Reserve Bank makes $21-billion cut to US treasury holdings in March

Central bank does huge OMO silently to control domestic bond yields

The Reserve Bank of India (RBI) reduced its US treasury holdings by $21 billion in March, even as it is silently buying a huge amount of bonds from the secondary market.

The data released by the US Treasury Department shows India held $156.5 billion of US treasury papers in March, down from $177.5 billion in February. In March 2019, India held $152 billion of US treasury assets.

US treasury holdings typically rise and fall with a country’s foreign exchange reserves. By the end of March 2020, India’s foreign exchange reserves were $474.66 billion; in February, they were about $481.54 billion. In March 2019, the reserves were about $412 billion. In the calendar year so far, foreign investors have liquidated $18.24 billion from the equities and debt market. Most of the outflow, $15.7 billion, happened in March.

Saudi Arabia, Brazil, and India were the top three countries to shed the US assets in March.

Overall, foreign countries sold $299.35 billion in US treasuries, a record high, compared with the buying of $4.88 billion in the previous month.

The domestic bond purchases are also necessitated to help the RBI keep its balance sheet size protected, as the local bonds compensate for the US treasury papers to keep the asset side intact. It has an added advantage: Such bond purchases keep the yields low in the domestic market.

“Most of the central banks are using foreign exchange reserves to meet sudden volatility in the Balance of Payments account, and simultaneously buying domestic bonds to keep domestic liquidity at ease,” said Soumyajit Niyogi, associate director at India Ratings and Research.

Amid the outflow of funds, and in the face of heavy borrowing programme by the government, the central bank has been silently buying a large quantity of bonds. Since March, the central bank has bought a net of Rs 1.63 trillion in domestic bonds from the secondary market, as an anonymous participant, data shows. But the bonds are not bought during the auction, which would be a direct monetisation of the government deficit.

Still, monetisation of deficits, either done directly or indirectly or through any other means, leads to the same outcome, and could be the only choice left.

“Amid sharply lower than budgeted revenue collections and Covid-related expenditures, India’s real combined FY21 fiscal deficit could exceed 14 per cent of our subdued GDP. With savings remaining soft, the RBI will have no choice but to monetise a chunk of this slippage. OMOs, TLTROs, expansion in WMA and perhaps higher surplus transfers could all be routes for this monetisation. This monetisation is already underway,” said Ananth Narayan, associate professor at SP Jain Institute of Management and Research.

The government plans to borrow Rs 12 trillion from the market to bridge its deficits amid a Covid-19-led slowdown. According to sources, the government has told the RBI to do whatever it takes to keep yields under check so that the borrowing can be done cheaply. The markets expected an official OMO call by the RBI, but it has not done so yet. That is because OMOs also cause excess liquidity. OMOs also help the RBI shore up the quantity of bonds in its books to allow absorption of excess liquidity from the banking system.

Conducting an OMO purchase when the liquidity surplus is above Rs 7.5-8 trillion could create a signal extraction problem and hit the central bank's credibility, and it's better to buy directly in the secondary or primary market for the avoidance of unwarranted announcement effects, said Niyogi, adding the unusual central bank actions would continue for some more time, “given the bleak outlook on global trade, and could intensify with escalation of global trade politics”.