Understanding the Buying & Selling of Government Securities by RBI and the Bond Yield (GS 3, Economics, The Hindu, Indian Express, RBI)

Understanding the Buying & Selling of Government Securities by RBI and the Bond Yield (GS 3, Economics, The Hindu, Indian Express, RBI)

News: The Reserve Bank of India (RBI) announced that it would conduct open market purchase of government securities under the Government Securities Acquisition Programme 2.0 for ₹15,000 crore on September 30, 2021. The RBI has also decided for simultaneous sale of government securities under Open Market Operations for ₹15,000 crore on the same day, according to its circular. It will purchase three securities that mature in 2029, 2031 and 2035, and sell three having different maturity dates in 2022.

Context: In the backdrop of the government’s elevated borrowing for this  financial year (2021-22), which the RBI has to ensure goes through without causing disruption, Government Securities Acquisition Programme (G-SAP) aims to provide more comfort to the bond market.

The Government-Bond market – The Government issues government securities (also said as government bond) in the market through RBI to manage the deficit in the budget. 

(Deficit in the budget is called fiscal-deficit which means that the Expenditure of the government is more than its Receipt for any financial year). The market ( Banks, NBFC etc) Purchase these government securities against payment of annual interest and  promise of repayment of principal amount on maturity.

Understanding through an example: If RBI issues government securities of Rs 1cr (face value) having maturity of 10 years with 7.5 % interest in 2021.  Say  A  has bought this Government Security, means A will give Rs 1 crore to RBI. In return A will be getting Rs 7.5Lakh as interest every year and  the principal amount Rs 1cr on redemption in 2031. 

The amount 1 crore which is collected by RBI from A will be given to the government. The government will use this money until 2031.  In 2031, on the redemption of the said  government Security (when the issued government security gets mature), the government requires to pay back Rs 1cr to A through RBI. Interest of Rs 7.5L will also be paid by the government (Ministry of Finance) to A annually through RBI. Here RBI is just like mediating between the government and the market. Or it can be said as, RBI is managing the debt for the government from the market. 

Now if the said government bond is “tradable” then A can sell the same Government Security to B, further B can sell the same Government Security to C and then C can sell to somebody else. This selling and buying of the same Government Security can take place between 2021 to 2031.

This is nothing but the market of Government-Security or bond market for the Government Security. Market players are purchasing and selling government securities among one another.

In this market sometimes the RBI also gets involved in buying and selling of existing government securities. When RBI  buys and sells Government Security from the open market then it is called Open Market Operations.

The market price of the said government  security will be varying from its face value(1cr). If the price decreases, the bond yield would be increasing and vice versa. Bond yield is defined as percentage return on by the government securities.  supposedly in the above example if B buys the Government Security of 1 crore from A  in Rs 98L And keep it for 1 year then he will get 7.5 lakh Rupees as interest.  The return to B as percentage is 7.6%, which is higher than the original 7.5%. Here the price of the government Security came down from Rs 1cr to 98L and hence the  bond-yield (percentage interest) went up from 7.5% to 7.6%. 

It can be considered good for B but from the government perspective it will be a concern. It means the demand for Government Security in the market is going down and if the government issues fresh government securities  to manage the deficit in the upcoming budget then it will be difficult for RBI to sell the new government securities. Or we can  say the market is not supporting the government in debt management. Hence the increasing bond yield  raises his concerns for the RBI and the government.

Issue/Concern: The government-bond market has been witnessing high bond-yield for long. It suggests that the market is not interested in buying government securities and that’s why the demand for the government securities is going down and hence its price. Price of the government securities and bond-yield are inversely proportional, meaning when the price goes down bond yield goes up and vice versa.

Hence If the bond yield is high it will not be considered as good by the government/RBI as nobody in the market is interested in buying the government securities due to which its price is going down and the bond yield is increasing. 

The RBI has decided to support the bond market of the government securities through buying the existing government securities as per its Government-Securities Acquisition Plan (G-SAP) announced in April this year. Through this action of the RBI, more money will go into the market and it will ease the liquidity in the market (Money Supply will increase in the market and hence the interest rate in the market will come down,  which can boost the investment).  

RBI Governor Shaktikanta Das had announced that the central bank will conduct open market purchase of government securities of Rs 1.2 lakh crore under the G-SAP 2.0. Earlier this year under  G-SAP 1.0. RBI conducted open market purchase of government securities (G-secs) of Rs 1 lakh crore. This is how RBI is supporting the government security market. This can be inflationary. 

But The RBI’s decision of simultaneous  selling and purchasing of government securities worth 15000 Cr is convincing. Atually this time RBI will purchase three securities that matures in 2029, 2031 and 2035, and sell three having different maturity dates in 2022, Both  purchasing and selling worth 15000 crore. In this case through purchasing of long term government security (matures in 2029, 2031 and 2035, worth 15000 cr) money will go into the market and the same amount of money will come back into the hand of the RBI when RBI will buy short term government  security (2022  worth 15000 cr). This particular action will be not inflationary as it makes no change in money supply in the market. 

Way forward: Apart from the support given by RBI the government has to think on other aspects in respect to the increasing bond yield. The government has to work in improving the different macroeconomic indicators upon which the bond yield depends or market speculates, for example the fiscal deficit, exchange rate, inflation, balance of payment taxation and other economic policies etc.

Md Layeeque Azam, Economics Faculty

25th september 2021 current Affairs Download

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