The Indian central bank’s conventional and unconventional policy responses to assist the economy through the pandemic ceased to function to curtail the government’s borrowing expenses by a lot, says a new study.
Policy actions by the Reserve Bank of India have had just a modest effect on the term premium’ –- an indicator of the market’s expectations of future interest rates, according to the research authored by Rajeswari Sengupta of the RBI-funded Indira Gandhi Institute of Development Research in Mumbai, and Harsh Vardhan of the SP Jain Institute of Management and Research. There were thresholds to which monetary policy alone could deliver an economic impetus during a crisis, they wrote in the ‘Ideas for India’ portal.
The RBI was at the forefront of delivering a stimulus to the economy last year. At the same time, the Narendra Modi-led government followed modest fiscal steps. The central bank cut interest rates by 115 basis points. It inoculated billions of dollars through unconventional monetary policy to lower borrowing costs.
The RBI actions did not have any noticeable impact on the term premium’s behavior — the compensation investors mandate holding longer-term debt — particularly during the pandemic epoch, wrote the authors who used inter-bank call rates one-year T-bills yield to assess the premium. At best, the RBI halted a sharp spike such as the one glimpsed after the global financial crisis, they said.
“This implies that concerns of large fiscal deficits, high inflationary expectations, and the resulting likelihood of high future interest rates could possibly have been the more important drivers of term premium,” Sengupta and Vardhan wrote.
Their view chimes with Jayanth R Varma, a member of the RBI’s Monetary Policy Committee, who said higher term premiums disclosed a shortage of market confidence in the central bank’s inflation estimates.
Sengupta and Vardhan also wrote:
- The RBI’s long-term repo auctions, or LTRO, for providing 1.6 trillion rupees ($22 billion) of cheap funds to lenders between last September and November fell short, given term premium was fairly stable at around 250 basis points afterward
- The effect was the same for Operation Twist — where the RBI buys long-dated bonds and sells shorter maturities to keep a handle on the yield curve and term premiums
- “When measured over call rate, the average decline in term premium before and after OT was just three basis points. On the other hand, when measured over the yield of 1-year T-bills the term premium increased by one basis point.”