Tuesday 9 February 2021

Fiscal Deficit and Its Indirect Monetisation by Reserve Bank of India - vrk100 - 09Feb2021

Fiscal Deficit and Its Indirect Monetisation by Reserve Bank of India

Indirect monetisation of fiscal deficit by Reserve Bank of India (RBI) has been heavy since 2008-09, with OMO (open market operations) purchases by RBI peaking at 63 per cent of net market borrowing in 2018-19 (not to speak of scheduled commercial banks' support to Government of India via mandatory SLR or statutory liquidity ratio)--leading to crowding out of the private sector.
 
Rising fiscal deficit has become a thorny issue for India since 2008-09, with OMO purchases supporting Government to an extent of 40 per cent of net market borrowings. In the past 13 years, only in 2014-15 and 2017-18, there were net OMO sales by RBI. The details of RBI's OMO purchases are provided in the table given below (click on it for expanded view):

 

 
 


With open market operations, RBI purchases and sells government securities and treasury bills. It is one of the main instruments of sterilisation used by the RBI. OMO sales entail the permanent absorption of the liquidity. Through OMO purchases, RBI injects liquidity into the banking system. RBI conducts open market operations regularly.

 Open Market Operations (OMO) by RBI are supposed to be two ways. Committee after committee have spoken against outright monetisation of fiscal deficit via OMO purchases--eroding RBI's credibility in discretionary liquidity management.

Practically, Government of India's fiscal deficits are financed by RBI's one-sided OMO buying (see image) & support from commercial banks through mandatory SLR (statutory liquidity ratio). On top of that, banks hold excess SLR securities leading to market distortions. 

With the introduction of FRBM (Fiscal Responsibility and Budget Management) Act in 2004, RBI cannot participate in the primary issuance of government bonds. But RBI is still resorting to government debt financing through outright OMO purchases in the secondary market.

No other major central bank uses OMO (one-sided) as blatantly as RBI in yield curve management, though OMOs are not to be used for that. Bond prices are the building blocks of asset pricing--with such distortions how can market players be sure of pricing of other assets? 

RBI uses OMO to bring down long term yields by resorting to buying of government bonds, which is practically yield curve management, also known as yield curve control (YCC). Lower bond yields help governments in borrowing money from markets at cheaper rates.

With automatic monetisation via large OMO purchases, Reserve Bank of India has been printing money leading to debasement of money (lowering the purchasing power of currency).

In financial markets, government bond (called G-Secs in India for short) yields are the starting point for pricing of other assets. For example, corporate bonds are priced as a spread over G-Sec yields. G-Sec yields are also used for pricing equities and others.

With this indirect monetisation of fiscal deficits, RBI loses its credibility in conducting monetary policy objectively--reflecting poorly on central bank independence.

Side note: In financial market operations,  open market operations are termed as open mouth operations.

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Please check my comments posted below >

Related articles:

Primer on Market Stabilisation Scheme and Liquidity Management 02Dec2016

What is LAF Repo Rate 23Jul2013

Bank Rate and its relevance 23Jul2013

What are cash management bills 15Jun2010

What is Marginal Standing Facility 20Jul2013

References:

My tweet  thread dated 08Feb2021 on the above topic can be accessed at: weblink

Yield curve control (YCC): St Louis Fed blog dated 11Aug2020

Jan2014 Urjit Patel Report on Monetary Policy Framework (MPF)

04Mar2013 Fiscal-Monetary Co-ordination in India : An Assessment

Disclosure:  I've vested interest in Indian stocks. It's safe to assume I've interest in the stocks discussed, if any.

Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets. He blogs at:

https://ramakrishnavadlamudi.blogspot.com/

https://www.scribd.com/vrk100

Twitter @vrk100    

 

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Monday 8 February 2021

Real Estate Investment Trusts (REITs) - My Tweets - vrk100 - 08Feb2021

Real Estate Investment Trusts (REITs) - My Tweets

 

 

(Update 27Sep2021 on REITs is available) 

 

 

India is no stranger to REITs or Real  Estate Investment Trusts. REITs first caught my attention back in June 2006 when I wrote an article on them. The article can be accessed at: REITs - What Are They?
 
Since then, many things have happened though belatedly. India's capital market regulator was slow to introduce them to financial markets. The lethargy can be gauged from the fact that India's first REIT went public only in March 2019, with Embassy Office Parks REIT coming out with an initial public offer (IPO). The REIT's units were listed on BSE (formerly Bombay Stock Exchange) and NSE (National Stock Exchange of India) on 1st of April 2019.

The second REIT in India is Mindspace Business Parks REIT, which was listed on 07Aug2020.

A third REIT will be listed this week. It is Brookfield India Real Estate Trust, whose IPO was closed on 05Feb2021.

The details, as of today, are:

 

As can be seen from the below chart, the interest in the two listed REITs is subdued now even though initially investor interest was high in them. Embassy REIT's issue price was Rs 300 and it closed on first day of its listing (01Apr2019) at Rs 315. On 05Mar2020, it touched all-time-high of Rs 480, but as of now it slipped to Rs 355.

And Mindspace REIT is now quoting at Rs 330, a gain of 20 per cent from its issue in August 2020.  

In comparison, the stock of DLF Ltd is now quoting at Rs 313 with a market cap of Rs 77,600 crore. 

You can read the story of REITs in India through the following tweets: 

1) As more players are likely to join the space, we may see more REITs in public markets going forward. For example, DLF Limited has expressed its interest in launching a REIT. My tweet dated 01Nov2020 (click on the tweet thread for more details):

2) My tweet dated 08Oct2019 commenting on the market fancy for Embassy Office Parks REIT as compared to DLF stock (click on the tweet thread for more details). In Oct2019, DLF's market capitalisation was Rs 35,600 crore and that of Embassy REIT was Rs 33,150 crore. As of now, DLF's market cap is Rs 77,600 crore, a gain of 118 per cent in the past 16 months. 

Whereas, Embassy REIT's market cap is now Rs 33,600 crore, a gain of just one per cent in the same period. It's obvious that the initial euphoria surrounding the REIT's IPO died down, which is natural. In the past 16 months, the pendulum has swung to the other side, with investors turning euphoric about real estate stocks, while showing little interest in the two listed REITs.

Actually, there is a flaw in comparing unit prices of REITs with share prices of real estate companies. Most of the income of REITs comes from dividends paid by the underlying SPVs.

These SPVs receive cash flows mainly through rental income from income-generating properties, either residential or commercial. As per SEBI mandate, REITs have to pay out at least 90 per cent of their net distributable cash flows to unitholders on a half-yearly basis.

Whereas, distributions to shareholders from listed companies comprise of dividends and share buybacks.  And companies are not mandated to compulsorily pay dividends or undertake share buybacks; unlike REITs which have to distribute 90 per cent of their cash flows. 

  

3) My tweet dated 01Nov2020 about Embassy REIT joining S&P Global Property Index (click on the tweet thread for more details):

 

 

4) My tweet dated 19May2019 with details of Embassy REIT's offer document: 

 

5) DLF expressed its intention to float a REIT back in November 2014. Even after six years, the REIT has still been in the pipeline. It is hoped that its REIT may see the light of the day in 2021. My tweet dated 15Nov2014 about DLF's intention:

 

 6) My tweet dated 16Aug2014 about REITs' potential if implemented and regulated properly: 

 

 7) My tweet dated 13Aug2014 about hurdles to REITs:

 

  8) My tweet dated 10Aug2014 about SEBI approving REIT norms:

 

9) My tweet dated 11Jul2014 about tax clarity: 

 

10) My tweet dated 11Jul2014 about diversification benefits of REITs: 

 

 For more on REITs and my tweets, you can check this: weblink

 

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Disclosure:  I've vested interested in Indian stocks. It's safe to assume I've interest in the stocks discussed, if any.

Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets. He blogs at:

https://ramakrishnavadlamudi.blogspot.com/

https://www.scribd.com/vrk100

Twitter @vrk100    
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