Twist 2.0
It may be recalled that the RBI had undertaken Twist operations some time back where it was selling short end securities and buying longer from the market. It has now announced the next “Twist” Operation to be held for INR 10,000 crores. However the big difference here is that while it is buying dated government bonds ranging between 2026 to 2030 maturities, it is selling off very short maturity treasury and cash management bills from its books. This is effectively then almost an outright open market operation (OMO) purchase of bonds.
As a first step to assuring financing, the RBI had significantly raised short term financing to the government. Thus with a substantially higher treasury bill issuance program and a significantly enhanced ways and means advances (WMA) limit, the central bank has assured around 2.5% of GDP (Gross Domestic Product) as short term financing to the government. Furthermore, it is speculated by market participants that RBI has also lately been buying into the treasury bill issuances of the government. With the newly announced Twist (and one assumes this is only the first such announcement), the RBI is now effectively converting its very short term assets into longer dated bonds in its balance sheet. Thus RBI seems to have used this 2 step process instead of a direct private placement of part of the government’s borrowing program with itself.
Monetization Unavoidable
There has been a strong case for the RBI beginning to outright monetize the fiscal deficit given the exceptional growth challenge that the world and India is currently facing. Our base case is for India’s nominal GDP growth of just 3 – 4% for the current financial year. If true this will be the largest growth shock in multiple decades. Basis an anticipated sharp revenue slowdown and the need for a discretionary expenditure expansion, we are also looking for deficit expansion of 4-6% of GDP at a combined center and state level. This throws up a big ask for financing, a majority of which has to be financed by the central bank. Indeed this is the template that seems to have evolved, in some form or fashion, in most major economies across the world.
With these steps around hiking short term financing support to the government and starting monetizing apparently, the bond market will now be significantly comforted that a financing plan is beginning to emerge for the substantial fiscal expansion ahead. Term spreads at the mid-long end of the curve have been the highest in the past 10 years, and significantly higher when compared with the expected nominal GDP growth rate for the year ahead. These should now compress but provided that the total size of RBI measures turn out to be meaningful in relation with the financing requirements of the government. Other supporting measures can also be deployed including hiking the held to maturity limit (HTM) for banks for a period of time in order to incentivize demand for bonds in the system. Finally, states may perhaps require some greater support still given that the only avenue provided to them so far is the enhancement in their WMA limits. This increase may still be very small when compared with their overall borrowing requirements.
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