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Debt monetisation by RBI could undermine investor confidence: S&P

By Abhijit Lele | Mumbai | Last Updated at 

This year, to counter the Covid-19-induced economic pain, the central banks of India and the Philippines have together purchased an additional $24 billion of government bonds

Sovereign bond buying by central banks in emerging markets, including India, is seen as an emergency action related to the Covid 19 pandemic. However, if the central banks including the Reserve Bank of India, progress to debt monetisation, it could undermine investor confidence, warned Standard and Poor's (S&P).

The global rating agency said sovereign-bond purchases by central banks in emerging markets have not spooked the markets because investors accept these operations as emergency actions related to the Covid-19 pandemic.

"Bond-buying programmes may impair the ability of emerging-market central banks to respond to future crises, with rating implications for the respective sovereigns," said S&P Global Ratings credit analyst Andrew Wood.

This year, to counter the Covid-19-induced economic pain, the central banks of India and the Philippines have together purchased an additional $24 billion of government bonds. Bank Indonesia also started its bond purchasing in July.

The policy developments have so far not triggered high inflation or spikes in financing costs in these economies. “We believe this reflects the credibility of the central banks concerned, and investors' patience for aggressive action in the face the pandemic," S&P said.

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However, if investors begin to view government reliance on central bank funding as a long-term, structural feature of the economy, these monetary authorities could lose credibility. In this scenario, the central banks are effectively "monetising" the fiscal deficit by using money creation as a permanent source of government funding. In some cases, this could weaken monetary flexibility and economic stability, which could increase the likelihood of sovereign rating downgrades.

"There are risks to sovereign credit metrics associated with central bank large accumulations of government debt over a long period," said S&P Global Ratings' credit analyst Kim Eng Tan.

Advanced countries typically have deep domestic capital markets, strong public institutions (including independent central banks), low and stable inflation, and transparency and predictability in economic policies. These attributes allow their central banks to maintain large government bond holdings without losing investor confidence, creating fear of higher inflation, or triggering capital outflow.

Conversely, sovereigns with less credible public institutions and less monetary, exchange rate and fiscal flexibility have less capacity to monetise fiscal deficits without running the risk of higher inflation. This may trigger large capital outflows, devaluing the currency and prompting domestic interest rates to rise, as seen in Argentina over the past decade, the rating agency added.