RBI Develops Green Bonds Amid Market Demand

The Reserve Bank of India (RBI) has recently engaged in the partial devolution of sovereign green bonds worth Rs 3,945 crore. This move is part of a broader strategy to sell these bonds at a premium, known as “greenium.” The auction attracted interest, reflecting the growing demand for sustainable investment options. Concurrently, the RBI conducted a dollar/rupee buy-sell swap auction, which saw overwhelming participation, indicating robust market liquidity concerns.

About Green Bonds

• Green bonds are fixed-income securities designed to fund projects with positive environmental impacts.
• Investors are increasingly willing to pay a premium for these bonds, known as “greenium,” due to their sustainability benefits.
• The RBI’s recent auction aimed to tap into this trend, although it accepted only Rs 1,054 crore out of the Rs 5,000 crore it had notified.
• This indicates a selective but growing interest in environmentally focused investments.

Market Dynamics and Liquidity Measures

The RBI’s auction of $5 billion in dollar/rupee swaps attracted five times the bids, totalling $25 billion. This high demand puts stress on liquidity pressures in the banking system, which was reported to be in a deficit of Rs 2.2 trillion. The RBI’s actions are aimed at injecting durable liquidity into the market, helping to stabilise financial conditions amid fluctuating foreign exchange rates.

Impact on the Indian Rupee

Following the auction, the dollar-rupee one-year forward premium slightly decreased. The Indian rupee experienced depreciation, closing at 86.62 per dollar. This depreciation is attributed to increased demand for dollars from foreign portfolio investors and month-end pressures. Such fluctuations highlight the interconnectedness of global markets and local currency dynamics.

Government Bonds and Fiscal Expectations

The government bond market remains cautious ahead of the upcoming Union Budget for the financial year 2025-26. Analysts expect the Centre to maintain its fiscal consolidation strategy, with minimal changes anticipated in debt-related taxation policies. The benchmark bond yield has remained stable at 6.69 per cent, reflecting market sentiment and expectations.

Foreign Exchange Reserves Trends

India’s foreign exchange reserves saw a notable increase of $5.57 billion, ending an eight-week decline. This rise was primarily due to an increase in foreign currency assets and gold reserves. The total reserves now stand at $629.56 billion. Such fluctuations in reserves are critical indicators of economic health and investor confidence.

Questions for UPSC:

1. Critically examine the significance of green bonds in promoting sustainable finance.
2. Discuss the impact of liquidity measures by central banks on the overall economy.
3. Explain the relationship between foreign exchange reserves and a country’s economic stability.
4. With suitable examples, discuss the role of fiscal policy in managing inflation and economic growth.

Answer Hints:

1. Critically examine the significance of green bonds in promoting sustainable finance.

1. Green bonds fund projects with positive environmental impacts, encouraging sustainability.
2. They attract investors willing to pay a premium, known as “greenium,” enhancing capital for green initiatives.
3. Green bonds contribute to climate change mitigation, aligning investments with environmental goals.
4. They help diversify investment portfolios, appealing to socially responsible investors.
5. Governments and institutions issue green bonds, promoting transparency and accountability in funding.

2. Discuss the impact of liquidity measures by central banks on the overall economy.

1. Liquidity measures stabilize financial markets by providing necessary funds to banks during shortages.
2. They lower interest rates, encouraging borrowing and investment, which stimulates economic growth.
3. Increased liquidity can prevent financial crises by ensuring banks can meet obligations.
4. However, excessive liquidity can lead to inflation and asset bubbles if not managed properly.
5. Central banks use liquidity measures to influence currency values and control inflation rates.

3. Explain the relationship between foreign exchange reserves and a country’s economic stability.

1. High foreign exchange reserves provide a buffer against external shocks and currency volatility.
2. Reserves enhance investor confidence, stabilizing the local currency and attracting foreign investment.
3. They enable countries to meet international payment obligations, reducing default risk.
4. Reserves can be used to intervene in currency markets to stabilize exchange rates.
5. Low reserves may signal economic weakness, leading to increased borrowing costs and reduced growth prospects.

4. With suitable examples, discuss the role of fiscal policy in managing inflation and economic growth.

1. Fiscal policy involves government spending and taxation to influence economic activity and inflation rates.
2. Expansionary fiscal policy, such as increased government spending, can stimulate growth during recessions (e.g., stimulus packages).
3. Conversely, contractionary fiscal policy (e.g., tax increases) can help cool down an overheating economy and curb inflation.
4. Examples include the U.S. stimulus during the COVID-19 pandemic to boost growth and the UK’s austerity measures to control debt.
5. Effective fiscal policy balances growth and inflation, ensuring sustainable economic development over time.