The Reserve Bank of India (RBI) reduced its US government assets by USD 21 billion in March, despite the tacit purchase of a large number of bonds on the secondary market.

The data released by the U.S. Treasury Department shows that India held $156.5 billion in U.S. treasury bills in March, up from $177.5 billion in February. As of March 2019, India had US Treasury assets worth $152 billion.

US Treasury assets generally rise and fall in line with the country’s foreign exchange reserves. At the end of March 2020, India’s gold and foreign exchange reserves stood at USD 474.66 billion in February, or around USD 481.54 billion. As of March 2019, reserves amounted to approximately $412 billion. Since the beginning of the calendar year, foreign investors have withdrawn $18.24 billion from the equity and debt markets. Most of the outflow, $15.7 billion, took place in March.

Saudi Arabia, Brazil and India were among the three countries that invested in the US in March.

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In total, foreign countries sold $299.35 billion in U.S. government bonds, a record amount compared to $4.88 billion in the previous month.

The purchase of domestic bonds is also necessary to help RBI maintain the size of its balance sheet, as domestic bonds compensate US Treasury bills to maintain its active balance sheet. It has the added advantage: These bond purchases keep domestic yields low.

Most central banks use foreign exchange reserves to cope with sudden balance of payments fluctuations while buying domestic bonds to maintain the country’s liquidity, said Soumyajit Niyogi, deputy director of India Ratings and Research.

In an environment of capital outflows and a tightening of the government’s lending programme, the central bank tacitly buys a large number of bonds. Since March, the central bank, as an anonymous participant, has repurchased domestic bonds for Rs. 1.63 trillion on the secondary market. But the bonds will not be auctioned, which would mean a direct monetization of the government’s budget deficit.

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However, direct or indirect realisation of deficits or otherwise leads to the same result and may be the only remaining option.

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In a context of Covida’s revenues and expenditures well below budgeted levels, India’s actual cumulated budget deficit for the FY21 could exceed 14% of our modest GDP. Since the savings are still low, RBI has no choice but to cash part of this note. Expansion of the OMO, TLTRO, WMA and possibly larger excess transfers can all be a means of monetization. This monetization is already underway, says Anant Narayan, Associate Professor at the SP Jain Institute for Management and Research.

The Government intends to borrow Rs 12 trillion on the market to cover its deficit in the context of slowing growth at the level of Kovida 19. According to some sources, the government has asked RBI to do its utmost to keep revenue under control so that it can borrow cheaply. Markets have been waiting for a formal OMO call from RBI, but have not yet done so. This is due to the fact that MEAs also generate surplus liquidity. OLOs also help RBIs to increase the number of bonds on their books so that they can absorb excess liquidity from the banking system.

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Buying OMOs when excess liquidity exceeds Rs 7.5-8 trillion could create a signal problem and undermine central bank confidence. It is preferable to buy directly on the secondary or primary market to avoid the unwarranted effects of the announcement, Niyogi said, adding that given the gloomy outlook for world trade, the unusual actions of the central bank will continue for some time and may become even more pronounced as world trade policy intensifies.