A temporary reprieve: Bond market cheer may fade due to underlying problems

On Monday, the Union government released details of its plan for market borrowing in the first half of the coming financial year. In what came as a pleasant surprise for the bond markets, the government said that it was not going to front-load borrowing in 2018-19. In fact, borrowing in the first six months of 2018-19 was planned at just under Rs 2.9 trillion, about 47.6 per cent of the total borrowing budgeted for the year, as opposed to over 60 per cent that is the norm. This is welcome news, at least in the short term. It follows one of the longest spells of rising yields for Indian bonds in recent memory, which have risen over 100 basis points in less than a year to stand perilously close to the 8 per cent mark earlier this month. State-owned banks had begun to avoid bond auctions, and some of them were actually postponed as a result. But as a consequence of this latest news, yields on the benchmark 10-year security dropped by 29 basis points on Tuesday, among the biggest such slides. The buying did not wipe out all of the yield increase, but it took yields on the benchmark security back to where they were in late January.

 
Yet, euphoria should be carefully avoided. After all, it is difficult to see any moderation in yields as being anything other than transitory. Fiddling with the schedule does not change the overall borrowing requirement; the bond markets will still be flooded with government and quasi-sovereign paper. Almost simultaneously with the change in the borrowing schedule, news came that the Union finance ministry had approved a government guarantee for Rs 50 million worth of Indian Railway Financial Corporation bonds in the current financial year. There were also other changes announced, including reduced buyback of government securities, which brings down the gross borrowing figure. Bonds in additional maturities are also likely to be issued in order to better segment demand. But it is unclear if these, cumulatively, will have an effect that is large enough or sustained for long enough to make a difference. Problems piling up in the second half of the financial year could be particularly worrisome, as that is when political pressure to spend in the run-up to the general election will be sharpest. The fiscal situation will also appear adverse at that point, given the front-loading of spending in most years. Together, these may spook the markets.

 
Much depends on choices made by the Reserve Bank of India’s Monetary Policy Committee (MPC) when it meets in early April. The MPC has sounded increasingly hawkish while holding interest rates steady. However, an altered government borrowing schedule may well factor into the MPC’s calculations. While many hope the RBI will be less inclined to raise rates now, hopefully the committee will note that underlying pressures, including calls on the government’s purse, have not changed. For sustainable change, the government must examine either its structural deficit position, by cutting its outgo or by increasing revenue; or it must increase supply, by examining whether, for example, foreign demand for rupee-denominated bonds is being tapped sufficiently.