Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

© Prof. Jayanth R. Varma
jrvarma@iima.ac.in

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Wed, 25 Dec 2019

Quantitative easing by any name is fine

Update: Rate hike of August 2017 corrected to rate cut.

In early November, I wrote a blog post arguing that the Reserve Bank of India (RBI) needs to consider some form of Quantitative Easing (purchase of long term bonds) to address the complete lack of monetary transmission from policy rate cuts to long term rates.

Last week, the RBI announced an open market operation (OMO) that was quickly labelled by market commentators as its version of Operation Twist:

On a review of the current liquidity and market situation and an assessment of the evolving financial conditions, the Reserve Bank has decided to conduct simultaneous purchase and sale of government securities under Open Market Operations (OMO)

The RBI offered to buy INR 100 billion of ten year bonds and sell the same amount of bonds of maturities less than one year. When this OMO was carried out on Monday, the RBI ended up buying the entire INR 100 billion of ten year bonds but it sold only INR 68 billion of short term bonds.

I think this is to be expected. In the current situation, the RBI can ill afford to allow any increase in yields even at the short end. If the RBI repeats the operation, I expect the results to be similar: full offtake of the long end purchase and much lower offtake of the short end sales. If the RBI wants to avoid the suggestion that it is doing any easing or any monetization of the fiscal deficit, we should not have any quarrel with the operation being called a Twist or a Special OMO or whatever. The important thing is get on with this in greater size or more frequently until the ten year yield drops 100-150 basis points below its August 2017 level. (While the OMO did reduce the ten year yield by about 25 basis points, this yield is still about 25 basis points higher than it was before the rate cut of early August 2017).

On the other hand, if the RBI stops with just this one operation, it would leave itself open to the insinuation that this was just a cosmetic attempt to help the banks window dress their balance sheets at the December quarter end.

Posted at 19:54 on Wed, 25 Dec 2019     0 comments     permanent link

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