Interventions of the World Central Bank in the bond markets leading to a poor assessment of risk: Viral Acharya

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NEW DELHI: A key response by the World Central Bank to tackle the economic fallout from the coronavirus pandemic has been to intervene in bond markets to keep overall borrowing costs low.

The phenomenon has been global, with the US Federal Reserve leading the way in unleashing a massive wave of quantitative easing – $ 120 billion in asset purchases per month (now reduced by $ 15 billion per month).

India also launched its own version of QE in April – the “Government Securities Acquisition Program”, under which, in a rare move, the central bank pledged in advance to buy bonds. 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 move towards a “new normal” and facilitate increasingly large injections of liquidity, it would be much more difficult to ” actually take cash out of the system. ”

“Look at the whole world. Which central bank found it easy to get out of its quantitative easing? Acharya said in an exclusive interview with ETMarkets.com.

“I think in the case of India, my experience as vice-governor was that you had to watch out for 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 the terms of bonds as interest rate increases become imminent.

Regardless of your perspective, the recent phase of ultra-accommodative global monetary policies is coming to an end. Monetary authorities around the world have signaled that higher interest rates are on the horizon, 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, India’s central bank has also taken steps to contain a massive excess 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 to the money markets.

“Because they (NBFC) don’t want to lock in a higher but more stable rate, they want to take the risk of a short rate that is lower due to the growing term structure,” Acharya said.

“And then what this creates is a rollover risk for these non-bank financial companies. So I would be particularly careful with liquid debt mutual funds… if they finance short-term debt for non-bank finance companies, ”he said.

The second issue Acharya raised was a recent rise in variable rate fixed income instruments, which he said is just another variation of wanting to take on a lower interest rate borrowing cost in the short term at the risk of face a higher interest rate on the decline. line.

The third red flag is the fact that in India it is the public sector banks which, among the lenders; Historically owns the bulk of government bonds, Acharya said.

With credit growth not keeping pace with deposit growth, an interest rate correction could likely affect the ability of PSU banks to continue buying government securities, the former central banker said.

In January 2018, when Acharya was deputy governor in charge of monetary policy, he criticized banks’ management of interest rate risk and the tendency to depend on the central bank to provide waivers if the situation was becoming unfavorable.

“Historically, that has always led to some tolerance, but you know, you can’t just hide economic losses forever,” he told ETMarkets.com.

“So, think that there are several points of stress and scum in the fixed income markets. If I were a central bank, I would do some serious stress tests right away to see how an interest rate hike would play out in banks, non-banks, and market corrections for large companies that have benefited from high inflation and a low interest rate, ”he said.

If the risks appear to be too great, he says, central banks should adopt softer rate hike paths rather than delaying policy tightening and then being forced to do too much at once. .


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