Govt’s borrowing programme: Adopting a new approach: Financial Express 27th March 2018

The announcement of the borrowing programme for the first half of the year was an important signal for the market, considering that the liquidity is tight at present with greater dependence on the repo auctions (term).

The borrowing programme of the government for the first half of FY19 is quite unique. After a long time, the first half of the year will witness less than 50% of the targeted amount of Rs 6.05 lakh crore being issued. The market was expecting the ratio to be maintained at 60% or slightly lower, given the prevailing liquidity conditions. The latest announcement will assuage the market to an extent, but it has several implications, which could become serious during the second half of the year. First, the government expects liquidity conditions to remain tight for the next six months. Otherwise, there would have been a natural tendency to borrow more during this period. Normally, during the first half of the year, there is less demand for credit, and deposits increase at a higher rate, leading to excess liquidity that can be mopped up by the government through G-Sec issuances. This is not expected, as per the implication of the announced programme. Second, the government would be issuing more of floating rate or CPI indexed bonds, to the extent of 10% of the Rs 2.88 lakh crore being borrowed. This is, again, indicative of the acceptance that inflation would tend to be higher, which will get reflected in the bond yields too that, in turn, will be the cost for the government. Both these concepts are interesting and should find favour among the players.

Third, the press release also talks of the new benchmark securities being introduced. This is a good sign for the development of the G-Sec yield curve. At present, there is more liquidity in the five- and 10-year tenures, while the others remain fairly illiquid. By getting in more benchmarks, especially at the lower spectrum of two and five years, there could be generation of liquidity that, in turn, will help even the yield curve. This is quite desperately required in the market to set standards. Fourth, the development of a smooth yield curve is also pertinent in the context of the government’s and RBI’s attempt to develop the corporate bond market. For the development of a corporate bond market, we need to have an active secondary market, which depends on having available rates or prices for various maturity of securities. This will normally be benchmarked against the G-Sec yield, and while such spreads exist for the 10-year paper to an extent, the same is not visible for other bonds. Focusing on such period of maturities will also help develop prices for corporate bonds that are a prerequisite for the evolution of the same.

Fifth, the distribution of securities across maturities is also interesting. This time, it is being well spread across various tenures and not concentrated at the far end, which was the tendency in the last few years. This will eschew the threat of bunching up of debt repayments in future, which is the case today. While there was a strong argument for having long-term maturities to prolong the repayment cycle, spreading them across different maturities makes sense as it also reduces the cost of debt that would be locked in the current year, besides avoiding the bunching of repayment. It, however, remains to be seen whether this policy would be pursued in the coming years too, or whether this would be more tuned to the current liquidity conditions.

The announcement of the borrowing programme for the first half of the year was an important signal for the market, considering that the liquidity is tight at present with greater dependence on the repo auctions (term). Deposits are not increasing at the same level rate, while credit growth is relatively swifter. The aftereffects of an upsurge of deposits last year following demonetisation have got reversed in FY18, leading to a very low growth rate as households have taken their money out of banks. Banks, interestingly, already have excess SLR to the extent of 7-8%, which means that there are high MTM losses to be booked on March 31. (This was also the case in December 2017 when they had to book losses following the increase in yields). With interest rates expected to increase in the coming months as inflationary expectations look negative, banks may be less willing to invest in G-Secs since they will have to take on a higher loss on portfolio—do they have any other option in the face of rising NPAs? This could be another reason for lowering the quantum of borrowing in the first half.

The problem of liquidity, however, can get accentuated in the second half of the year, and the market could turn volatile if growth in credit picks up sharply, provided the monsoon is good. This is the typical busy season that witnesses increase in demand for credit from agriculture, industry and retail. If the government is going to push through a higher borrowing programme, then there will be liquidity squeeze that will necessitate intervention from RBI through some aggressive open market operations as well as term repo funding to ensure stability. It must be remembered that, for FY19, the government has also buffered in a high flow of small savings, which has been increased from Rs 75,000 crore to Rs 1 lakh crore, according to the announcement. In case there are any shortfalls here, as these flows are exogenous and depend largely on how households behave, the overall market borrowings may have to be increased unless the government resort to higher drawdown of cash balances to manage the deficit.
Also, the overall cost of borrowing could come under pressure during the second half of the year, if liquidity becomes tight. This is something that will be monitored closely by the market.