Normally, when there is a discussion on markets and liquidity it is invariably on the surpluses or deficits in the system as well as the conduct of liquidity operations by the RBI. A surplus results in variable rate reverse repo (VRRR) auctions and deficits in variable rate repo (VRR) auction. The idea behind this framework is to keep call rates in a corridor of 6.25-6.75 per cent, where the higher limit is supported by the Marginal Standing Facility (MSF). By doing so excess volatility in the market is eschewed. The weighted average call rate in the market also runs in general through a known corridor.

Recently, the RBI carried out the second buyback of securities worth ₹25,000 crore. The first was on October 10 and the second on October 17. This is distinct from the conventional open market operations calendar of the past where banks would anticipate the liquidity situation in advance and manage their funds accordingly. The announcement of the second buyback does send a signal that there could be more to follow. The securities which are being bought back are of the same tenor for both the auctions. What is one to make of such buybacks?

The first is that since these securities mature in 2025 or 2026, it does appear that the RBI would like to lower the quantum of short term outstanding loans of the government. This fits in with the general ethos of the government/RBI pitching for debt with longer maturities to avoid too much of bunching up of redemption in the short run.

The second is that since the overall borrowing of the government has not changed from what was targeted in the Budget, this is not a case of doing a ‘buy and sell’ transaction to manage the yield curve, as was the case with ‘operation twist’. It is unequivocally a case of lowering the debt level of the government, as it involves just buybacks of securities by the RBI. Under ‘operation twist’, securities were bought and sold by the RBI of the same quantum which did not change the quantum of debt but altered the maturity pattern of debt.

Third, this buyback appears to follow from the fact that the government has substantial cash balances which work out to almost upwards of ₹2 lakh crore on a daily basis. This is a result of a policy of ‘just in time’ when money is spent only when needed; hence the large tax collections lie with the RBI for extended periods of time until the expenses are incurred. A good way to use these balances is to lower the quantum of overall debt.

Fourth, such buybacks help in balancing the interest costs of the government. Some of these securities have a coupon rate of 7.59-8.20 per cent. Hence lowering this quantum of debt due to excess cash available with the government helps to moderate interest payments.

Fifth, while overall liquidity in the system is in surplus, there are challenges faced by banks which have been raising higher cost deposits in the form of CDs and bulk deposits to meet credit requirements. With the higher liquidity norms proposed by the RBI (LCR levels), the buyback of securities will provide support to the banking system.

Further buyback likely

Sixth, given that the outstanding debt on these five securities is above ₹4 lakh crore, there can be further buybacks conducted by the RBI to both provide liquidity as well as to repay debt in advance. In the absence of such buybacks this entire amount would have to be redeemed in FY26 which would affect the net borrowings of the government. Therefore, this should be good news for the market as gross borrowings pressure would also come down. This would enable lowering of the fiscal deficit ratio for FY26. In fact, even for FY25 it is expected that the deficit will be lower than the targeted 4.9 per cent of GDP.

Seventh, the buyback also helps in lowering yields on government paper in the market. By withdrawing these bonds, the supply of paper goes down which pushes up the price and hence lowers yields. Therefore, ideally the 1-year yield should move downwards as these buybacks take place. This can hence be achieved without changing the repo rate which becomes more a benchmark for banks for setting deposits and lending rates.

It is argued that while both open market operations as well as buybacks do the same thing — buying back paper of the government — the motivation is different. In the case of the former the aim is to inject liquidity while in the latter it is also to cool down bond yields.

Hence, buyback has become a very potent tool from the point of the view of the RBI to achieve multiple objectives. However, while buybacks do enhance liquidity, interest rates in the call market have still been driven more by what the RBI does when conducting its liquidity management policy.

The VRRR auction cut-offs which tend to converge just below the repo rate at 6.49 per cent tend to be the benchmark for all transactions. But the call market and T-Bill have moved southwards.

The writer is Chief Economist, Bank of Baroda. Views are personal

While buybacks do enhance liquidity, interest rates in the call market have still been driven more by what the RBI does when conducting its liquidity management policy