New Delhi: The Narendra Modi government announced last week that it will borrow Rs 8.45 lakh crore from the market, in this case banks and financial institutions, in the first half of 2022-23 (till September) by issuing bonds.
This amount is 59 per cent of the total gross borrowing target they had announced during the presentation of the Union Budget for the current financial year starting 1 April.
The borrowing for April-September period is slightly higher from what the market participants (essentially the investors of government bonds) were expecting. These bonds will be auctioned on a weekly basis starting 4 April, just as is the practice every financial year.
But what is so different about the overall borrowing scenario this time, and how can it impact the consumer demand for home and auto loans? There is high inflation.
As inflation erodes the purchasing power of money, bond investors typically seek returns that are over and above the rate of inflation. This means that the country’s biggest borrower — the Government of India — will also have to cough up higher rates on its bond offerings when inflation rises.
Since sovereign bonds are considered risk-free, the cost of borrowing for every other entity — be it corporates, or home loan borrowers — is over and above the rate on government bonds. In the current scenario, when the government will borrow at steep costs, every borrower in the country will feel the pinch.
The retail inflation or inflation based on the Consumer Price Index (CPI) surged to an eight-month high of 6.07 per cent in February, primarily on account of the rise in fuel prices.
This is the second month in which the retail inflation has been above the inflation target band of 2-6 per cent as prescribed by the Reserve Bank of India (RBI).
Various estimates suggest that the inflation will further rise in the coming months once the increase in fuel prices is fed into the CPI, and will be in the range of 5.5-6 per cent.
“Elevated commodity prices, especially crude oil, are likely to exacerbate the impact of large market borrowings of the government on bond yields,” a report by rating agency ICRA said.
Why does a government borrow?
In a given financial year, the government earns a certain income through various means.
The majority of its income comes from taxes — direct and indirect. At the same time, the government also makes regular spending on various central schemes to spur growth. It also spends a high amount on providing subsidies — food, petroleum, and fertiliser — keeping the prices of products and services low for people to be able to afford them, and also to encourage production and consumption.
The difference between what a government earns and what it spends is known as the fiscal deficit, where the latter is higher than the former.
To fund this gap, the government uses three routes — market borrowing, receipts in the National Small Savings Fund, and loans from multilateral institutions like the World Bank and Asian Development Bank.
In the last three years, market borrowings have usually accounted for 50-60 per cent of the fiscal deficit, which is pegged at 6.4 per cent of the GDP for 2022-23.
Large market borrowing by Centre
Over the last 10 years, there has been a substantial increase in the borrowings of the central government through bonds, almost three times.
In 2011, the government borrowed Rs 5.09 lakh crore from the market to fund its deficit, as compared to Rs 8.45 lakh crore that it plans to borrow only in the first half of the current fiscal. The total gross borrowing for 2022-23 is estimated at Rs 14.31 lakh crore.
The government’s market borrowing stood at Rs 7.1 lakh crore in 2019-20. In the 10 years ending in 2019-20, the government increased its borrowings only by Rs 2 lakh crore or 40 per cent.
However, with the ravaging impact of the Covid-19 pandemic on the government’s revenues, the Centre’s borrowings shot up to Rs 12.6 lakh crore in 2020-21.
Within three years, the government’s gross borrowing has doubled in size, while the balance sheets of banks, which buy the bulk of these bonds, have expanded by around 33 per cent.
It was expected that as the economy revives and achieves pre-pandemic levels, the government would be able to bring down its fiscal deficit and, thus, its borrowings. But with the increase in interest payments from past years’ borrowings, the overall burden of debt servicing has become heavier.
Impact on cost of capital
Since the start of the pandemic, the Monetary Policy Committee (MPC) of the RBI has followed an ultra-loose monetary policy, keeping the repurchase rate — or the rate at which banks borrow from the RBI — at 4 per cent, the lowest level in two decades.
This is despite record high levels of retail inflation.
Simultaneously, the central bank has maintained surplus liquidity in the banking system so that the government’s weekly borrowings do not face any pressure.
But with market forces in play and the expectation that the United States Federal Reserve will continue to press forward with aggressive tightening, which means increasing the interest rates, the RBI may have to finally change its accommodative stance and reverse the loose-rate cycle.
Juxtaposing the above with a large market borrowing may result in higher borrowing cost for the government, and thereby on companies and individuals.
Another factor is that, in the last two years, a significant chunk of the government’s large borrowing programme was absorbed by the RBI.
The central bank bought bonds worth Rs 3 lakh crore under open market operations in 2020-21, and another Rs 2.2 lakh crore worth of bonds under its government securities acquisition programme in 2021-22, keeping the cost of borrowing in check.
This year, however, the RBI will not be able to buy as many bonds as the monetary policy will change its course and the central bank would in fact be raising interest rates, departing from monetary accommodation.
The yield on the 10-year government bond, which represents return to an investor from the bond’s interest payment, is currently at 6.84 per cent.
Companies and banks usually track this yield in deciding interest rates on various loans they offer to the consumers. When bond yields fall, it results in lower borrowing costs for corporations and the government, leading to increased spending.
Market experts estimate the 10-year bond yield to range between 7 and 7.4 per cent in the first half of the current financial year.
With the increase in yields and RBI hiking rates, the banks may pass on the increase in rates to the consumers, denting the demand for loans.
(Edited by Sunanda Ranjan)