Subject: Economics

The Reserve Bank of India (RBI) has decided to infuse ₹10,000 crore liquidity in the banking system by buying government securities through open market operations (OMO).

What are Open Market Operations (OMOs)?

• OMOs are conducted by the RBI by way of sale and purchase of G-Secs to and from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.
• When the RBI feels that there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity.
• Similarly, when the liquidity conditions are tight, RBI may buy securities from the market, thereby releasing liquidity into the market.

How and in what form can government securities be held?

• The public debt office (PDO) of RBI, acts as the registry and central depository for G-Secs.
• They may be held by investors either as physical stock or in dematerialized (demat/electronic) form.
• It is mandatory for all the RBI regulated entities to hold and transact in G-Secs only in dematerialized subsidiary general ledger or SGL form.

Types:

i) Physical form

• G-Secs may be held in the form of stock certificates. A stock certificate is registered in the books of PDO.
• Ownership in stock certificates cannot be transferred by way of endorsement and delivery.
• They are transferred by executing a transfer form as the ownership and transfer details are recorded in the books of PDO.
• The transfer of a stock certificate is final and valid only when the same is registered in the books of PDO.

ii) Demat form:

• Holding G-Secs in the electronic or scripless form is the safest and the most convenient alternative as it eliminates the problems relating to their custody, viz., loss of security.
• Besides, transfers and servicing of securities in electronic form is hassle free.

How are the G-Secs issued?

• G-Secs are issued through auctions conducted by the RBI.
• Auctions are conducted on the electronic platform called the E-Kuber, the Core Banking Solution (CBS) platform of RBI.
• The RBI, in consultation with the Government of India, issues an indicative half-yearly auction calendar which contains information about the amount of borrowing, the range of the tenor of securities and the period during which auctions will be held.
• The RBI conducts auctions usually every Wednesday to issue T-bills (Treasury Bills) of 91-day, 182-day and 364-day tenors.
• Settlement for the T-bills auctioned is made on T+1 day i.e. on a working day following the trading day. Like T-bills, CMBs are also issued at a discount and redeemed at face value on maturity.
• The tenor, notified amount and date of issue of the CMBs depend upon the temporary cash requirement of the Government. The tenors of CMBs are generally less than 91 days.

What is meant by repurchase (buyback) of G-Secs?

• Repurchase (buyback) of G-Secs is a process whereby the central government and state governments buy back their existing securities, by redeeming them prematurely, from the holders.
• The objectives of buyback can be the reduction of cost (by buying back high coupon securities), reduction in the number of outstanding securities and improving liquidity in the G-Secs market (by buying back illiquid securities) and infusion of liquidity in the system.
• The repurchase is also undertaken for effective cash management by utilising the surplus cash balances.
• The state governments can also buy back their high coupon (high-cost debt) bearing securities to reduce their interest outflows in the times when interest rates show a falling trend.
• States can also retire their high-cost debt pre-maturely in order to fulfil some of the conditions put by international lenders like Asian Development Bank, World Bank etc. to grant them low-cost loans.

Context

Although we could not have predicted it, Covid-19 was not the reason, but just the trigger for the ongoing financial crash as all we needed was the proverbial straw to break the finance sector’s back

Economic sudden stop

• Not just any trigger: Covid-19 was not just any trigger as it gave birth to the concept of the economic “sudden stop.” When the global equity markets dropped on 31 January 2020 following the WHO declaration of the Public Health Emergency of International Concern, El-Erian (2020) warned the investors on 2 February 2020 that they should snap out of the “buy the dip” mentality.
  • Pointing out two vulnerabilities, namely structurally weak global growth and less effective central banks, he introduced the concept of “sudden stop” economic dynamics.
• What is sudden stop? It can be considered as an abrupt onset of a deep recession.
  • Supply and demand shock: In the case of Covid-19, it is a sudden stop of economic activity resulting in supply and demand shocks to the global economy as major cities in infected countries, more than 100 and counting, are put on lockdown.
  • And, add to that the deepening oil price war between Russia and Saudi Arabia.
• On 8 March 2020 in New York, the futures markets opened and oil futures (both Brent and WTI) are trading about 21% down, gold is above $1,700 per ounce, and all United States (US) equity index futures are trading about 4% down.
• Long terms treasury yield at historical lows: What is worse is that with the long-term US Treasury yields at their historical lows (10-year yield below 0.5% and 30-year yield below 1%), the capital markets are frozen (not to mention many oil projects that will go bust at these prices).

Disorderly non-financial private sector debt leading to dire consequences

• A disorderly global non-financial private sector debt deleveraging, which is likely to lead to deep global debt deflation, followed by a recession (and possibly a depression).
  • Which could result in creating financial and economic instabilities, and further tensions in international relations with dire consequences for emerging and developing countries, not to mention developed countries.
• Difference in developed and developing countries debts: While in developed and high-income developing countries, the non-financial private sector is more over-indebted, in middle-income and low-income developing countries, the public sector is more over-indebted.
• Impact on developed economies: Given that the global non-financial private sector debt deleveraging has already started, the public sector debts of the developed and high-income developing countries will also go up and the governments’ ability to rescue their economies will also decline in these countries.
• Impact on funding for climate change: Furthermore, this will severely constrain the governments’ ability to spend on climate change-related projects to address the potentially catastrophic effects for many years to come, diminishing our hopes to make the necessary investments and innovations to address the now existential climate crisis on time will diminish.
• The corona factor: The measures we have to take to control the spread of Covid-19 before a cure is found will further challenge the financial system, as people stop earning an income and businesses go bankrupt.

Way forward

• Three authorities solution: In the suggested framework, there would be three authorities to maintain a deposit account at the central bank in each country
  • 1. A deleveraging authority for leverage reduction.
  • 2. Lastenausgleich (based on German Currency Reforms) authority for capital levies.
  • 3. Climate authority for financing needs in developing national climate plans.
  • These national authorities should be globally coordinated through the appropriate United Nations agencies.
• Control the three authorities: The Lastenausgleich authority would be under the finance ministry, whereas the deleveraging and climate authorities would be not-for-profit corporations promoted by the government.
• Capitalisation issue: The government would capitalise the deleveraging and climate authorities by the Treasury-issued zero-coupon perpetual bonds.
• The deleveraging authority would then sell its equalisation claims to the central bank in exchange for an increased balance in its deposit account at the bank, while the climate authority would wait until the deleveraging concludes.
  • Further, the climate authority would not be allowed to open deposit accounts to its borrowers to ensure that it would be a pure financial intermediary, not a bank.
• Framework: Assuming that a globally agreed-upon debt reduction percentage that would bring the global non-financial sector leverage well under 100% is determined and that all countries agree to act simultaneously, the framework is as follows
  • (i) the financial institutions comprising the banks and non-bank financial institutions (NBFIs) write down all the loans and debt securities on both sides of their balance sheets by the required percentage;
  • (ii) the deleveraging authority compensates the banks and NBFIs for the loss if any; and
  • (iii) the deleveraging authority pays each qualified resident their allocated amount less than the debt relief if any.
  • If an NBFI gain after the above debt reduction, it should owe equalisation liabilities to the deleveraging authority of its jurisdiction.
  • Note that as all debts mean all debts, public sector debts will also be written down by the same percentage except the official debts of the sovereigns that fall out of the scope of our proposed framework and should be handled by other means.
• After deleveraging: After deleveraging the balance of the deleveraging authority account at the central bank goes down whereas the total balance of the bank accounts (reserves) at the central bank goes up by the total payment made by the deleveraging authority.
  • Hence, the base money goes up by the total payment of the deleveraging authority.
  • Since NBFIs and residents cannot maintain deposit accounts at the central bank, they have to be paid through a bank which creates deposits for the NBFIs and residents against reserves.
  • Hence, the broad money goes up by the amount of the payment to the NBFIs and residents.
• Issue of multi-currency balance sheet: One issue is that in many countries, the bank and NBFI balance sheets are multi-currency balance sheets.
  • However, the deleveraging authority payments are in domestic currency, which may create currency risk for some banks and NBFIs.
  • Backed by the central banks, the globally coordinated national deleveraging authorities should stand ready to intervene to avoid potential crises.
• Condition to spend on climate bonds: The authorities would require their domestic banks and other financial institutions to spend an internationally agreed-upon percentage of their newly found money, if any, after the deleveraging on the interest-bearing, finite-maturity bonds the national climate authorities would issue.
  • Since the promoter of the climate authority is the government, the bonds of the climate authority would have the same credit with the government bonds, and the central bank would accept the climate authority bonds in its open market operations.
• Climate authority bonds as reserves: Therefore, the climate authority bonds would be the main tool to manage the reserves and deposits created through the equalisation claims.
  • In addition, the climate authority bonds could be used for the greening of the financial system through the investment of foreign exchange reserves of the central banks proposed by the Bank of International Settlements (BIS 2019).
• Progressive wealth tax collection: Lastly, equipped with a “globally coordinated wealth registry” (Stiglitz et al 2019), the Lastenausgleich authorities would collect progressive wealth taxes from the owners of real and non-debt financial assets for the equalisation of burdens.
  • While a part of these taxes could be used to retire some of the equalisation claims and the corresponding reserves and deposits created in the deleveraging process, another part could be transferred to the climate authorities, and the rest could be spent in the interests of the society.