With rate cuts not helping, here's an unconventional step that RBI can try

RBI governor Shaktikanta Das
It’s time for the Reserve Bank of India to take unconventional policy measures as rate cuts are failing to stimulate the economy, according to the head of fixed income at IDFC Asset Management Co.

The central bank, which reviews policy on Thursday, should look to pull down long-term yields by selling short-tenor bonds and reinvesting in longer-term ones, said Suyash Choudhary, who correctly predicted the credit crunch that has been hurting banks.

“Cutting policy rates is no longer enough,” Choudhary, who oversees $10.5 billion in debt, said in an interview in Mumbai.

The concept proposed by Choudhary is similar to Operation Twist used by the US Federal Reserve in 2011-2012 in an effort to cheapen long-term borrowing and spur bank lending. The Fed then swapped short-term Treasury securities for longer-term government debt, which reduced the gap between two- and 10-year yields.

In India, the spread between the most-traded 10-year notes and two-year debt is the widest in nine years. That’s hindered the pass through of five rate cuts this year, frustrating efforts to revive the $2.7 trillion economy. Data last week showed gross domestic product fell below the 5 per cent rate for the first time in six years.

“The RBI can buy bonds from the market to adjust the term spreads with a view to facilitate transmission,” said Choudhary. “Alternatively, it can buy medium- to long-end bonds and sell short-end bonds. These measures require conviction on the conceptual point of whether term spreads matter for transmission.”

The Reserve Bank of India didn’t respond to a request for comments.

The weak GDP print has also reinforced doubts about the government meeting its budget aim of 3.3 per cent of GDP this fiscal year as it continues to push for growth. That’s put long-tenor bonds under pressure despite the more than 3 trillion rupees ($42 billion) of excess liquidity in the banking system.

“There are enough people who fear that the fiscal lever will ultimately be deployed to boost growth even though there’s zero space,” said Choudhary. “If that were to happen, the yield curve can steepen further.”

The yield on benchmark 10-year bonds was little changed at 6.47 per cent on Wednesday. The yield spread between the most-traded 10-year notes to two-year debt is at 110 basis points, the highest since 2010.

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