The government on Friday steeply revised its 2020-21 borrowing programme by 53.85 per cent to Rs 12 trillion from Rs 7.8 trillion estimated earlier, indicating that the Centre was giving shape to an imminent and sizeable fiscal package to address the Covid-19-related slowdown. “The above revision in borrowings has been necessitated on account of the Covid-19 pandemic,” the Reserve Bank of India (RBI) said in a statement on its website.
Between May 11 and September 30, the government will borrow Rs 6 trillion from the market. The original plan, as announced on March 31, was that the borrowing in the first half (between April and September) would be Rs 4.88 trillion, of which the government has already borrowed Rs 98,000 crore from the markets.
“This indicates that stimulus measures are probably around the corner. The government has got resources from fuel excise, and now additional borrowing,” said Badrish Kulhalli, head of fixed income at HDFC Life Insurance.
Senior government sources confirmed to Business Standard that the RBI had been given a relatively free hand to keep the yield curve in check through expanded open-market operations (OMOs) in the secondary markets.
“The RBI will have to participate in OMOs in some way and keep the yield curve from jumping up. There will clearly be pressure on yields and the RBI will have to manage it. It will involve expanded OMOs,” said an official involved in the discussions on the increased borrowing. When asked if the increased target also means that the RBI will monetise the deficit by directly purchasing bonds from the government, the official said: “The RBI has so far not been keen on private placements.”
Officials confirmed that the discussions between the finance ministry and the central bank on increasing the borrowing target took place in the past 7-8 days, after the new economic affairs secretary, Tarun Bajaj, took charge. There were extensive deliberations on whether the increase should be announced now or in September, along with the borrowing calendar for October-March.
A second official admitted that the increased borrowing means the 2020-21 fiscal deficit target of 3.5 per cent of gross domestic product (GDP) no longer holds, since borrowing is one of the means of financing the deficit.
A quick calculation shows that, provided all other parameters remain the same, the fiscal deficit will expand to around 5.3 per cent of GDP this year. However, the other assumptions made in the Budget, like a 10 per cent nominal growth in GDP, will clearly not be realised because of the pandemic.
“The fiscal deficit will expand, but we can’t put a number on it, since the situation is quite dynamic,” the second official said. The revised calendar showed that there would be Rs 1.2 trillion of borrowing every month. Clearly, this is way more than the market’s appetite. All kind of dated securities maturing in two years and above will be used, including floating rate bonds, official said.
Bond yields nosedived on Friday as the government introduced a new 10-year bond with a cut-off coupon of 5.79 per cent. The old benchmark 10-year bond yield also dipped below 6 per cent for the first time since February 2009, closing at 5.97 per cent, down from its previous close of 6.05 per cent. The bond market was bullish, before the surprise borrowing calendar was announced, expecting further rate cuts and not a very large package, according to Harihar Krishnamurthy, head of treasury at FirstRand Bank.
Clearly, the government aims to borrow cheap, but the yields will shoot up, unless the RBI comes up with deep rate cuts, or declares heavy secondary market bond purchases, say experts. With the borrowing calendar in place, chances of private placement with the RBI have more or less been nixed. “We need considerable support from the RBI, else its rate cuts will become redundant. Amid a credit crisis, borrowers would face more challenges, while investors would be more focused on intertemporal choices,” said Soumyajit Niyogi, associate director at India Ratings and Research.
According to Soumya Kanti Ghosh, group chief economic advisor of State Bank of India, the central bank must now conduct reverse repo and term reverse repo operations without any collateral.
Such non-availability of securities in liquidity operations will boost the demand for government securities, and if a Standing Deposit Facility is introduced — under which the RBI would absorb liquidity at a lower rate than reverse repo and without any collateral — the entire interest rate structure could be pulled down.
“In particular, lower operative overnight rate, short-term rate and lower supply and generation of additional demand will bring down the yield of long-dated government bonds also, thereby pulling down the sovereign yield curve. This will also reduce the interest cost of RBI,” Ghosh said.
Ghosh added that this additional borrowing could result in a spike in g-sec yields, but ultimately empirical research in the Indian context suggests that term structure of interest rates are a function of real economic activity and, hence, it could decline.