawal of modest savings price reduce by 50-110 bps for June 2021 quarter comes as a breather to the finish-savers constituency, largely comprising of senior citizens and pensioners, following the shock of about 1% typical cuts last year.
To finance government borrowings effectively, RBI has ensured that G-Sec yields are subdued by playing out quantitative easing instruments at its disposal, like the Operation Twist—large liquidity infusions that hold yields artificially low by promoting close to-term treasuries to get longer-dated ones, thereby driving down extended-term interest rates—helping borrowers no doubt, but breaking the back of finish-savers who earn decrease interest revenue, additional eaten away by increasing inflation, due to the fact in the end modest savings prices are linked to G-Secs.
Secondly, with RBI infusing liquidity through the Operation Twist and current open industry operations like the G-Sec Acquisition Programme (G-SAP) to minimize yields, bond rates that are inversely proportional to yields have consequently gone up. Forget equity markets, even the currency markets seem to be jittery!
As investors increasingly come across prices getting unattractive, bond yield differential tilts and increases the price of owning the decrease yielding currency. The rupee depreciation in April appears to be following this script and appears a different unintended consequence of maintaining government borrowing price in verify by suppressing G-Sec yields. With commodity rates heating up and frequent Middle East crude turbulences adding to the import bill and net inflationary impact, the rupee is probably to stay volatile in the brief run and RBI could require to often intervene to guarantee that powerful overseas institutional inflows that have hitherto supported the rupee are not reversed.
The moot query is no matter whether a 25-30 bps raise in the G-Sec benchmark yield more than time can be so fiscally catastrophic, and how important is the trade-off taking into consideration each dollars and currency markets? RBI employing ammunition solely to cap bond yields could be the incorrect battle to concentrate on as demand-provide dynamics would recommend letting benchmark prices glide upwards smoothly, a great deal like its personal currency industry interventions.
The third trade-off to be evaluated is the declining domestic savings more than the last decade, which impacts the investment price unfavourably.
India’s gross domestic savings price, which was 34.6% of GDP in FY12, fell to 30.1% in FY19 vis-à-vis about 45% in China. Household savings in monetary/physical assets, which constitute roughly 60% of the gross savings, fell from 23.6% of GDP in FY12 to 18.2% in FY19. The savings level is unlikely to materially transform in FY21 and FY22 as livelihoods get impacted due to loss of momentum, labour contribution contraction, restricted mobility and periodic lockdown/second-wave restrictions.
Theoretically, a falling savings price leads to Indian entities accessing more capital overseas, thereby rising external debt and existing account deficits. True, record foreign inflows in later half of FY21 have been most welcome, but there is no certainty of the future. The value of rising savings price in the extended term to bolster investments can not be overemphasised. To encourage savings, in particular in monetary assets, nominal returns on bank deposits and modest savings should really meaningfully compensate the finish-savers.
Lastly, the effect of suppressed benchmark prices on mispricing threat by lenders and consequential undesirable loan issue cannot be ignored. Mispriced loans to particular sectors with bigger ticket sizes apart from laxity in assessing borrowers for state schemes coupled with undesirable/constrained lending practices worsen all round systemic threat. It is crucial to cost credit correct, basis the scarce investment capital out there and true price of capital, apart from extensive evaluation of sectoral nuances and counterparty threat.
With asset-heavy monetary statements producing it an best candidate, banking credit to business stood at an impressive 40% level till about FY16. However, with the services’ contribution to the GDP becoming dominant, coupled with the reduction in money/undocumented transactions rapidly-tracked in the digital GST era, credit disbursement to the services sector is progressively inching upwards, with a higher upside possible.
Given the evolving sectoral contribution to India’s GDP, there is also a transform in dynamics of non-meals bank credit allocation across business, retail, services and agriculture, which stood at 29%, 29%, 28% and 13%, respectively, in February 2021 as per current RBI information evaluation by QuantEco Research. This is a very good time for RBI to relook at banks’ internal mechanisms to keep away from the temptation of mispricing threat in straightforward liquidity situation.
The possibilities
Now, what can the banking regulator do to handle the spend-offs nicely and proficiently navigate its challenging part of being the government’s banker, while simultaneously making sure that savers get a greater deal on bank and modest savings deposits?
For starters, letting benchmark yields inch up marginally more than time can be regarded seriously, which will have a trickle-down impact on the term deposit prices. With G-SAPs lowering longer-term yields, RBI can use the reverse repo route to raise brief-term prices. While this could flatten the yield curve at some point, it would make a case for banks raising brief-finish deposit prices, also.
Changing the benchmark for modest savings or delinking from G-Sec and tweaking the price of deposit funding benchmarks to allow savers make worthwhile nominal returns net of inflation merits consideration. Finally, pricing threat correct across infrastructure, manufacturing and services segments opens up that a great deal more leeway for raising deposit prices for the finish-savers.
The pandemic-induced challenges and the consequent government spending make it essential for RBI to continue juggling its several hats nicely to handle positive and damaging spend-offs dexterously.
The author is a certified treasury manager and a veteran corporate banker