Rate cuts to 'operation twist', RBI governor is pushing policy boundaries

From a 35-basis point interest rate cut to embracing a Federal Reserve-style ‘Operation Twist’, Reserve Bank of India Governor Shaktikanta Das is pushing the boundaries of conventional central bank policy making to improve rate transmission and spur credit to the economy.

The central bank announced Thursday it will buy longer-dated debt and simultaneously sell shorter maturity notes in a concept similar to Operation Twist used by the U.S. Fed in 2011-12. The move is aimed at bringing down the soaring cost of borrowing, or term premia -- the difference between the benchmark 10-year yields and the central bank’s policy rate.

The new tool is part of the broader measures put in place by the RBI to bolster rate transmission after banks failed to fully pass on its 135 basis points of policy easing since February. The central bank has separately prodded banks to peg part of their loan books to external benchmarks such as treasury bills and the repurchase rate, and pumped in billions of dollars to keep liquidity in surplus in the banking system.

The policy easing cycle this year saw Das and his rate-setting panel deliver a rare 35 basis-point cut in August. The governor had then termed the move as neither “excessive” nor “inadequate.”

“Governor Das and his team are evidently open to experimenting with unconventional policy instruments,” said Saugata Bhattacharya, chief economist at Axis Bank Ltd. This is the “optimal approach” given the uncertain response from banks despite an environment of huge surplus liquidity, and yet stubbornly high credit costs.

Earlier this month, the six-member Monetary Policy Committee surprised markets by deciding to hold the repo rate steady at 5.15%, citing high inflation. The MPC, headed by Das, preferred to wait and watch for the previous rate cuts to trickle through before easing further.

“More steps are likely to smoothen the liquidity and credit premia aspects of the lending rates to hasten the pass-through of an easy monetary policy,” Radhika Rao and Eugene Leow, analysts at DBS Bank Ltd. in Singapore, wrote in a note.

Forex Swaps

Das has tried unconventional methods to manage liquidity before.

When the markets faced a cash shortfall in March, the RBI chose to do forex swaps instead of its traditional bond purchases.

It announced two swaps of $5 billion each in March and April, both of which were fully subscribed. By doing this, the RBI managed to tackle two issues: inject rupee liquidity and bring down elevated forward premia rates and reduce hedging costs.

Unlike his predecessor Urjit Patel, Das is known for widespread consultations with market participants.

Some in the market had suggested ‘Operation Twist’ as a way to pass on more of the central bank’s five rate cuts to businesses and individual borrowers. With investment and consumption weak in India, Das hasn’t dithered about measures to spur credit and lift economic growth from a six-year low.

“Unconventional problems require unconventional measures,” said Sandeep Bagla, associate director at Trust Capital Services India. “Generally, central bankers have limited influence on the longer end of the curve, which is determined more by the inflation and fiscal dynamics. But in the short run, the RBI intervention can help to reduce the steepness.”

Not all are convinced about the effectiveness of the move. A central bank experiments with such maneuvers only after extinguishing conventional monetary policy options, according to a note by ICICI Securities Primary Dealership. There could be adverse unintended consequences if the RBI adopts these measures, it said.