The phenomenon has been a worldwide one, with the US Federal Reserve leading the way by unleashing a massive round of quantitative easing -$120 billion worth of asset purchases a month (now to be tapered by $15 billion per month).
India, too, launched its own version of QE in April –the ‘Government Securities Acquisition Programme’, under which, in a rare move, the central bank gave upfront commitments to bond purchases in its quest for an orderly evolution of the sovereign yield curve.
Former RBI Deputy Governor Viral Acharya believes that as central bank balance sheets keep moving to a “new normal” and facilitate larger and larger liquidity infusions, it would be much harder to “actually take the liquidity back out of the system”.
“Look at the world over. Which central bank has found it easy to unwind from its quantitative easing?” Acharya said in an exclusive interview with ETMarkets.com.
“I think in the case of India my experience as the deputy governor was that one has to pay attention to two or three sources of vulnerability in the debt markets,” he said.
At the outset, he referred to the tendency of entities in the non-bank financial sector to shorten duration of bonds as interest rate increases become imminent.
Whichever way one looks at it, the recent phase of global ultra-loose monetary policies is coming to an end. Monetary authorities the world over have signalled that higher interest rates are in the offing, including the Federal Reserve and the Bank of England.
While the RBI has reiterated its commitment to revive India’s economic growth on a sustained basis, the Indian central bank has also taken steps to rein in a massive surplus of liquidity in the banking system and speculation is rife that the next step could be a hike in the reverse repo rate, which currently dictates the cost of funds for money markets.
“Because they (NBFCs) do not want to lock in a higher but steadier rate, they want to take the risk of a short rate which is lower because of the rising term structure,” Acharya said.
“And then what that creates is a rollover risk for these non-bank financial companies. So I would especially lookout for liquid debt mutual funds… whether they are funding short-term debt for non-bank finance companies,” he said.
The second issue raised by Acharya was a recent rise in floating rate fixed income instruments, which according to him is just another variant of wanting to take on a lower interest rate borrowing cost in the short run at the risk of facing a higher interest rate down the line.
The third red flag is the fact that in India, it is public sector banks which among lenders; historically own the largest chunk of government bonds, Acharya, said.
With credit growth not keeping pace with growth in deposits, a correction in interest rates could likely have a bearing on the ability of PSU banks to keep on purchasing government paper, the former central banker said.
In January, 2018, when Acharya was the Deputy Governor in charge of monetary policy, he had criticised banks’ management of interest rate risk and the tendency to depend on the central bank to provide dispensation if situations turned adverse.
“Historically that has always led to some forbearance but you know, you cannot just hide economic losses away forever,” he said to ETMarkets.com.
“So think there are multiple points of stress and froth in the fixed income markets. If I were a central bank I would do serious stress tests right now to see how an interest rate hike would play out in banks, in non-banks and in stock market corrections for large companies which have been the beneficiaries of high inflation and low interest rates,” he said.
According to him, if the risks seem to be of too great a magnitude, central banks should adopt smoother rate hike trajectories rather than back-loading policy tightening and then being compelled to do too much all of a sudden.