RBI and the impact of expanding money supply on inflation
It’s a testy beginning for the RBI. In its first bi-monthly monetary policy review last week, the central bank for the first time announced a new Rs 1 lakh crore Government Securities Acquisition Plan (G-SAP). This, it said, was ‘committing the balance sheet’ for the quarter unlike the practice of keeping its cards close to its chest. But the RBI seems to have somewhat failed in its first attempt of managing the 10-year yield on G-Securities.
Yields rose above 6.1% on Friday after the first phase of the G-SAP auction worth Rs 25,000 crore across five different maturities concluded on Thursday. That’s because traders expected the RBI to be a bit more aggressive in buying bonds. Besides, WPI inflation touching an eight-year high of 7.39% on rising crude oil and metal prices warranting tightening of interest rates spooked investors.
G-SAP was expected to flatten the yield curve, reduce the government’s borrowing costs and ensure markets remain conducive for the large borrowing programme. The Centre is set to borrow Rs 12.03 lakh crore in FY22 and if you add states, total borrowings will touch Rs 20 lakh crore. This incoming excess supply was upsetting bond prices lower and pushing yields higher. The RBI wanted to enable an orderly evolution of the yield curve and ensure congenial financial conditions for economic recovery to gain traction.
In essence, the aim of G-SAP was not to infuse liquidity, but to create demand for the government paper, keeping costs low. But higher money supply devalues the currency and predictably, the rupee slipped below the 75 level against the US dollar, becoming Asia’s worst performing currency so far this month. On the day of the G-SAP announcement, the rupee declined 105 paise—the worst single day fall since 5 August 2019. But some believe the depreciation was due to the relative increase in the dollar’s strength. Still, the RBI needs to keep in mind the impact of expanding money supply on inflation, which is firming up. Moreover, none can rule out volatility in bond markets considering global cues and rising commodity prices.