RBI recently buyback govt. bonds in this mid-election period for various reasons, let’s understand the reasons and the maturity of those bonds and how it’ll impact the banks and liquidity floating in the market.
The above table shows the maturity remaining for different bonds and at how much yield they buyback.
Positive Impacts:
a) Increased liquidity in the banking system: The banking system was at a deficit of ₹1.2T and this money would make banks more confident to lend retail, gold, education, and other loan types as needed. Recently housing loans were on the rise in the Indian wedding season.
Educational loan is the next vertical that’d have more demand for domestic & abroad educational needs.
b) Downward pressure on interest rates: Businesses would get more cash flow through loans and banking schemes to expand business operations with bigger teams. This rise in economies of scale would lower production costs and the same benefit can be passed to consumers.
Negative Impacts:
a) Reduced profitability for banks: Banks often hold government bonds as part of their investment portfolio. If the RBI buys back a significant amount of these bonds, it can reduce the income banks earn from interest payments.
b) Steeper yield curve: The yield curve depicts the relationship between a bond's maturity and its yield. When the RBI buys back short-term bonds at low yields, it can lead to a steeper yield curve. This means the difference in yield between short-term and long-term bonds becomes larger, which can discourage long-term investments.
c) Signaling effect: If the RBI is actively buying back bonds at low yields, it might signal to the market that it expects interest rates to remain low in the near future. This could discourage investors from investing in long-term bonds, potentially impacting economic growth.
RBI has kept the policy repo rate consistent over the period and standard deposit facility rate is what banks expect to increase by more basis points for a smooth credit creation process.
Some more factors to look into:
a) The extent of the buyback: The impact will depend on the amount of bonds the RBI buys back. A large-scale buyback is likely to have a more significant effect than a smaller one.
b) The reason for the buyback: The RBI's motivations for the buyback will also influence the outcome. If it's aimed at managing inflation, the impact might differ from a liquidity-boosting measure.
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