The fiscal situation is unlikely to improve even this year. A higher fiscal deficit number, coupled with the government’s more-than-expected net market borrowing figures for 2012-13 of Rs 4.79 lakh crore in 2012-13, disappointed the bond market, which reacted negatively to the news. Bond yields rose sharply following the announcement.
Yields on the 10-year benchmark government bond, which fell when trading started, rose nine basis point (bps) immediately after the figures were out. Market participants expect yields to touch 8.5 – 8.6 per cent in March. Yields on the 10-year benchmark bond closed at 8.42 per cent on Friday, compared to 8.36 per cent of previous close.
Slippages on the fiscal situation have dampened hope for a rate cut the market was expecting in April.
The government has announced a fiscal deficit of 5.9 per cent of gross domestic product (GDP) for 2011-12,compared to an estimate of 4.6 per cent made in the previous year’s Budget.
For 2012-13, the fiscal deficit is pegged at 5.1 per cent. More than 90 per cent of the deficit will be funded by market borrowing. “This would impact government bond yields negatively and the 10-year yield would move up to 8.40 to 8.50 by March end. We think the Reserve Bank of India (RBI) will have to conduct open market operations (OMOs) next year to support the government’s borrowing programme,” said Pawan Bajaj, general manager (treasury operations), Bank of India.
In its mid quarter monetary policy review announced on Thursday, the RBI had said credible fiscal consolidation will be an important factor in shaping the inflation outlook. Concerns on inflation due to high prices and fiscal gap had made the central bank to hold policy rates in the last three reviews. RBI had increased key policy rate or repo rate 13 times between March 2010 and October 2012 before pressing the pause button in the December policy review.
The market, which was expecting a reversal of the policy rates from April, now says chances are the process will be delayed. RBI will meet on April 17 for the annual policy review.
“The borrowing target is higher than expectations. Overall, there could be 50-75 bps rate cuts in the next financial year against 100 bps expected earlier. The bond markets have factored that in. With the liquidity deficit high again, we expect one or two more OMOs by the end of this financial year,” said T S Srinivasan, general manager-treasury, Indian Overseas Bank.
Despite a 125 bps reduction in the cash reserve ratio since January, the liquidity deficit in the system is more than double than RBI’s comfort level which is +/- 1 per cent of banks’ net demand and time liabilities or Rs 60,000 crore. Today, banks have borrowed Rs 1.77 lakh crore from the repo window of RBI.
Due to rise in yields banks now face the grim possibility of mark-to-market losses on their bond portfolio.
“Markets expected some fiscal consolidation, which did not happen. Yields will trade above 8.5 per cent and higher yields means higher mark-to-market provisions for banks. The probability of rate cut in April has reduced now,” said T S Srinivasan, general manager (treasury), Indian Overseas Bank.
Mark-to-market provisioning for banks could be higher, if the yields rise beyond 8.56 per cent levels that were seen towards December-quarter end, bankers said.
The pressure on inflation will also come from a weakening rupee as the country imports more than 80 per cent of its crude oil requirements.
“The current account deficit as a proportion of GDP for 2011-12 is likely to be 3.6 per cent. This, along with reduced net capital inflows in the second and third quarters, put pressure on the exchange rate,” said Pranab Mukherjee in his Budget speech.
